409a – a practical administrative perspective this presentation is not intended to be used as a...

409A – A Practical

Administrative Perspective

This presentation is not intended to be used as a legal opinion nor does it represent specific legal or investment advice. Plan Fiduciaries should discuss topics covered in this presentation with an attorney knowledgeable in this specific area of law.

Speaker IntroductionSpeaker Introduction

Blaine Laverick, CEBS, CRPS®, CLU®, ChFC® , CMS• Recipient of the following designations:

Certified Employee Benefit Specialist Chartered Retirement Plan Specialist Chartered Life Underwriter Chartered Financial Consultant Compensation Management Specialist

• More than 23 years experience with qualified and nonqualified plan solutions. Provided solutions to employers ranging from small growing

businesses to Fortune 100 companies Vice President and founding partner of Executive Benefit Services

(now part of Principal Financial Group) The Principal Financial Group currently provides services to over

1,800 nonqualified deferred compensation plans representing over 1,000 employers.

Working Together To Meet Your NeedsHelping Corporations Recruit, Retain, Reward, Retire

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3 Takeaways3 Takeaways

• Modern plan designs are flexible

• Great care is needed in designing NQDC plans

• Financing is important and there are several choices

• And the fourth takeaway…

Key employees highly value this benefit!!

“Excess” 457(b) 457(f)

Defined Benefit

For Profit Not For Profit

457(f) DB

DC

DB

Deferred Compensation Solutions


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Deferred CompensationDeferred CompensationRetirement GapRetirement Gap


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Market trends amongMarket trends amongPlan SponsorsPlan Sponsors

Dept. of Labor Top Hat filings per year

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

-

20,000

40,000

60,000

80,000

100,000

120,000

Number of Plans Number of Participants

Pending and existing regulation hampered

plan growth in 2005 and 2006.


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Market trends amongMarket trends amongPlan SponsorsPlan Sponsors

Nonqualified plan penetration by number of employees

13%10%

32%

40%

61%64%

81% 83% 84%

1-99 100-499 500-999 1,000-2,499

2,500-4,999

5,000-9,999

10,000-24,999

25,000-49,999

50,000+

Based on number of employees, plan prevalence is still low for smaller employers,

especially those under 1,000 employees. There is slight dip in the 100-499 market.

Source: Boston Research Group, Key Findings from 2005 Executive Benefit Study

Survey*

• 95% sponsor NQDC Plans

• 68% finance plan liabilities, 3% considering

• 87% credit mutual funds and/orcompany stock

• 72% credit earnings daily

• 79% use a 3rd party administrator

* Clark Consulting 2007 Annual Executive Benefits Survey of Current Trends

Prevalence of Nonqualified Plans

More than just the”Big Guys”


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NQDC ExpectationsNQDC Expectations

The “Modern” NQDC Plan Design is being driven largely by the qualified plan world

• Daily Valuation

• Internet Access 24/7

• On-line Transactions

• Multiple Investment Options (self directed)

• Bells and Whistles


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Sample Plan Design/Operation Sample Plan Design/Operation

The income tax would be payable in the year the money is actually received by the executive.

Key Employee Base Income $170,000 Bonus $100,000

Key Employee elects to defer 10% of base pay and 50% of bonus

Deferral Amounts:• Base = $17,000• Bonus = $50,000• Total = $67,000

Objectives:• 2 kids need college $$• Planning second home• Build retirement

Annual Deferral Elections Allocation20% College Mary 20% College Michael 20% Beach House 40% Retirement

$26,800$13,400$13,400$13,400

June 2009

April 2011

Jan 2015

NRD

4 Payments 4 Payments 1 Payment 7 Payments10


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Generally required before the end of the preceding tax year

• Requires both time and form of payment

• Evergreen Elections are permitted

Timing of Deferral ElectionsTiming of Deferral Elections

$Bonus$Payment

Dec2007

1/1/08 6/30/08

Performance Based Elections

12/31/08

Q12009


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Practical ApplicationPractical Application

• Nov-Dec enrollment for “regular” deferrals AND Performance Based Compensation

– generally allow changes to PBC if elected prior to June(if on calendar year)

• Deferral Agreements may be creative

– Example: 10% of salary then “ladder” bonus

• If bonus is less than x then defer 0

• If bonus is between x and y then defer 25%

• If bonus is between y and z then defer 50%

• Deferral Elections are “irrevocable”

– Can be suspended

• Unforeseeable Emergency Distributions


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• Transition Rules extended to 12/31/08

• Elections can be different for multiple permissible distributions

• Subsequent Changes are permitted:

– 12 month advance notice

– Payment(s) must be delayed at least 5 years

• Installment payments

– Treated as “single” payment

– Treated as separate payments

Distribution ElectionsDistribution Elections


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Subsequent Changes are permitted:

• 12 month advance notice

• Payment(s) must be delayed at least 5 years

Practical Application

Need To Manage the 5 Year Kick Out

Distribution ElectionsDistribution Elections

09 10 11 12 13 1408

$

07

12 Months Advance

Need Admin. To Track Notice and 5 Year Periods


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409A Separation of Service409A Separation of Service

• No distinction between “quitting” and “retiring”

Administrative Design Issue

Design Solution

Design minimum attained age, length of service, or both to create distinctionNot meet requirements = Lump Sum DistributionDo meet requirements = Distribution Elected Valid

Doctrine of Constructive ReceiptDoctrine of Constructive Receipt

Liability(Deferred Comp Account)

Asset(COLI / Taxable

Investments, Securities)


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Plan Financing Options Plan Financing Options • An “Excess” plan is an unfunded & unsecured contractual obligation

(liability) to pay a future benefit.

• The company finances this liability in one of three ways:• Unfinanced

• Taxable investments (mutual funds)

• Tax Deferred Variable COLI (corporate owned life insurance)

• The best approach depends on the company’s:1. Income tax bracket

2. Cost of money

3. Earnings assumption

4. Realized vs. unrealized distributions

5. Cash flow


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Fortune 1000 Financing Techniques*Fortune 1000 Financing Techniques*

*Clark Consulting 2007 Annual Executive Benefit Survey of Current TrendsTotal % equals 137% - the survey question allowed more than one response

Corporate Owned

Life Insurance (COLI) 72%Taxable

Investments 37%

ER Stock 14%

Other 14%

Plan Financing Options Plan Financing Options Unfinanced ApproachUnfinanced Approach

Advantages

• Simple

• ROE > promise, benefits company

• Provides cash to grow the company

Disadvantages

• Liquidity (increased risk to participant)

• Company liable for benefit regardless of earnings

• “Legacy vs. liability”- Leaving future management the responsibility for cash flow to pay benefit liability


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Plan Financing Options Plan Financing Options Financed with Taxable InvestmentsFinanced with Taxable Investments

Advantages

• Many investment options

• Direct crediting of earnings

• Easy to understand

Disadvantages

• Earnings “taxable” to company

• Highest cash flow to support tax on earnings

• Transaction accounting & recordkeeping

may be difficultWorking Together To Meet Your Needs

Helping Corporations Recruit, Retain, Reward, Retire

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Plan Financing Options Plan Financing Options Financed with Variable COLIFinanced with Variable COLI

Advantages

• Earnings accumulate “tax deferred”

• Tax-free distributions (subject to contract limitations/charges)

• Tax-free life insurance death proceeds

Disadvantages

• Mortality cost of life insurance

• Process of underwriting

• Education


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- Subject to FASB 159. booked as income. - All earnings are tax deferred and

- Subject to FASB Technical Bulleting 85-4.

Death Proceeds to Employer

or Share with

Exec

Loans & Withdrawals

to Pay Benefits

Fundsliquidated

toPay

Benefits

Mutual Funds

Hypothetical Net Investment Yield

7%

COLIHypothetical Net Investment Yield

7%

Deposit PremiumPLAN SPONSOR

SENDS $$$ TO INFORMALLY FINANCE BENEFIT LIABILITIES

8% 8%

Two Popular Financing MethodsTaxable Taxable

SecuritiesSecurities Corporate Corporate

Owned Life Owned Life InsuranceInsurance

Mutual Funds AdvantagesMutual Funds Advantages

• Plan Sponsor paying little tono tax

• Short time horizon

• Uncertain business succession

– Venture Capital


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Four Advantages of COLI FinancingFour Advantages of COLI Financing1. Significantly reduces cash flow as a result of tax

deferral

2. Tax arbitrage between cash flow out for tax paid on deferral and income tax benefit at distribution

• Earnings withdrawn from COLI policy tax free and paid out tax deductible as a deferred compensation expense

• Cost recovery at distribution

3. GAAP accounting advantages

4. Income tax-free death benefit


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Few COLI polices vs. policy per person

• Administrative efficiencies

• Simplicity = CFOs think less is more

• Long-term economic gains / actuarial perspective

Aggregate FinancingAggregate Financing


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Integrating NQDC with Qualified PlansIntegrating NQDC with Qualified Plans• Coordinate Benefits

– Restore benefits reduced by definition of compensation in qualified plan

• Enhance Communication

– Qualified and NQDC values on summary report

– Values via integrated website

– Retirement benefits consolidated for planning purposes

• Plan Administrative Services

– Integrated deferral elections (“wrap” or “pour over” designs)

– Integrated reporting of participant data

• Discounts on administrative fees


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Plan Administrative ServicesPlan Administrative Services

• Liability tracking based on variable indexes

• Asset/Liability balancing daily valued

– Minimize corporate financial risk

– Minimize tax liabilities and cash flow

• Aggregate Financing of Corporate Owned Life Insurance (COLI)

– Few policies vs. policy per person

– Better pricing via full underwriting (less cost to ER)

• Pre and Post AJCA benefit amounts

• 401(k) type experience and then some

Employer Needs


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Future of Nonqualified PlansFuture of Nonqualified Plans

• Looks bright…

• Congressional activity “Pay Go”

– $1 million annual addition cap

– Contribution Only (not likely to include any earnings or average test)

• W-2 reporting for 2008 likely(not just noncompliant $$)

• 2008 Document Compliance likely not extended again


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Future of Nonqualified PlansFuture of Nonqualified Plans

• More and more like 401(k) experience

– ERs looking to retain HCEs

• Product Evolution

– COLI getting more cost effective(2001 CSO tables)

– Mutual Funds (FASB 159)

• Administration

– Online everything…

• Very important – this isn’t a qualified plan

What to do now?What to do now?• Identify plans impacted by legislation

• Inform plan participants

• Evaluate plan administrative services capabilities in light of new legislation

• Document compliance due by 12/31/08

• Review service provider agreements


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This publication is intended to provide accurate and authoritative information in regard to the subject matter covered. The accuracy of the information is not guaranteed and is provided with the understanding that The Principal® is not rendering legal, accounting, or tax advice. While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is not a marketing opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance issued and administrative services provided by Principal Life Insurance Company. Securities offered through Princor® Financial Services Corporation, 800/247-4123, member SIPC. Principal Life and Princor® are members of the Principal Financial Group®, Des Moines, IA 50392. cc-540012008

Disclosure StatementDisclosure Statement

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409a – a practical administrative perspective this presentation is not intended to be used as a...

Documents

corporations recruit

plan prevalence

plan growth

plan fiduciaries

nonqualified plan solutions

modern nqdc plan design

finance plan liabilities

sample plan designoperation