One key to business stability and growth is retaining top talent in an organization. The shock of key employees leaving can reverberate through a company impairing morale while potentially missing key profit target achievement. One way that a company can incent key members to stay for the long haul is to reward them for successful goal achievement and their dedicated service over time with a non-qualified deferred compensation plan (NQDC).
Unlike traditional 401K plans, these types of plans are designed to reward key personnel or teams of employees for achieving company goals over an extended period. The incentive could be in the form of deferred compensation, equity, options, or phantom stock. This incentive ensures employees have a vested interest in the company’s future success and are motivated to stay at the company. These compensation plans help implement an effective strategy for business owners to safeguard their company’s human capital.
Non-qualified plans are employer-sponsored, tax-deferred retirement savings plans that are outside the Employment Retirement Income Security Act (ERISA) purview. They are not subject to the same regulations and testing that apply to qualified plans, offering more flexibility.
Non-qualified plans are typically limited to key executives and select senior employees. They come into play when regular retirement plans are deemed inadequate for high earners. They provide a way for such employees to defer a portion of their salary or other forms of income until a specific date in the future. This allows for the deferral of federal or state income tax on that portion of compensation in the year it is deferred, so it has the potential to grow tax-deferred until it is received. Compensation deferred into the NQDC remains in the employer’s general assets and essentially represents a promise by the company to pay you at a future date.
Key types of nonqualified plans include:
These plans are designed to supplement executives’ retirement income, provide supplemental benefits, offer life insurance arrangements, and facilitate shared ownership of life insurance policies as a tax effective funding mechanism.
Non-qualified plans often have crafted vesting schedules to support employee retention. The vesting helps encourage employees to remain with the company, as benefits are usually tied to the length of service. However, unlike qualified plans, non-qualified plans do not offer features like loans, and the deferred compensation remains under the employer’s general assets.
Business owners commonly utilize nonqualified deferred compensation plans to incentivize and reward key executives. These plans can show favoritism towards vital personnel without breaching non-discrimination rules. However, there are characteristics of these plans you will want to be familiar with to determine if they are the right fit for you.
Funding Nonqualified Plans
Nonqualified plans can be either funded or unfunded, with the latter being more prevalent due to tax benefits and the avoidance of the more cumbersome ERISA requirements.
Tax implications vary with plans. Employers can get tax deductions for contributions to NQDC plans, though funded plans have extra considerations and potential double tax on trust earnings.
Several ways exist to fund plans, including secular trusts, annuities, rabbi trusts, different types of insurance, and third-party guarantees. NQDC plans offer benefits such as flexibility in timing and funding short-term goals.
Potential Risks of Nonqualified Plans
Nonqualified deferred compensation plans offer numerous unique benefits, although they do come with certain considerations. One major point is that company contributions to the plan are not deductible until the employee receives the compensation, which might impact business tax planning.
Further, these plans pose an inherent risk for employees as the deferred payments are not secured or guaranteed. Employees might not receive their anticipated funds if the company goes bankrupt and faces creditors’ claims. However, employers can alleviate some of this risk by creating thoughtful plan designs and using trusts to hold plan assets.
Moreover, employers must pay careful attention to their NQDC plans’ structure, including payment timing and the number of plan recipients. Multiple deferred payments could be made at once, especially with multiple executives. Planning for this potential cash outflow is crucial. On the downside for participants, assets set aside for benefits remain vulnerable to the claims of general creditors. This lack of security might make employees apprehensive about receiving deferred compensation in the future.
Nonqualified deferred compensation plans can significantly help retain and attract top talent. These plans provide a flexible, tax-deferred incentive for key personnel, rewarding them for their dedication and contribution to the company’s success over an extended period. Exploring various nonqualified plans that suit their unique situation is a wise course of action for businesses looking for ways to retain their top executives.
However, these plans have their considerations, including potential tax implications and risks. Please reach out to a SWP advisor to explore the right retention strategies for your unique needs.
Disclosure:
This article contains general information that is not suitable for everyone. The information contained herein should not be constructed as personalized investment advice. Reading or utilizing this information does not create an advisory relationship. An advisory relationship can be established only after the following two events have been completed (1) our thorough review with you of all the relevant facts pertaining to a potential engagement; and (2) the execution of a Client Advisory Agreement. There is no guarantee that the views and opinions expressed in this article will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.
Strategic Wealth Partners (“SWP”) is d/b/a of, and investment advisory services are offered through, Kovitz Investment Group Partners, LLC (“Kovitz), an investment adviser registered with the United States Securities and Exchange Commission (SEC). SEC registration does not constitute an endorsement of Kovitz by the SEC nor does it indicate that Kovitz has attained a particular level of skill or ability. The brochure is limited to the dissemination of general information pertaining to its investment advisory services, views on the market, and investment philosophy. Any subsequent, direct communication by SWP with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Kovitz Investment Group Partners, LLC, please contact SWP or refer to the Investment Advisor Public Disclosure website (http://www.adviserinfo.sec.gov).
For additional information about SWP, including fees and services, send for Kovitz’s disclosure brochure as set forth on Form ADV from Kovitz using the contact information herein. Please read the disclosure brochure carefully before you invest or send money (http://www.stratwealth.com/legal).
