But while executive benefits are increasingly popular among advisers and their clients, a major issue needs to be considered: compliance with IRS and various other regulations. The compliance landscape has materially changed since the passing and implementation of 409A and subsequent regulations.
Clients will want to thoroughly review and understand compliance issues pertaining to their NQDC plans. They will expect, if not explicitly demand, that advisers and their plan providers will be able to help them do so. High-quality administrative practices are the best way to avoid the potential headaches of non-compliance.
With the advent of 409A, NQDC plans are subject to a unique set of tax, accounting and securities rules. If plan sponsors violate these rules, substantial tax penalties are imposed on participants or their beneficiaries.
For example, improper deferral elections and distribution payments can result in immediate taxation of a participant’s vested benefit, an additional 20% tax, and a “premium interest tax” on vested deferrals dating back to the year compensation was deferred into the plan or became vested. Failure to comply with FICA timing rules may result in payment of unnecessary taxes upon termination of employment. These can sometimes occur as a result of plan document deficiencies, or if the plan is administered in a manner not entirely consistent with the plan document.
In addition to knowing the law, you and your provider should follow several established best practices to help ensure NQDC plan compliance.
1. Clear plan design. It is important to remember that compliance begins with plan design. Documents should be clearly written, defining what types and amounts of compensation are deferrable, how accounts are credited with earnings and how and when accounts are valued and paid. This promotes consistency in administration and compliance, protects the plan sponsor, and makes for simple and consistent participant communications.
2. Allow plenty of time when setting up initial payroll deductions. New plans should have at least 30 days before a first deadline for making deferral elections is established, thus allowing the sponsor time to properly set up payroll without missing deductions or making incorrect ones.
3. Be proactive. Plan advisers should position themselves to help plan sponsors understand when there should be an administration discussion or a specific action taken to avoid 409A or other compliance issues. Some examples might include the following circumstances:
- When special compensation items are paid or awarded, such as annual, spot or sign-on bonuses; restricted stock awards; or LTIP awards and vesting
- As corporate changes occur which may impact non-qualified plans, including mergers, acquisitions and corporate restructurings
- Executives’ experience status changes such as transfers with the control group (including transfers abroad), termination, disability or retirement.
- At the beginning of each fourth quarter, the sponsor should run a compliance check to ensure human resources and provider records match and are up to date.
4. Be aware. The administration of the non-qualified plan may affect your client’s 401(k) program, and vice versa. For example, as part of the set-up process, the sponsor needs to determine which payroll deductions should be made first: 401(k) or non-qualified plan deferrals. This is important: done incorrectly, it could disqualify your client’s 401(k) and result in penalty taxes on non-qualified plan accounts. The answer as to which deduction should be made first can usually be found in the plan documents.
Because there is so much at stake and the issues can be complex, it is best for plan advisers to collaborate with an experienced non-qualified plan provider to maximize the value of these programs for clients. The provider should have expertise in both qualified and non-qualified plans and be able to understand issues from a human resources, financial, and compliance perspective.
Through such an approach, many plan advisers not only expand their business with existing clients—they are able to have a competitive advantage in pursuing new qualified and non-qualified business opportunities.
Sam Brkich is Vice President and Chief Counsel with The Newport Group, a nationwide firm that provides customized retirement and executive benefits plans and investment counseling services.