The Value of NQDC Plans
Art by Virginia Zamora
Considering the growing recognition that one’s income replacement rate is key, what is the answer for the high-income earner, when the most he can defer to his 401(k) plan, pre-tax, is $18,500 a year?
If his employer is not acquainted with nonqualified deferred compensation (NQDC) plans, having one could make all the difference: letting the employee defer, pretax, up to 100% of his earnings, while helping the company retain his talent and the adviser who suggested the plan win or solidify the business.
Advisers have been catching onto the value of these benefits. According to the 2017 PLANSPONSOR DC Survey Benchmarking Report, published this January, 16% of adviser firms predicted that NQDC plans would be their most significant strategy and growth area this year—an increase of 4 percentage points since the 2016 report. And the market looks fairly wide open. As of last August, just 10.2% of plan sponsors offered an NQDC plan.
Moreover, employers that sponsor the plans report liking them. The Prudential/PLANSPONSOR 2017 Executive Benefit Survey found that the plans’ perceived effectiveness is climbing annually. Last year, over 80% of plan sponsor respondents called their plans “effective or extremely effective.”
The reason may be the numbers. John Iezzi, a principal with The Todd Organization, in Richmond, Virginia, cites one client who, earning $250,000 annually between salary and bonuses, decided to save 90%. “[He’s] deferring an incredible amount of money,” Iezzi says, noting that plan balances snowball, sometimes reaching $1 million in three or four years, compared with the 20 or 30 years needed to meet that scale in a 401(k). This participant ultimately deferred $2 million.
Before withdrawals are made, Iezzi says, the adviser should supply good education, to ensure an effective drawdown. By spreading $2 million over five to 10 years, this participant could avoid several hundred thousand dollars in taxes—a not uncommon savings, Iezzi says.
As to that five-to-10-year time frame, most executives today want to accumulate their money, then get out. “They [now] treat deferred compensation as more of an early retirement benefit,” Iezzi says, noting their fear of creditor risk after high-profile bankruptcy cases such as Enron. A plus of the plans is that they need not be saved as a nest egg, however. The saver can defer money for a child’s college or other future expense and take out money while still employed.
Along with employee contributions, employers may add a match. That is typically a recruiting and retention tool, observes Warren May, national vice president, life insurance, at Principal Financial Group in Des Moines, Iowa. Matches are becoming more prevalent since last year’s tax reform, he says.
Advisers stand to gain by adding significant value for clients, as well as through revenue opportunities. Those come in two forms, says Jason Burlie, senior vice president, nonqualified practice leader at Prudential Retirement in Dallas. One is consulting and/or providing investment advisory services, to support the plan, “taking on that fee-based role. The second is, if they act in a broker capacity, they can participate in being a broker on the asset that’s set aside to informally fund the plan,”—i.e., the mutual-fund or company-life-insurance wrapper, he says.
“But the bigger opportunity for them,” he adds, “may be thinking about their strategic plan and how {offering NQDCs] supports their business goal.”
May thinks more advisers should give NQDCs a chance and says the plans are often misunderstood. “It’s not a fat-cat benefit,” he stresses. “We’re dealing with folks making $125,000 and up; it has applications across a broad spectrum of earnings.”