nonqualified deferred compensation – today’s perspective the advisors forum march 17, 2010 for...

Nonqualified Deferred Compensation – Today’s Perspective

The Advisors Forum

March 17, 2010

For advisor and financial professional information only. Not for distribution to the public.

Speaker IntroductionSpeaker Introduction

Michael Stolbach, MBA, JD

Vice President – Executive Benefits Consulting

• Education

– Penn State University, undergraduate degree

– University of Pennsylvania, MBA

– American University, JD

• More than 30 years experience in the legal, nonqualified benefits and insurance community. Serves advisors and plan sponsors as a consultative NQDC

resource – plan design, financing alternatives & sales support. Vice President – Executive Benefits Consulting, for Principal

Financial Group The Principal Financial Group currently provides administrative

services to over 4,500 nonqualified plans representing over 4,100 employers.

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Ideas to rememberIdeas to remember

• 409A provides a great Road Map for designing NQDC plans

• NQDC plans can solve multiple problems

• Keep the plans simple

• NQDC is a valued, mainstream 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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The retirement gap

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Market trends amongMarket trends amongPlan SponsorsPlan Sponsors

Cumulative Dept. of Labor Top Hat filings: 1994 - 2009

05000100001500020000250003000035000400004500050000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009est

Year

# of

DO

L Fi

lings


https://secure02.principal.com/vforms/Detail?fm=ZZ23390-0

Survey*

• 85% sponsor NQDC Plans

• 71% finance plan liabilities, 5% considering

• 91% credit returns of 401(k) investment option, stock index or company stock

• 68% credit earnings daily

• 97% use a 3rd party administrator exclusively or in combination w/inside resources

* 2009 Executive Benefits: Survey of Current Trends, Clark Consulting

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

• Recruit / reward / retain / retire8


Plan Design Considerations

1. Eligibility

• “Select group of management or highly compensated employees”

2. Compensation

• Salary, bonus, LTIP, 1099 income

3. Plan contributions

• Employee and employer contributions

4. Earnings crediting

• Multiple investment choices

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Plan Design Considerations

5. Vesting

• Wide range of choices beyond qualified plans

6. Benefit payment events

• Separation from service, death, disability, unforeseeable emergency, change in control, plan termination and education and in-service withdrawals

7. Benefit payment options

• Lump sum or annual installments

8. Security mechanisms

• Rabbi Trust

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A Popular Provision: In-Service DistributionA Popular Provision: In-Service DistributionSample Plan Design/Operation

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

Key Employee Base Income $150,000 Bonus $50,000

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

Deferral Amounts:• Base = $15,000• Bonus = $25,000• Total = $40,000

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

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

$16,000$8,000$8,000$8,000

June 2012

April 2014

Jan 2015

NRD

4 Payments 4 Payments 1 Payment 7 Payments11


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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

Dec2010

1/1/11 6/30/11

Performance Based Elections

12/31/11

Q12012


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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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• Lump sum & annual installments are popular choices

• 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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409A Separation of Service409A Separation of Service

• Leaving the company means just that

Administrative Design Issue

Plan Sponsor Considerations

• Design minimum attained age, length of service, or both to create distinction

• Not meet requirements = Lump sum distribution

• Do 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*

*2009 Executive Benefits: Survey of Current Trends, Clark Consulting Total % equals 144% - the survey question allowed more than one response

Corporate Owned Life Insurance (COLI)

61%

TaxableInvestments

45%

ER Stock 23%

Other 15%


The Executive Nonqualified "Excess" PlanThe Executive Nonqualified "Excess" PlanSMSM from The Principal – Financing Techniques*from The Principal – Financing Techniques*

COLI 67%

28%

Unfinanced 5%TaxableInvestments

*Based on actual plan data for the Principal Financial Group (The Principal) as of 06/30/2008

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Plan Financing Options Plan Financing Options Unfinanced ApproachUnfinanced Approach

Advantages

• Simple

• Company benefits from ROA greater than growth in participant accounts

• Provides cash to grow the company

Disadvantages

• Liquidity (increased risk to participant)

• Company liable for benefit regardless of earnings

• “Legacy vs. liability”- Future management responsible for cash flow needed to pay benefits

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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

• Policy charges

• Process of underwriting

• Education21


COLI Financing COLI Financing – when it makes sense

1. 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. Income tax-free death benefit

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

Advantages

• Many investment options

• Direct link of earnings on assets to plan liabilities

Disadvantages

• Higher cash flow to pay tax on earnings

• Transaction accounting & recordkeeping may be difficult

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Taxable Investments Taxable Investments – when it makes sense

• Plan Sponsor paying little to no tax

• Uncertain business succession

• Short time horizon

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Few COLI polices vs. policy per person

• Administrative efficiencies

• Simplicity = CFOs think less is more

Aggregate FinancingAggregate Financing – An Attractive Choice

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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

– Consolidated plan information 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 fees26


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 COLI

– Few policies vs. policy per person

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

• Pre-409A and 409A account balances

– Multiple “plans” are often the norm

• 401(k) type experience and then some

Employer Needs

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Future of Nonqualified PlansFuture of Nonqualified Plans

• Looks bright…

• Congressional activity

– $1 million annual addition cap

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

• W-2 reporting still on the horizon

• Document Corrections Notice 2010-6

• Inadvertent Error Corrections Notice 2008-113


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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

– Institutional pricing of COLI and taxable investments

• Administration

– Better do it right

– Communication is important

– Flexibility to handle multiple plans & designs


What to do now?What to do now?

• Identify deferred compensation plans

• Is it a best practices plan design?

• Evaluate plan administrative services capabilities

• Make sure the plan provider is doing it right

• 409A documentation & operation compliant

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Disclaimer Statement

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that The Principal is not rendering legal, accounting, or tax advice. It is not a marketed 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, 800/247-1737, member SIPC. Principal Life and Princor are members of The Principal Financial Group, Des Moines, IA 50392.

No part of this presentation may be reproduced or used in any form or by any means, electronic or mechanical, including photocopying or recording, or by any information storage and retrieval system, without prior written permission from the Principal Financial Group®.

Copyright ©2010 Principal Financial Services, Inc.

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nonqualified deferred compensation – today’s perspective the advisors forum march 17, 2010 for...

Documents

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