Nonqualified Deferred Compensation Plan Essentials What You Need To Know

Transcription

1 Nonqualified Deferred Compensation Plan Essentials What You Need To Know

2 What is a Nonqualified Deferred Compensation Plan? Nonqualified deferred compensation (NQDC) plans are company-sponsored programs that allow participants to delay receiving income on a pre-tax basis. These powerful benefit programs are only available to a select group of management and highly compensated employees, which makes them exempt from most provisions of the Employee Retirement Income Security Act of 1974 (ERISA). Because they offer flexible options for contributions, distributions and tax-deferral, deferred compensation plans are a popular incentive for recruiting and retaining the best talent. NQDC plans compared to 401(k) plans NQDC PLAN 1 401(k) PLAN 2 Deferrals and investment returns defer income taxation until distribution. Participants can choose from a variety of investment options. Deferrals are not subject to statutory limits. Penalty-free scheduled distributions before the age of 59½. Plan balances can be rolled over to an IRA or other qualified plan. Plans are formally funded and protected from the claims of creditors in the event of company bankruptcy. 1. Subject to IRC 409A. 2. Subject to maintaining qualified plan status. Deferrals may be subject to state or local income tax prior to distribution.

3 The Advantages of Deferred Compensation Plans......FOR THE COMPANY Attract the best Recruit, retain and motivate key employees with a benefit program designed to help them plan for retirement and other financial goals. Because deferred compensation plans can offer additional distribution opportunities outside of just retirement, they have been a powerful motivator. Flexible and customized for your needs An NQDC plan can be tailored to meet your company s unique objectives. Because these plans are exempt from most ERISA requirements, you have the freedom to set eligibility to reward your most valued performers. You can also include vesting schedules to strengthen retention, incorporate company stock to closely align participant and shareholder interests, match participant deferrals, or make additional contributions to specific participants. Cost effective With an NQDC plan, your company can provide a valued benefit to select executives without having to increase the compensation participants would otherwise be paid. Manage bottom-line impact Informally funding your plan s growing liabilities can help support the promise to pay future benefits and minimize income statement volatility. You can explore a variety of informal funding strategies to suit your specific situation. When you partner with MullinTBG, you have over 50 years of executive benefits experience working for you. We have developed innovative programs, pioneered new retirement products, and helped many of the world s leading companies strengthen key employee loyalty. As a Prudential Financial company, MullinTBG offers the confidence that comes from working with a solid executive benefits resource. Talk to our experts about implementing a plan that s right for you. For more information visit

4 ...FOR THE EMPLOYEE Defer more pre-tax compensation For the highly compensated, 401(k) plans restrict pre-tax retirement savings to $17,500 in 2014 for most employees ($23,000 for those over age 50). In contrast, NQDC plans may allow participants to defer up to 100% of their compensation. Bridge the retirement savings gap As people live longer and lead more active lives, 401(k) plans and Social Security payments may not provide enough income for the highly compensated to sustain their lifestyle. NQDC plans are a tax-deferred way to fill this retirement savings gap. 1 The Power of Tax-Deferral NQDC plans increase earnings power by only taxing deferred amounts as income at distribution. After-tax investments, on the other hand, are taxed as income and then any gains are taxed as investment returns. As a result, both the amount that can be invested and ultimately, the after-tax earnings, assuming a positive rate of return, are greater in an NQDC plan. 2 NQDC plans enable participants to defer current income taxes on compensation they place in the plan until it is distributed. Choose from flexible payout options Unlike 401(k) plans, NQDC plans allow participants to schedule penalty-free payouts while employed, at termination, or upon retirement, even prior to age 59½. Payouts can also be made in installments, which allows the unpaid balance to continue to grow taxdeferred. Note: Subject to maintaining IRC 409A compliance. Benefit from tax-deferred earnings For after-tax savings to achieve earnings equivalent to a deferred compensation account, the returns would need to be approximately 38% higher. Accomplishing this higher return could require more aggressive investments with greater potential risk. 3 Assumptions: 1 45-year-old who will retire at age 60 and live to age (k) starting balance of $75,000 Salary increases 4% annually; Social Security includes 3% annual cost-of-living increase Ongoing 401(k) deferrals to retirement 1, 2, 3 Pre-tax returns of 7% annually (4.23% after taxes) 2, 3 Ordinary federal income tax rate of 33% 2, 3 Taxes on investment returns assume half taxed at an ordinary federal income tax rate of 33% and half taxed at a capital gains/dividend rate of 20% 2, 3 State income tax is not factored in analysis due to variations among states; if it were, the benefits of deferring compensation would be even higher Note: Any NQDC plan tax-deferred investment is a deemed investment. Reduce current income tax liability

5 Frequently Asked Questions How does the plan work? A participant elects to defer compensation and when they would like to receive that income and any associated earnings. The company is responsible for paying distributions at that time. The company can choose to have either an unfunded plan or an informally funded plan to meet IRS requirements and preserve the taxdeferred status of the plan. Who can participate? Only a select group of management and highly compensated employees are eligible to participate. Because deferred compensation plans are not qualified plans under ERISA, companies must limit the eligibility pool, which enables them to use these plans as a way to recruit or reward specific employees. What can be deferred? Participants can defer as much of their compensation by source as allowed by the company. A plan might allow unlimited bonus deferrals but limit salary deferrals to pay for FICA taxes and other benefits. When can participants receive distributions from the plan? Participants can receive penalty-free scheduled distributions based on the timeframes they establish when they defer compensation. They can receive payment at retirement, separation from service or while they are employed. Note: Subject to maintaining IRC 409A compliance. What investment choices are available? A deferred compensation plan may offer a wide array of investment crediting choices. Participants can select multiple investment allocations for their balances, including different investments for different distribution timeframes. How are deferred compensation plans informally funded? Informal funding means the company sets amounts aside in an effort to help cover the plan s future liabilities. The two most prevalent assets (source 2013 PlanSponsor survey) are corporate-owned life insurance (COLI) and taxable securities. How secure are deferred compensation plans? Due to their unfunded nature, deferred compensation plans pose a greater degree of risk to participants than qualified plans. To help counter this, many companies place assets in a rabbi trust. When properly structured, the trust can ensure that the assets will be used to pay deferral account balances, except in the event of the company s bankruptcy or insolvency, in which case assets would be subject to the claims of the company s creditors. How important is plan design? Your deferred compensation plan should reflect the specific needs and realities of your company. In many instances, off-the-shelf solutions aren t appropriate. Your experienced MullinTBG team can help you develop the plan design and funding strategy most suited to your situation.

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