For too long, a dark cloud has covered the landscape of executive benefits. It is a cloud of change and uncertainty, regulations and tax notices, transition deadlines and severe tax penalties. It is one of the offspring of the American Jobs Creation Act of 2004. Has anyone besides me wondered how many jobs the American Jobs Creation Act actually created?
Industry reaction has been mostly “doom and gloom.” Agents have retreated from the executive benefits business, believing that the new rules and regulations are too restrictive. New agents are hesitant to enter the executive benefits business for fear that the rules are too complicated.
But executives still need to accumulate assets for retirement and employers still need tools for recruiting and retaining quality executives. It is time to shine a light and step out from under the shadows. The truth is that now is the time for you to increase your business by serving the executive benefits market.
The “good news”
The good news is that nonqualified executive benefits using deferrals or salary continuation plans are still very much alive. Congress did not eliminate this area of planning for executives. Rather, it provided some much needed guidance and leveled the playing field for agents and clients.
Deferred compensation remains a viable planning technique for today’s executives, and agents now have more certainty regarding what is and isn’t permissible for such arrangements. The real effect of ?409A is to provide certainty in an area of planning that once was a quagmire.
It offers one set of rules for all executive benefits arrangements that fall within the meaning of a “non-qualified deferred compensation plan.” While the rules create new restrictions they also may make it easier for new agents to get into the executive benefits business.
Executive turnover today remains at somewhat lower levels than the workforce in general. However, the cost to replace an executive remains very high. Some estimates of the hard and soft costs of executive turnover are at 100% to 300%, respectively of annual salary. I would submit turnover in the executive suite is at the higher end of this range.
If you factor in the increase in executive salaries, the cost of turnover could be growing and significant. The cost to replace an executive with an annual salary of $250,000 could be between $400,000 and $600,000. Sound high to you? Consider not only the hard costs of a recruiter, signing bonus, relocation expenses, etc., but also the soft costs of vacancy, training, and down time of others. It adds up quickly and all of these are proportionately higher for executives.
Is an employer better off funding an executive benefit retention plan for an executive team or living with the costs of turnover? Looking at the numbers, it is clearly better to share the potential costs of turnover with the executive and give him or her incentives to stay. There is also anecdotal evidence suggesting that less turnover in the executive suite lessens overall turnover, thereby potentially increasing corporate profit.
Why not provide a nonqualified plan funded at $30,000 per year payable at age 65 for that 55-year-old CEO? The employer potentially saves costs and improves results; and the CEO has an incentive to stay. In addition, that CEO can plan for a high priority goal: a funded retirement.
The fact is that executives still need nonqualified benefits to help them prepare for retirement and employers still need ways to help recruit and retain talented executives. None of this need was diminished by ?409A, but with fewer agents engaged in the executive benefits business, the opportunity has grown.
Executives need nonqualified benefits to make up for the limits on contributions to qualified retirement plans. Qualified retirement plans still offer the best savings opportunity for retirement–contributions are not taxed to employees until withdrawn from the plan and employer contributions are tax-deductible. But there is a limit to how much a participant can contribute to a qualified plan ($15,500 annually for 401(k), 403(b), and 457(b) plans). The effect of this limitation is to discriminate against highly paid executives.
A highly paid executive who participates in a 401(k), 403(b) or 457(b) plan fails to receive the same ratio of before-to-after retirement income as the average worker. For example, an employee making $50,000 a year can contribute more than 30% of his or her income to a 401(k)/403(b)/457(b) plan whereas an executive making $200,000 can only contribute 7.75% of income. (See chart.)
Even with the new restrictions added by ?409A, nonqualified plans can be used to help highly paid executives achieve the same ratio of tax-deferred retirement contributions enjoyed by average workers.
Employers also have a growing need for executive benefits arrangements. The Bureau of Labor Statistics estimates there are over 350,000 chief executives and 2.2 million “top executives” in the U.S. According to a 2006 Pricewaterhouse Coopers survey, the number one concern of CEOs is attracting and retaining quality employees.
In a rapidly changing and competitive marketplace, nonqualified plans can be an effective tool for recruiting, retaining and rewarding valuable executives. With flexibility in design and the ability to discriminate in favor of key executives, these plans can be customized to meet the needs of the business and top management. Competitive benefit levels, deferred vesting of substantial benefits, future benefits dependent on meeting current company objectives, and similar incentives encourage top executives to remain with the company.
While the good news is that ?409A still permits the use of deferral and salary continuation arrangements, the better news is that there are additional plan designs available to your clients that are not subject to ?409A.
Clients who desire flexibility or secured funding of benefits may want a Section 162 executive bonus arrangement or Section 79 plan. Other arrangements, including split-dollar loans, may (if properly structured and implemented) also be exempt from ?409A. The smart agent will let ?409A open the door to executive benefits planning, but also offer the client choices that are exempt from ?409A.
The truth is …
The truth is that regulatory/legislative changes have leveled the playing field and opened the door to executive benefits planning. We now have uniform rules for all to follow. With more need and a level playing field, now is the time for you to get into the executive benefits business. Executive Benefits are needed–now more than ever!
Randy Kemnitz, CFP, is a Minneapolis, Minn.-based manager of executive benefits for ING’s life companies. You may e-mail him at