What are the benefits of offering a NQDC plan?
There are benefits to both the company and the employee. The employee has an opportunity to defer compensation beyond what he or she is able to defer in the company 401(k) plan. Nonqualified plans are also less restrictive for participants in other ways. For example, there are no contribution limits and minimum withdrawal requirements at age 70-and-a-half.
For the employer, the obvious benefit is being able to offer a really attractive benefit to executives. And, there’s a lot of flexibility on the employer end, too. For example, the employer can make discretionary contributions to reward select employees.
What are the risks of a NQDC plan?
One of the key requirements for a nonqualified deferred compensation plan is that there must be a substantial risk of forfeiture for the participant. If this requirement is not met, the IRS will deem the benefit to be ‘funded’ and immediately taxable to the participant. The two primary risks to the participant are that the deferrals are subject to the claims of creditors of the company and if there is a change of control at the company, the new owner may choose not to honor the nonqualified plan agreements.
How are NQDC plans financed?
There are three basic options. The first is to simply pay benefits out of future cash flow. Of course, that’s the riskiest option — it requires the company to have sufficient profits or earnings to pay future benefits. If a company wants to informally finance their plan, money can be set aside to pay future benefits. The prevailing methods used to informally finance plans are taxable investments, such as mutual funds and tax-favored investments like Corporate Owned Life Insurance (COLI).
What should an employer do to get started?
Companies considering implementing a nonqualified deferred compensation plan should first enlist the help of experienced professionals. An experienced executive benefit consultant, along with the company’s accountant or attorney, can walk you through all of the details and decisions that must be made. There are a lot of moving parts initially — but once the plan is up and running, the administration is really quite simple.
A well designed and thought out plan, will take into consideration the following items: plan financing, plan implementation and communication. This process usually takes between nine and 12 months. These plans tend to be in place for a long time. It’s important to do it right the first time.
Mark J. Dorman is the president of Dorman Farrell LLC. Dorman has more than 20 years of experience in the financial services industry and assists public and private Northeast Ohio employers with their executive benefits and retirement asset management needs. He also works with business owners on business succession strategies. Reach him at (330) 725-0501 or [email protected]. Dorman is a Registered Representative of and offers securities, investment advisory and fee-based financial planning services through MML Investors Services, Inc. Member SIPC. Supervisory Office: 1660 West 2nd Street, Suite 850, Cleveland, Ohio 44113-1454. Phone: (216) 621-5680. CRN201206-135767
