In the aftermath of the Sarbanes-Oxley Act, new split-dollar insurance rules, changes to stock-option plan accounting, and 409A legislation limiting nonqualified deferred compensation plans, what executive benefit solutions are still available?
Plenty. You just have to look a bit harder.
Not long ago, the primary rule was that non-qualified plans had to be limited to a select group of executives. But in the last 20 years, creativity in plan design increased as competition grew. Pushing the limits ultimately led to today’s more regulated environment.
But the “good old days” weren’t so good. Now, for the first time, clear rules specify what can be done in the executive benefits marketplace. We’d much rather play between the lines knowing what the rules are. In more than 2 years, we have not had a debate with a tax or ERISA attorney regarding how to interpret a certain plan’s design based on related tax law.
After waiting for new rules, clients who have been sitting on the fence are moving forward, and the demand is greater than ever. So what is the market buying? Buyers want a return to basics, keeping the plan simple and well documented.
Traditional supplemental executive retirement plans continue to be used because they are the most effective approach for pure retention of a key executive. SERPs are always company-provided and subject to creditors for the purpose of enhancing retirement benefits. One trend is the movement away from an offset-driven SERP (which may use qualified plans and Social Security when determining the benefit) towards a net SERP approach, in which the SERP amount or benefit is fixed.
With fewer variables determining the benefit, a SERP becomes easier to understand, appreciate, predict and administer. SERP benefits are also increasingly being tied to performance. Performance-based SERP use is growing greatest with public companies that are concerned with proxy disclosures.
Buyers have historically turned to SERPs to make up for the shortfalls in qualified pension plans caused by governmental caps on recognizable compensation and contribution limits. SERPs are an unfunded liability of the company, and the executive is generally an unsecured creditor.
Traditionally, SERPs have been informally funded with cash, equities or life insurance cash values to ensure that the necessary cash flow is available at time of payout. They have also been combined with life insurance to recover the cost of providing the benefit.
In addition to SERPs, 3 other plans provide retirement or death benefits: (1) non-qualified deferred compensation plans; (2) IRC section 162 executive bonus plans; and (3) split-dollar life insurance plans.
Deferred compensation plans
Deferred compensation has always been a popular benefit, and it will continue to be so. In light of 409A restrictions, companies are reviewing and updating their plans. Like a traditional SERP, deferred compensation is subject to creditors, but it operates more like a 401(k) because it can be funded through executive salary deferrals, as well as company-paid or company-matching contributions. Because the money remains under the control of company creditors, deferred compensation allows an individual to defer on a pre-tax basis in amounts greater than what a qualified 401(k) plan permits.
New 409A regulations deal extensively with how a deferred compensation plan needs to be set up to be in compliance. For example, executives who want to defer $50,000 must do so before they earn it. At the time of deferral, they must also decide when they want the income back and when they will pay taxes on it. For new plans, the initial deferral must be for a minimum of 3 years. Payout dates can never be accelerated. And if executives want to delay the date, they must do so 12 months prior to when the deferred compensation is to be paid; they must defer the compensation for a minimum of 5 more years.