My feature article in this issue on advanced planning techniques for small businesses only fleetingly touches on a key tool for compensating corporate executives: non-qualified deferred compensation plans. That likely won’t surprise advisors who have, in past years, found the market for such plans limited among very small businesses.

Why should that be case? Producers I’ve spoken to have most often cited the higher administration costs and the greater complexity of rules relative to other non-qualified executive compensation plans.

Internal Revenue Code Section 409A, an outgrowth of the American Jobs Creation Act of 2004, imposes restrictions on NQDC plans in respect to the timing of distributions, acceleration of benefits and the timing of deferral elections. Among them: Distributions can only be payable upon the employee’s separation from service, disability or death; a fixed time or schedule specified under the plan; a change in ownership or control of the business; a change in the ownership of a substantial portion of the assets of the business; or the occurrence of an unforeseeable emergency.

Plan participants also have to weigh the prospect of Congressional legislation that would make the plans financially unpalatable; executives will be less willing to defer compensation if, when they begin taking distributions, they’ll subject to higher income tax rates.

Additionally, the recession of 2007-2009 dampened plan adoption among financially strapped firms. Those with cash to spare tended to fund business operational needs and expansion plans at the expense of executive perks.

Despite these issues, NQDC plans remain a primary vehicle for compensating executives among most businesses. That’s the conclusion of a new survey from MullinTBG, a Los Angeles-based Prudential Financial company, which notes that companies are turning to NQDC plans to restore retirement savings eroded during the recent financial crisis.

Why? The short answer is tax benefits. When informally funded with corporate-owned, cash value life insurance, the plans let highly compensated employees defer more pre-tax compensation than they can in 401(k) qualified plans, significantly reducing current-year tax liabilities. Income taxes on investment returns are also deferred until plan benefits are distributed.

Unlike 401(k)s, the non-qualified plans are subject to the employer’s creditors in the event of bankruptcy. Plan participants thus have a vested interest in contributing to their companies’ financial success.

Participation rates in NQDC plans, which had held steady at 50% for several years, slipped slightly overall to 46.3%. But this dip was exclusive to companies that don’t offer matching contributions or informal funding. The percentage is significantly higher (57.6%) among plans that are informally funded and provide a company match. What is more, participation in large firms (those with 250-plus participants) increased to 57% from 44%, nearly offsetting decreases in smaller plans.

While the retirement savings opportunity is the most widely cited rational for offering the plans (80%), employers also favor them for allowing tax-deferred savings limited under 401(k) plans and as a tool for attracting and retaining top managerial talent.

A majority of the respondents reported that they informally fund their plans, though the number was down nearly 7% from a high of 64.6% reported last year. Of particular interest to life insurance professionals is the percentage of plans informally funded with corporate-owned life insurance. More than 4 in 10 (41.3%) of plans use COLI, as compared to a somewhat higher percentage (48.8%) that opt for mutual funds.

Also boding well for this market space is the percentage of executives who opted out of an NQDC plan due to an expected rise in tax rates. This percentage dipped to 26.2% from 39% in 2009–a nearly 13% decline. No doubt the 2010 tax law, which extended by two years the Bush-era tax cuts, reduced executives’ fears on this issue.

Shute cites other factors that have contributed to the continuing high prevalence of NQDC plans among businesses: new technology solutions that have reduced administration and eased regulatory compliance; greater adoption among smaller firms; and an increased desire among firms that historically relied on expensive defined benefit plans to provide executives with a less costly non-qualified alternative.

Among businesses where NQDC participation rates remain low, the key factor holding executives back is a lack of confidence in their companies’ ability to make good on long-term commitments. But that’s a trust issue that only business owners themselves can resolve.