Another Retention Tool
This may be a good time to expand into nonqualified deferred compensation plans, for employers seeking new ways to recruit and retain key employees in this tight labor market.
NQDC plans can meet a variety of needs. For one, they let highly compensated employees save more money, pre-tax, for retirement beyond 401(k) or 403(b) limits.
The applicable tax rules vary between for-profit companies and nonprofits. For-profit NQDC plans are governed by Section 409A of the tax code and permit both employer and employee contributions. Some employers match worker contributions. Employers may also contribute to NQDC plan accounts for signing or performance bonuses; these may grow, tax-deferred, for five to 10 years or until retirement, depending on the plan.
Nonprofits may offer NQDC plans under Section 457(b) or 457(f). 457(b) plans have a $20,500 contribution limit this year and may include employee deferrals and employer contributions. Employees may also make catch-up contributions, with different rules applying for nongovernmental vs. governmental 457(b) plans.
Nonprofits may provide 457(f) plans, as well. These have no contribution cap but do have vesting requirements. “Because 457(f) plans don’t allow immediate vesting, the employee deferral feature isn’t used,” says Mark West, national vice president of business solutions for Principal Financial Group in Des Moines, Iowa. “The vesting requirement fits better with employer money, as the employer’s objective is typically employee retention.”
An option for nonprofits is to offer both types of 457 plans. “457(b) and 457(f) fit nicely together—the 457(b) for the employee money and the 457(f) for employer money,” says West.
“The usual place to start is with a 457(b) plan because it empowers employees to take responsibility for their own retirement. Then the 457(f) is how employers can enhance the employee’s retirement as they achieve the organization’s goals.”
Interest in NQDCs is increasing at for-profit companies, too. “Both types of employers have similar needs—to retain and recruit top talent,” West says.
“We’re seeing an overall rise in popularity in nonqualified plans, in terms of attracting talent and with the uncertainty of the tax code,” says John Larson, vice president, benefit solutions for Conduent’s human capital solutions in New York City. “Because of that rise in demand, I think we’ve also seen the qualified plan advisers beginning to step more firmly into the nonqualified business.”
Assets in NQDC plans reached $183 billion in 2021, a 130% increase from 2015, according to the 2021 PLANSPONSOR NQDC Market Survey. Advisers are taking notice.
“It used to be that the nonqualified plan was an afterthought and not part of a plan sponsor’s request for proposals,” says Phillip Currie, practice leader, nonqualified plans for OneDigital Investment Advisors in Sandy, Utah.
Currie, who gives presentations on NQDCs to plan advisers, says, “The nonqualified piece is gaining importance and starting to win [us all] new clients through a combined qualified and nonqualified approach.” When he works with a plan adviser, either in or outside OneDigital, he says, the 401(k) and the NQDC may be with separate recordkeepers.
Providing thoughtful insight about nonqualified plans to employer clients is also an opportunity to strengthen these relationships. “From advisers’ perspective, it allows them to talk to their clients about a topic that’s top of mind for them, which is retention. If you can go in with suggestions—and as to key employees, this is one of those types of solutions—that‘s something I’m sure they’ll welcome. And if advisers have an existing 401(k), it helps solidify that.”
When Principal surveyed plan sponsors last year about why they offer NQDC plans, 90% said they wanted to help participants save for retirement above qualified plan limits; 87% said to provide a competitive benefits package for key employees; and 80% said to retain such employees.
An NQDC plan can help higher-paid employees reach their retirement readiness goals, which may otherwise be difficult for some. The IRS allows plan deferrals of $20,500 this year in a defined contribution plan, or $27,000 for participants 50 or older; this means employees making more than around $136,000 may fall short of the recommended 15%.
Employers, having considerable flexibility in NQDCs’ plan design, may set much higher contribution limits for their plans. For example, they may offer a 409A NQDC that lets certain employees make pre-tax contributions of up to 80% of their base salary or 100% of their bonuses and commissions. The money grows, tax-deferred, until retirement. Some plans let workers defer money for less time—e.g., five or 10 years—which could help with children’s college bills or a second-home purchase. The employee decides how much to set aside each year and how long to defer the payouts.
“I’d suggest that every retirement plan adviser have some knowledge of these plans. If they’re good at their job, then retirement completion [can be an achievable] goal for all participants—not just those who can save 15% of their salary in a qualified plan,” says Tony Greene, senior vice president of business development at NFP Executive Benefits LLC in Roswell, Georgia. “If they don’t have this conversation with clients, somebody else will.”
Low-Hanging Fruit
Most of the largest companies already have NQDC plans. “Surveys show that 90% to 95% of the Fortune 1000 companies maintain an NQDC plan,” says Currie. “The large companies are putting in plans primarily for retirement readiness. For small and midsize companies, the main driver is retention—to compete against equity compensation.”
Greene say the small to midsize market offers some good opportunities. There, NQDCs are “very much a recruiting tool, especially as you’re seeing people move from large companies to small and midsize companies. They’ve had these programs, and they’d like to have similar benefits.”
Greene recommends starting by looking for companies with 401(k) plans that fail nondiscrimination testing. “That’s an immediate opportunity,” he says. The NQDC plan does not solve the nondiscrimination testing issues, but it gives the highly compensated employees who are receiving refunds of their contributions another pre-tax way to save. “We can capture those refunds and keep them from being distributed and taxed,” Greene says.
Companies where 10% or more of the employees max out their 401(k)s are also good prospects for NQDC plans, he adds.
Relationship Building
Working with NQDC plans also helps the plan adviser build personal relationships with the company executives using the plan.
“This really moves them up the trusted adviser ladder,” says Greene. “They’re going to move into a world where they’re helping solve problems for the decisionmakers, and that creates a more secure account for them.”
According to Currie, getting wealth advisers involved in the NQDC conversation is the next big development. “The change that occurred three years ago was the qualified adviser embracing nonqualified. The next evolution is that these qualified plan adviser practices are now embracing wealth management,” he says. “We’re doing a lot of joint work with wealth advisers now and having them participate in the education of our deferred compensation plans.”
A wealth adviser may help when an executive needs to make decisions about his deferral and distribution election. She can help him build a retirement cash flow model that considers all of his assets and helps him incorporate the NQDC into his overall financial plan. For example, executives may make larger NQDC deferrals in a year when they want to convert a traditional individual retirement account to a Roth, putting him in a lower tax bracket for the conversion.
Art by Andrea DAqunio