Expanding Savings Options

Art by David Huang

As the industry focuses on retirement readiness and ensuring that participants save enough to replace income, advisers often need to have a conversation with the sponsor about how much its participants should save—and whether, especially for highly compensated employees (HCEs), this is possible. As plan sponsors may realize their plan does not facilitate such savings rates, either because of testing failures or Internal Revenue Service (IRS) savings limits—$18,000 a year, or $24,000 for those 50 and older—they are increasingly considering nonqualified deferred compensation (NQDC) plans for their top employees, says Gary Dorton, vice president of nonqualified solutions and services at Principal Financial Group, in Raleigh, North Carolina.

Such plans allow participants to defer up to 100% of eligible income, although the plan sponsor may elect to place limits on what individuals may defer under their plan, Dorton says. The sponsor decides what types of compensation may be deferred, possibilities including salary, bonuses, incentive payments, etc. The result is that HCEs will have a far greater chance of attaining the retirement lifestyle they aspire to.

Plan sponsors might be unaware of the need for such savings opportunities, Dorton says, but advisers can add value for NQDC plan sponsors by detailing how nonqualified plans can help recruit and retain key people. For instance, some companies employ specialized talent that is difficult to retain or recruit. Adopting a nonqualified plan tailored to unique groups of individuals can help sponsors address this problem—and is a solution advisers can present.

Dan Barry, senior vice president with Lockton Executive Benefits in Charlotte, North Carolina, says there are various ways that advisers can add value for NQDC plan sponsors. First is to provide education and communications for HCEs to point out the value of the plan and teach them financial wellness strategies. “Qualified retirement plans are great for rank-and-file employees but disincentivizing for highly compensated participants because they are limited in the income ratio they can contribute,” Barry says. “Nonqualified plans allow them to make up the difference.”

Although a fraction of the overall defined contribution (DC) market, nonqualified plans are significant in the retirement marketplace overall: Data from the 2015 PLANSPONSOR NQDC/457(f) Buyer’s Guide reveals there are 18,313 nonqualified plans with over 1.3 million participants and over $162 billion in assets.

Barry points out that an NQDC plan is a top-hat plan, so any participant in one must meet the definition of highly compensated employee found in the Employee Retirement Income Security Act (ERISA).

Due to these restrictions, the plans cover only a small percentage of the employees. As Dorton explains, under ERISA, an NQDC plan is maintained by an employer “primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees,” which typically will include no more than 10% to 15% of the total employer work force. This is commonly known as a top-hat group. “The DOL has never issued regulations interpreting the meaning of this select group requirement,” he notes.

Further, Dorton says, NQDC plans are not subject to ERISA, Title 1, Parts 2, 3 and 4, which pertain to plan participation and anti-discrimination rules, vesting, funding and fiduciary requirements. In addition, by filing a simple notification with the Department of Labor (DOL) at plan inception, the employer also is exempt from Part 1, which addresses plan reporting and disclosure requirements, including to file an annual Form 5500. This leaves, in effect, only ERISA Part 5, this part typically being covered in nonqualified plan documents by including ERISA claims procedures.

Besides educating a plan sponsor client about its NQDC plan, an adviser can also add value by performing an annual review of the plan’s underlying investments, Barry says. The adviser can monitor investment options against industry standards. A third way is to consult with the sponsor about the circumstance of the tax effect of the deferred compensation arrangement on the employer, he says. Are assets being held in the most tax-efficient way possible to remove adverse items on the balance sheet?

He explains: “When a company has a nonqualified plan, it is accumulating the liability of what it will have to pay in the future. There are three options to hedge against this: do nothing and make payments from operational cash flow; use a mutual fund portfolio to fund liabilities, which will incur income tax liability during accumulation; or use corporate-owned life insurance [COLI] to reduce that tax effect.” Barry says astute advisers will help model out the implications of each option, so the client can make the best choice.

Getting Into the NQDC Business
According to Dorton, a nonqualified plan is a tool gaining in popularity, but few advisers specialize in these plans. This gives advisers an opportunity to differentiate themselves, he says.

One way an adviser can add nonqualifed plans to his book of business is to suggest the option to existing clients. According to Barry, when a plan sponsor faces various challenges in how benefit arrangements underserve the firm’s executives, an NQDC plan is one of just three possible solutions an adviser can recommend.

For example, if the plan sponsor periodically has testing failures in its qualified plans, and highly compensated employees are receiving refunds or are artificially limiting contributions to avoid refunds, a nonqualified plan can let the executives defer in a pre-tax arrangement in addition to and in excess of the qualified plan.

For plan advisers new to the NQDC plan business, Barry recommends studying the Dodd–Frank Act, the Sarbanes–Oxley Act, the Pension Protection Act (PPA) and 409A rules.

Sam Henson, director of legislative and regulatory affairs in Lockton’s Kansas City office, observes that Dodd–Frank and Sarbanes–Oxley include rules for financial institutions and publicly traded companies that could impact disclosures to both participants in nonqualified plans and investors in the firms. Section 409A—the primary concern for nonqualified plans and reflecting Internal Revenue Service (IRS) regulations that govern nonqualified plans—provides details about the taxation of deferred compensation. The PPA created distribution rules for certain nonqualified plans.

Further, Barry says, the PPA codifies best practices for uses of COLI [corporate-owned life insurance]—a common financing tool in nonqualified plans.

According to Barry, NQDC plan providers can help share this knowledge with their clients, “providing insight into historical trends, information about products and services and how they work, and explaining client case studies that show how all of the pieces fit together.”

Dorton says providers that are committed to the NQDC market typically have dedicated sales support teams to supply advisers with the guidance, training—sometimes via adviser seminars and presentations, but many times individualized meetings and consultations—and resources needed to begin identifying and qualifying NQDC sales opportunities.

If plan advisers are not in the NQDC plan business, there are many different NQDC providers that advisers can partner with, Dorton says. Twenty-seven providers responded to the 2015 PLANSPONSOR NQDC/457(f) Buyer’s Guide.

Additional Components of Executive Benefits
Adviser revenue from an NQDC plan can be similar or dissimilar to that made from qualified plans, Barry says. Advisers may be compensated via a direct fee; they can earn registered investment adviser (RIA) compensation or trails from mutual fund investments; or they can receive commissions from COLI sales.

Many different revenue models exist, so it is hard to say what is typical, Dorton observes. “For some, everything they do is fee-based, and others may charge a consulting fee for what they provide,” he says. “Others just share revenue for products. NQDC plans are priced separately from qualified plans and differently. It depends on the complexity and size of the plan.”

“When we talk about deferred compensation at Lockton, we look at it in a holistic fashion,” Barry says. “Questions become specific to supplemental savings for retirement, but if executives become disabled, they will need more. From a holistic standpoint, advisers need to look at group life and group long-term disability, which are affecting the same group of employees.”

In a Lockton article, “Executive Benefits as a Strategic Advantage,” which Barry co-wrote, the company presents four steps to building a competitive executive benefits plan. Besides to implement an NQDC, the article suggests equalizing group long-term disability and group life insurance payout ratios, offering personal excess liability—or umbrella—coverage and considering “key person” insurance.

Dorton concludes, “We hear the No. 1 reason for providing NQDC plans is to help meet retirement goals. Plan sponsors are concerned about it and focused on it. NQDC plans are becoming a more routine part of retirement and financial wellness programs.” However, these plans are not widely understood. Therefore, “if advisers can say they understand them, they can differentiate themselves.”

KEY TAKEAWAYS

• NQDC plans are a valuable resource for highly compensated employees, who may contribute a maximum of $18,000—$24,000 for those 50 and older—to a qualified plan, whereas they may contribute up to 100% of their compensation to an NQDC.
  
  
• Advisers can help sponsors determine how to fund the liabilities of what they will have to pay out of the NQDC plan in the future.
  
  
• Few advisers are familiar with NQDC plans, but those interested in pursuing this business can turn to providers for education.