By Cyril Tuohy
On Jan. 1, 2008, rules surrounding nonqualified deferred compensation (NQDC) plans went into effect, but ever since there has been scant information about how plan participants privileged enough to have access to such plans feel about them.
A new analysis attempts to benchmark NQDCs to give plan participants, sponsors and advisors a snapshot of their experience with such plans. The results of that analysis shed new light on NQDCs and the role insurance products play in them.
NQDCs are tax-deferred, employer-sponsored retirement plans that fall outside of Employee Retirement Income Security Act (ERISA) guidelines.
The survey, conducted by The Principal Financial Group, found that the average NQDC plan participant is 54 years old, and that 48 percent of NQDC participants are a senior or executive-level manager.
In addition, the average plan participant belongs to a household where the median income comes to $226,000, and where investable assets are $525,000.
Median NQDC plan balance is $180,000 and the prior year median annual NQDC plan contribution in 2013 was $23,000, an increase from $18,000 in 2009, the survey found.
The survey, titled “2013 Survey of Nonqualified Deferred Compensation: Spotlight on Plan Participants,” found that 44 percent of participating employees contribute $25,000 or more in NQDC plans, an increase of eight percentage points from 2010.
Clearly, these NQDC plan participants are not your average 401(k) employees. Think of NQDC account holders as the corporate equivalent of the 1 percenters. Organizations consider these men and women key to the company: chief executive officers, chief financial officers, executive vice presidents.
Since 2008, NQDCs have gone on to occupy a quiet corner of the retirement plan landscape, well away from the 401(k) disputes about fees and the investment choices that grabbed headlines in the aftermath of the financial crisis.
NQDC plan participants like their plans.
The survey found that 91 percent of respondents said NQDCs were important tools for them to reach retirement goals, 69 percent said they were an important factor in deciding whether to take a new job, and 61 percent said they were an important factor in deciding to stay with a current employer.Three out of five participants reported that their respective employers match contributions to their NQDC plans, and 96 percent of respondents defer enough to receive the maximum employer match, the survey also found.
When it comes to financing NQDC plans, employers typically belong to one of three camps, said John Baergen, vice president of executive benefits consulting with The Principal, though it’s possible that some employers use more than one method at the same time.
Baergen said that one option is not to finance the plan at all. Companies can adopt the pay-as-you-go method in which the plan sponsor leaves the assets generated by deferrals in the corporate checkbook as contributions are made to the plan.
Play assets are deployed throughout the corporation as cash, and distributions are paid from corporate cash when the benefits come due, Baergen said in a video presentation.
Unfinanced plans are often employed by large employers were the size of the plan has little impact on the company’s balance sheet, he said.
A second option is to finance NQDC’s with taxable investments — usually mutual funds — bought by the employer using investment allocations favored by individual plan participants. When benefits are paid, mutual funds are liquidated to make the benefits payments, Baergen said.
Employers with low tax rates, tax-exempt organizations, companies with longer-term net operating loss, corporations with alternative minimum tax positions, or employers with short-term benefit distributions tend to favor this approach, he said.
The third method of financing NQDCs is through corporate-owned life insurance (COLI) policies.
Using this method, contributions made into the plan are paid as premium into the insurance policies with separate accounts.
Those accounts have similar characteristics as mutual funds and are managed to reflect a participant’s investment choices. COLI’s offer tax advantages to finance NQDCs due to tax treatment of life insurance products under the IRS tax code, Baergen said.
Employers with high tax rates are attracted to NQDC financing through the COLI option, Baergen said.
The financial implications for employers can make a big difference when the time come to distribute the benefits from the plan and selecting the most appropriate strategy will vary with the characteristics of the plan sponsor, Baergen said.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at firstname.lastname@example.org.
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