Johnson is being tasked with promoting solutions to retirement system challenges stemming from the millions of employees entering and exiting 401(k) plans each year. Johnson has more than 30 years of experience as a senior executive in the retirement savings and retirement income industries with Federated Investors, MassMutual Financial Group, and most recently, New York Life Insurance Co.
The American Taxpayer Relief Act of 2012, otherwise known as
the “fiscal cliff” tax legislation, had no direct impact on the tax treatment
of nonqualified deferred compensation (NQDC) plans. But the tax implications
for an employer’s highly compensated key employees create big potential for
financial professionals to add value to their clients and prospects.
The key legislative provisions, effective January 1, 2013 (see
box: “Key Provisions of American Taxpayer Relief Act of 2012”), appear to have only
personal tax implications for higher-income individuals, not the companies they
work for. In addition to this legislation, higher-income employees were also
impacted by increased Medicare taxes and taxes on net investment income
(including dividends and capital gains) as a result of provisions of previous
health care legislation.
But as the adage goes, “All business is personal.” The tax
environment created by these changes has implications for
organizations and their key employees. And
that translates to a renewed interest in new and existing nonqualified deferred
compensation plans.
There are five considerations that the new tax legislation
creates for NQDC plan participants:
1. Higher marginal tax rates encourage deferrals into NQDC
plans. By reducing current taxable income, deferrals reduce a participant’s
taxable income at their highest marginal rate. The participant can pay taxes at
a lower rate by taking installment payments after retirement in many
circumstances.
2. Deferrals into a NQDC plan offer the potential to reduce
or eliminate the impact of the tax changes for participants who are close to
certain income thresholds. By deferring income, individuals could fall below
the thresholds triggering additional taxes.
3. Higher marginal income tax rates and higher capital gains
rates make pre-tax deferrals more attractive vs. after-tax investing. Investment
gains in deferred compensation accounts are not currently taxed, and also compound
on a tax-deferred basis. Compare this to the situation for after-tax investing.
Income from interest, dividends and realized capital gains for highly
compensated employees will be taxed at the corresponding increased ordinary
income tax or capital gains rates depending on the nature of the income under
the new legislation.
4. Reduced uncertainty over the future taxation of NQDC plan
distributions. The tax rates made “permanent” in this legislation offer
participants more clarity on receiving future plan distributions. With
effective planning of deferred compensation distributions, key employees can potentially
reduce their tax burden by spreading out distributions at retirement (as
allowed by plan design) and coordinating with qualified plan distributions and
Social Security.
5. NQDC plan deferrals offer more control over taxation
timing. Although some control may be exercised over when realized gains are
triggered, paying taxes inthe current year on dividends, interest and some
capital gains will almost always occur. NQDC plan participants have flexibility
to elect when to receive distributions based on the options outlined in the
plan documents. This flexibility provides greater control over the timing of
whenincome is actually received and taxes paid on it. IRS guidelines for NQDC
plans provide plan participants the flexibility of delaying distributions
beyond the original scheduled timing.
Some disincentives existed to participating in deferred
compensation plans prior to the passage of this legislation. First, tax rates
on high-income earners were at historic lows. Second, taxes on capital gains
and dividends were also quite low (maximum 15% at the federal level). And
finally, due to the “temporary” nature of the soon to expire tax rates,
individuals were somewhat reluctant to defer current income into a very
uncertain and potentially rising tax environment.
(Cont’d…)
According to research with NQDC plan participants in late
summer of 2012(see chart–“Participants Planning to Increase Their NQDC Plan
Contributions…” Source: 2012 Survey of NQDC Plan Sponsors & Participants,
Principal Financial Group), 35% of participants expected to increase their
deferrals in the coming year and 60% planned to maintain the same contribution amount. Nearly 2 out of 3 who planned to increase
contributions identified the expected increase in tax rates as the reason. So, regarding tax legislation, it seems NQDC plan
participants were very accurate in their collective predictive skills.
An uncertain tax environment, coupled with a difficult
economic environment, made nonqualified deferred compensation a tough topic for
advisers to discuss with clients and prospects. Many plan participants clearly
saw value in the benefits provided, and many plan sponsors chose to continue
offering NQDC plans, new sales were tough to come by.
With the economy improving, companies returning to long-term
profitability, and the tax environment for higher income taxpayers settled (at
least for the time being), it’s a good time to approach clients and prospects
regarding the benefits of nonqualified deferred compensation plans.
For employers:
·
The ability to recruit, retain, reward and
retire their most key employees
·
The ability to provide discretionary employer
contributions to retain and reward key employees in a competitive environment
·
The ability to control compensation through
vesting and payment timing
For participants:
·
The ability to save on a tax-deferred basis in
excess of qualified plan limits
·
The ability to better control the timing and
rate of taxation
·
With proper plan design, the ability to design
an individual investment strategy
For you as an adviser, the ability to provide value to your
clients and prospects by offering them your expertise to take advantage of the
benefits of nonqualified deferred compensation.
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
none of the member companies of The Principal are 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. Clients should consult with
appropriate counsel or other advisers on all matters pertaining to legal, tax,
or accounting obligations and requirements.
Insurance
issued and plan administrative services provided by Principal Life Insurance
Company. Securities offered through Princor Financial Services Corporation,
800/247-1737, member SIPC and/or independent broker/dealers. Securities sold by a Princor Registered
Representative are offered through Princor®. Principal Life and
Princor® are members of the Principal Financial Groupâ, Des Moines, IA50392.
