Financial advisors working with highly paid executives need to be aware of new regulations for both qualified and non-qualified deferred compensation plans, 2 types of plans that are the building blocks for retirement income planning, according to experts.
Non-qualified deferred compensation plans are one way that planners can help highly paid executives save more, these experts say.
Advisors need to make these clients aware that there are additional savings tools beyond the qualified plan that should be used, says George Middleton, a financial advisor with Limoges Investment Management PC, Vancouver, Wash.
The non-qualified deferred comp programs are offered mostly by large companies and professional companies such as architectural or medical firms where the owners have control over what retirement plans are established, he says.
The “big mistake” and the “real danger,” according to Middleton, is that an employee will save up to the rate they are allowed under the restrictions and then do nothing beyond that, he says. If they save up to the limits allowed them under non-discrimination rules, then they might assume they are saving enough, when in fact they may not be putting enough away for sufficient retirement income, he continues.
Under current rules, companies must comply with certain requirements in order to avoid having the plans deemed discriminatory against non-highly compensated employees.
For instance, the top 20% of highly paid employees can put in only 1.25 times as much into a qualified plan as a non-highly compensated employee. So, for instance, if the non-highly compensated employees contribute an average of 3%, then the top 20% can only put in 3.75% maximum.
If the above test is not met, a plan will still meet the non-discrimination requirements if the actual deferral percentage for highly compensated employees does not exceed, by more than 2%, that of other eligible employees for the proceeding year and if the actual percentage of highly compensated employees for the current year is not more than twice the deferral percentage for all other employees for the previous year.
An employer sponsoring a plan can, however, choose to contribute 3% of compensation across the board or a 100% match on the first 3% of elected contributions and 50% on the next 2% and satisfy regulatory guidelines.
A qualified plan is considered top heavy if the total account value of key employees exceeds 60% of all employees, says Josh Itzoe, Greenspring Wealth Management, Towson, Md.
But, under the Pension Protection Act of 2006, after December 31, 2007, plans may engage in automatic enrollment for employees in qualified plans, Itzoe adds, and in certain situations, automatic enrollment will exclude a plan from the top heavy rules.
Companies with qualified plans that meet certain requirements receive a safe harbor exemption from the actual deferral percentage and actual contribution percentage requirements, he says.
In addition to the benefit that it brings to employees who will be helped to save, this is an added inducement for companies to add this feature, Itzoe says.
For employees enrolled through automatic enrollment, each employee must be treated as if he or she elected to defer at least 3% in the first year; at least 4% in the second year; at least 5% in year 3; and 6% in any subsequent year, he says.
A higher percentage may be selected, but the selected percentage may not exceed 10%.
These requirements do not apply to employees who are already active participants, Itzoe explains.
There also has to be a match of 100% of the first 1% of pay plus 50% of the next 5% of pay, he continues. Or, according to Itzoe, at least 3% of non-elected contributions have to be provided, and there needs to be vesting of 100% no more than 2 years after an employee is enrolled.
Then a company is deemed to have met the top heavy requirement and the ADP/ACP requirements, Itzoe says.