Primary Uses of Deferred Compensation
Blaine Laverick,
CEBS, CLU, ChFC, CRPS, CMS Managing RVP
NONQUALIFIED DEFERRED COMPENSATION (NQDC)
Updated April 2016
For Registered Representative Information Only. Not for Use with the General Public.
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For Registered Representative Information Only. Not for Use with the General Public. 2
• Restore contribution limits HCEs face in qualified plan testing and employer contributions
• Employee deferrals and employer contributions
• Performance based contributions and vesting
• Defined contribution and defined benefit
• The 4th “R” - Not just Recruit, Retain & Reward, it’s also “Retire”…
• Not just the “C” suite anymore, expanded eligibility
Use of NQ Solutions
For Registered Representative Information Only. Not for Use with the General Public.
Growth in NQ Top Hat Plans Cumulative Plans Adopted Since 1995
source: U.S. Dept. of Labor
# of Plans
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For Registered Representative Information Only. Not for Use with the General Public.
NQDC Market: Plan Prevalence
Employer Size by # of Employees
The percent of plans generally increases
with company size Source: Profit Sharing/401(k) Council of America & Boston Research Group,
An Analysis of the Non-Qualified Plan Sponsor Industry, March 2012. Note small base of responses for companies with 50,000+ employees.
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For Registered Representative Information Only. Not for Use with the General Public.
• Nonqualified defined contribution plan
• Not subject to qualified plan restrictions due to contribution or compensation limits, or to coverage and discrimination testing
• An “unfunded” contractual agreement between a Plan Sponsor and a Plan Participant to pay compensation at a future date
• A plan not subject to the fiduciary and reporting requirements of ERISA
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What is an “Excess” Plan?
For Registered Representative Information Only. Not for Use with the General Public.
NQ Plan Financing A Deferred Compensation Plan is an unfunded and unsecured contractual
obligation (liability) to pay a future benefit, subject to general creditors
Liability (Deferred Comp Account)
Asset (Life Insurance / mutual funds,
or unfinanced)
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Financially stable – Established, Profitable, Good cash flow
• C corporations – Owners and employees
• S corporations, LLCs – Only for key employees (non-shareholders)
• Not-for-Profit organizations
Not appropriate for governmental employers and certain other tax exempt entities.
* Contributions to the plan are subject to FICA when benefits vest. Deferrals may not be treated as
deferred for state income tax purposes in all states. Distributions are taxable to participants upon receipt.
Client company characteristics
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Flexibility
• Can pick and choose plan participants
• Plan design – Offer participants a plan that feels similar to complementary qualified plans
• Control vesting schedules
• Plan may provide tax free key person protection for the company
• Clear legal and regulatory environment (IRC 409(a))
• Employer receives a tax deduction when the benefit is paid
* Contributions to the plan are subject to FICA when benefits vest. Deferrals may not be treated as
deferred for state income tax purposes in all states. Distributions are taxable to participants upon receipt.
Benefits for the employer
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• Options for financing plans - unfinanced, taxable, or tax deferred – Effect of financing option on current and future deductions
• Administration and reporting requirements – Principal provides comprehensive administrative services
– Generally fee based, depending on financing solution
Issues to consider for the employer
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“Highly Compensated” – generally $115,000 or more of total compensation
Key management position(s) that have the
ability to “influence plan design”
No more than 10% of employees eligible compared to the entire employee group
Eligibility – general “Top Hat” guidelines
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• Plan participant makes an election to defer compensation on a pre-tax basis. The income is deferred prior to it being earned.*
• Potential earnings accumulate tax deferred.
• No contribution limitations. The plan participant can defer up to 100% of his/her compensation.
• No IRS age 59 ½ early withdrawal penalties
• No minimum withdrawals at age 70 ½
• High quality participant information similar to a 401(k) program
• The ability to design an individualized investment strategy
* Contributions to the plan are subject to FICA when benefits vest. Deferrals may not be treated as
deferred for state income tax purposes in all states. Distributions are taxable to participants upon receipt.
Benefits for the plan participant
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• Contractual obligation vs. fiduciary liability
• Assets are owned by the company and are subject to company’s creditors in the event of bankruptcy
• Election to defer income only once per year in advance of earning income
• No loan provisions
• No rollover provisions into an IRA, a qualified plan or a nonqualified plan
• Nonqualified deferrals may reduce wages for qualified plan contributions
Issues to consider for the plan participant
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For Registered Representative Information Only. Not for Use with the General Public.
401(k) Restoration & Retirement Savings
Taxation Timing
Compensation Management
PRIMARY USES OF NONQUALIFIED DEFERRED COMPENSATION
PRIMARY USES OF DEFERRED COMPENSATION 13
For Registered Representative Information Only. Not for Use with the General Public.
401(k) Restoration & Retirement Savings
PRIMARY USES:
PRIMARY USES OF NONQUALIFIED DEFERRED COMPENSATION
For Registered Representative Information Only. Not for Use with the General Public.
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For Registered Representative Information Only. Not for Use with the General Public.
More than 8 in 10 participants say NQDC plans are important in reaching their retirement goals.
2014 Trends in Nonqualified Deferred Compensation Among Plan Sponsors and
Participants, the Principal Financial Group.
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For Registered Representative Information Only. Not for Use with the General Public.
401(k) Restoration & Retirement Savings
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For Registered Representative Information Only. Not for Use with the General Public.
Employer contributions can “restore” benefits that are
limited under a qualified retirement plan
• Allows eligible key employees to defer into
an NQDC plan
• Any amount restricted by qualified plan
non-discrimination testing
• Up to the maximum qualified plan amount
• Company contributions follow deferrals
401(k) restoration
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For Registered Representative Information Only. Not for Use with the General Public.
Retirement Savings Going beyond 401(k) restoration
Addressing the retirement gap higher earners face
• Deferral limits can be raised, or more commonly, eliminated
• May or may not include company matching amounts and/or
discretionary profit share contributions
• Employer has the ability to choose which key employees
to reward and how much.
▪ Plan design may allow ability to create tiers of the
Top Hat Group with different deferral limits,
employer contributions and vesting schedules
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For Registered Representative Information Only. Not for Use with the General Public.
Taxation Timing PRIMARY USES:
PRIMARY USES OF NONQUALIFIED DEFERRED COMPENSATION
For Registered Representative Information Only. Not for Use with the General Public.
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For Registered Representative Information Only. Not for Use with the General Public.
NQDC offers participants considerable flexibility and
control over distributions to meet their objectives but
also provides the distribution flexibility to control when
they take receipt of the money
Taxation Timing
Of those participants planning to increase their annual contribution,
67% identified
‘helping manage their current income tax‘ as a factor in the decision
• Eligible key employees may use NQDC plans to
choose when they take distributions
including the option to take installments.
They can also delay distributions beyond the
originally scheduled timing.
* 2014 Trends in Nonqualified Deferred Compensation Among Plan Sponsors and Participants, the Principal Financial Group.
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For Registered Representative Information Only. Not for Use with the General Public.
• Participants have the ability to coordinate their NQDC distributions
with distributions from Social Security or other pre-tax retirement
plans such as a 401(k) plan.
▪ Often participants will fund their retirement with NQDC
distributions first, then receive qualified plan distributions later.
• Participants can defer distributions while they’re working and their
marginal tax rates are potentially high and then take the distribution
during retirement when their effective tax rate may be lower.
• Income tax payable in the year money is actually received by the
key employee.
Taxation Timing - continued
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Key Employee Base Income $120,000 Bonus $40,000
• elects to defer 10% of base pay & 50% of bonus Deferral Amounts:
• Base = $12,000
• Bonus = $20,000
• Total = $32,000
Objectives:
• 2 Kids need College $$
• Planning Second Home
• Secure Retirement Annual Deferral Elections Allocation
20% College Mary 20% College Michael 20% Beach House 30% Retirement
$9,600 $6,400 $6,400 $6,400
July
2019
July
2020
July
2024 Retire
4 Payments 4 Payments 1 Payments 10 Payments
Taxation Timing - continued
10% Retirement
$3,200
Retire
1 Payments Conservative
Portfolio
Moderate
Portfolio
Moderate
Portfolio
Aggressive
Portfolio
Aggressive
Portfolio 22
For Registered Representative Information Only. Not for Use with the General Public.
NQDC provides the ability to reduce current taxes by deferring compensation and paying
taxes when distributions are received.
• Marginal Tax Rate: The percentage of tax paid on the next dollar of incremental
taxable income.
o For NQDC this tax rate would typically apply to any current deferrals into the
plan, as each dollar of deferral is coming off the top of the participant’s total
taxable income.
• Effective Tax Rate: The tax paid in total divided by total taxable income on the NQDC
distribution. This takes into account all tax brackets affecting the distributions to the
taxpayer.
o These tax brackets would typically apply to distributions from NQDC plans in
the early years of retirement, when many participants use NQDC distributions as
a primary source of retirement income.
Taxation Timing Marginal vs. Effective Tax Rates
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For Registered Representative Information Only. Not for Use with the General Public. For Registered Representative Information Only. Not for Use with the General Public. 24
For Registered Representative Information Only. Not for Use with the General Public.
Compensation Management
PRIMARY USES:
PRIMARY USES OF NONQUALIFIED DEFERRED COMPENSATION
For Registered Representative Information Only. Not for Use with the General Public.
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For Registered Representative Information Only. Not for Use with the General Public.
NQDC plans can provide employers with a program to help
recruit, retain, reward and/or provide incentives for the
people on whom the success of your business depends.
• Use performance-based contribution and
performance-based vesting to influence the
behavior you want from key performers
• Customize contribution and vesting schedules
to use as performance rewards for key employees
Compensation Management
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For Registered Representative Information Only. Not for Use with the General Public.
Use discretionary employer contributions based on the
particular needs of your organization
Compensation Management
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For Registered Representative Information Only. Not for Use with the General Public.
2020 2016 2017 2018 2019 2021
ER Contribution
2016 Vested 2017 Vested 2018 Vested
Laddering Employer Contributions
“Roll Forward Vesting”
ER Contribution
ER Contribution
Example shows 3 year cliff rolling vesting
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For Registered Representative Information Only. Not for Use with the General Public.
Key benefits of NQDC
However the plan sponsor chooses to design your plan, some key
benefits are universal. An NQDC plan:
Allows participants the opportunity to defer compensation in excess of qualified
retirement plan limits on a pre-tax basis (up to 100 percent deferral depending
on plan design)
Can allow organizations to make discretionary contributions to retain and
motivate key employees — including incentive-based contributions.
Restores contributions/benefits limited by IRS restrictions in retirement plans
Can give participants more flexibility in tax planning with flexible distribution
options
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For Registered Representative Information Only. Not for Use with the General Public.
Key benefits of NQDC - continued
Offers flexible distribution options including ability to take
prior to age 59½
Allows participants to design an individualized investment
strategy
Is not subject to contribution and participation limits
Has simplified government reporting and disclosure
rules, or none at all, depending on plan design
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For Registered Representative Information Only. Not for Use with the General Public.
• Are key employees concerned about saving enough for
retirement on a tax-advantaged basis?
• Do their retirement plans restrict their ability to discriminate
in favor of their most profitable employees?
• Are their compensation plans motivating the behavior they
want from their top executives?
• Are they concerned about turn-over of key people?
How can a plan sponsor evaluate if a new nonqualified plan is right for their business?
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For Registered Representative Information Only. Not for Use with the General Public.
Look for:
• Plans that are three or more years old
• Sponsors who are dissatisfied with current plan’s
performance
Your key to success:
• Identify the pain points and provide solutions
Opportunities to help with existing nonqualified plans
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For Registered Representative Information Only. Not for Use with the General Public.
Look closer at their plan. Key areas to evaluate:
• Plan design
• Plan financing options
• Unfinanced
• Taxable investments
• Variable corporate-owned life insurance (COLI)
• Plan administrative services
• Employee/employer service
Opportunities to help with existing nonqualified plans
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For Registered Representative Information Only. Not for Use with the General Public.
Action steps
Ask questions
Set up conference calls
Schedule client meetings
Schedule client seminars
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For Registered Representative Information Only. Not for Use with the General Public.
Required to sell training prior to presenting a solution
• Primary Uses of Deferred Compensation (this presentation)
Recognize advisor roles and responsibilities
Account Profile Form
Signed client disclosure
• Involvement of client’s own tax/legal consultants to provide advice for plan
establishment
• Selection of top-hat group to meet ERISA exemption
• Selection of financing option
─ Unfinanced, taxable investments, or variable corporate-owned life insurance
(COLI)
Requirements
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For Registered Representative Information Only. Not for Use with the General Public.
Learn More
Principal Non-Qualified Deferred Compensation Team
Sales support
Financing – COLI/mutual funds
Map on AdvisorCompass
DBS
Principal SERP Select
Retail life insurance products
AdvisorCompass® site
Required to sell training (this course)
Compliance policy
Contacts
Principal
1.800.654.4278
DBS - Diversified Brokerage Services
1.800.869.1328
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For Registered Representative Information Only. Not for Use with the General Public.
PRIMARY USES OF DEFERRED COMPENSATION
The subject matter in this communication is provided with the understanding that The Principal® is not rendering legal,
accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax,
or accounting obligations and requirements.
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®, Des Moines, IA 50392.
Copyright © 2016 Principal Financial Services, Inc.
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