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Planning Opportunities For Highly Paid Executives

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In the area of benefits for highly paid executives, many financial advisors are finding that non-qualified deferred compensation plans hold particular promise and pay handsome rewards. But agents new to this market face a number of different challenges, experts say, beginning with learning the basics.

Non-qualified deferred compensation plans can be very complicated and difficult to explain to a prospect. While agents can gain the expertise they need to get started in this market through industry courses, professional associations and study groups, many experts agree that the most effective way to learn the concept is being mentored by a specialist.

One of the initial obstacles agents face is learning all the terminology, says Andrew Shapiro, national manager for the Nationwide corporate incentive program, Nationwide Financial, Columbus, Ohio. His first recommendation to agents is to read “Comprehensive Deferred Compensation,” published by The National Underwriter Company.

“Then theyll know the terminology and the questions to ask,” Shapiro says.

Once an agent has a grasp of the fundamental concept behind non-qualified deferred compensation plans, working with another agent on cases will help him understand the entire sales process.

“Im a believer in joint work. I think for someone whos not familiar with any particular concept, if you can get an expert to work with you by giving up a percentage of the case, thats relatively cheap tuition,” says Thomas Monti, vice president of distribution services for MassMutual, Hartford, Conn.

“Buddy up with somebody whos experienced in the marketplace,” adds Terrence Kral of Kral, Goodenough and Kral, Inverness, Ill. “It wont take long to get up to speed.”

Some agents are successful building alliances with these specialists and referring prospects for some type of shared commission or fee, says John Oliver, vice president, strategic marketing services for Transamerica, Los Angeles, Calif. “If an agent can educate himself to identify prospects and then form an alliance with an expert, thats a pretty powerful relationship.”

Generally speaking, a deferred compensation plan allows the executive an opportunity to avoid immediate taxation on income earned today. That income is deferred until some future time, usually around retirement age.

A company implementing a supplemental deferred compensation plan makes a promise to pay a highly paid key executive an additional retirement benefit at some point in the future. “The promise is an unsecured promise,” explains Kral.

Larger companies usually have assets that can be repositioned to fund this future liability, but smaller companies will typically fund this executive benefit on an annual basis, making periodic deposits into different investment vehicles. Since this is a non-qualified plan, there are no ERISA requirements; the employer is free to choose whichever executives it wishes to participate, and there are no funding requirements of the employer.

This future benefit to the executive acts as a “golden handcuff,” keeping him or her tied to the company until a future point in time, which can vary by plan design. “The design of the plan can be whatever the employer wants,” continues Kral. “You can design the plan so theres no benefit whatsoever until the person reaches age 65.”

The money set aside to fund this future liability to the company generally is considered an asset of the company. In the event the company needs to access these dollars, it usually can. This may be tempting for small- to mid-sized business owners who fall on difficult economic times.

There are, however, a number of ways to design a plan to prevent the employer from invading these assets. Some plans can be designed with “financial triggers,” which will pay out the deferred compensation benefit to the executive if the company reaches a certain financial point, explains James Connell Jr., director of Connell Associates, Camillus, NY.

“Typically there would be a specified trigger that would create a payout prior to it getting so bad that the company couldnt meet the obligation,” he says.

Another protective measure is the use of a Rabbi trust to hold the assets set aside by the employer. Holding assets in a Rabbi trust does not protect the assets from the creditors of the company, but “a properly drafted Rabbi trust can prevent the business owner from accessing the monies for anything other than the deferred compensation payments,” says Shapiro.

Furthermore, a Rabbi trust can protect the executive from the loss of benefits due to changes in management or a sale of the company, adds Kral.

But the business owner may not like the restrictions imposed by these methods and may want to have access to the funds for emergency purposes. “Its always a balancing act,” says Shapiro. On one side youve got the business owner saying it would be nice to get to that money if its needed, he explains, and on the other side, youve got the executive saying he doesnt want the company to be able to touch that money.

Another situation that sometimes arises is that companies fail to fund the liability sufficiently from the onset of the plan. “They put in a plan but didnt fund it at adequate levels,” explains Oliver.

“Many times their expectations were unrealistic as to what was going to be contributed,” he says. “Or, maybe they didnt follow through on making sure the plan was funded.”

Today, some agents are seeing plans that require additional funding, mostly due to the poor performance of the equity markets. “Were underfunded on a lot of these plans,” says Kral.

It is very important to manage these plans on an annual basis and make adjustments accordingly, he says.

“You have to make sure there is sufficient funding. Or, youve got to account for the fact that youve got a liability on the books that you havent funded for a few years–youre in the hole and youre going to have to dig out,” says Kral.

The type of protection put into place largely depends on the type of deferred compensation plan implemented, according to Connell. In a supplemental deferred compensation plan, the employer is providing an additional retirement benefit for an executive. The employer typically funds this benefit. In this situation, the employer will usually want to have access to those assets.

In an employee-funded plan, often referred to as a salary reduction plan, the executive actually defers income until retirement, or at some future time. In this case, “most employees are not going to defer their own dollars into the plan if theres no promise or protection if things change,” Connell says.

“Sometimes well find that executives dont even want to participate unless theres a Rabbi trust,” Shapiro adds.

Reproduced from National Underwriter Edition, June 23, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.