Retirement Income Planning You Can Take With You
by John BaergenMr. Baergen is vice president executive benefits consulting for the Principal Financial Group, Des Moines, IA 50392. He can be reached at Baergen.John@principal.com
“Anthony Kirby: …A man can’t give up his business.
Grandpa Vanderhof: Why not? You’ve got all the money you need. You can’t take it with you.”
— From the play, You Can’t Take It With You
Playwrights George S. Kaufman and Moss Hart joked about the idea in their 1937 play. The dialogue – part of the exchange between a successful businessman and an eccentric family patriarch – highlights a dilemma long faced by many affluent clients. Tempering a current high income with saving for future life interests and goals, like retirement.
Today highly compensated employees (HCEs) have few options available to save money for retirement on a tax-advantaged basis. Worries over future events can compound this – college education costs continuing to rise in excess of inflation, volatile equity markets, employees having to work beyond their retirement dates and uncertainty over the impact of taxes and health care costs.
The most efficient way of reaching this market is by focusing on employers, with nonqualified deferred compensation plans (NQDC). While these employee benefits are a staple at larger organizations, market potential exists at midsize and even smaller employers less experienced with these plans. Employers with existing NQDC plans also offer potential opportunities through plan design updates that provide increased flexibility and customization.
Why HCEs need retirement-saving help
The idea that HCEs – well compensated for their work contributions – face retirement challenges seems puzzling. Most people are familiar with the design benefits of a 401(k) plan – defer pre-tax compensation, have it grow tax deferred and then pay tax at distribution. But the deferral limit set by the Internal Revenue Service can significantly affect the percentage of replacement income in retirement as an individual’s compensation grows. The following chart represents this impact as a “retirement gap” at higher individual income levels.
A nonqualified deferred compensation plan can address the retirement gap for HCEs by allowing tax deferred savings for retirement income beyond that of qualified plan benefits and Social Security. A NQDCP plan can be designed to allow up to 100% deferral of a participant’s compensation on a pre-tax basis, with any plan earnings growing tax-deferred as well. Well-designed plans can provide the opportunity to make personalized decisions regarding investment strategy. Plan distribution elections can also be tailored to meet retirement income needs, as well as shorter term savings needs while still in service with the organization.
And plan participants confirm that NQDC plans are meeting their needs. A recent Boston Research Group study sponsored by the Principal Financial Group found that 83% of participants were satisfied with their plan and plan provider. And more than nine out of 10 participants said they plan to maintain or increase their deferral contributions in the next 12 months.
For example, a typical NQDC plan participant might be a senior manager or executive at a company who wants to save more than the limits of the company’s 401(k) plan. An approach might be to defer 10-15% of salary and 20-40% of a performance bonus. (According to the 2011 survey, participants averaged $20,000 in annual NQDC plan contributions from all sources.) The participant would then pick a desired asset allocation to apply to the deferrals contributed, perhaps taking higher risk on money targeted for retirement and less risk on accumulation goals before retirement. Savings for accumulation goals before retirement go into an ‘in-service account’ and might be money targeted for distribution in several years when a child will start attending college.
Focus on benefits to employers offering plans
Why would an employer want to sponsor a NQDC plan? Many want to provide a competitive, well-rounded benefits package to their top talent. These plans can be designed cost-effectively to implement and maintain as long-term benefits.
The previously cited survey found employers list five primary reasons why they offer NQDC plan’s:
- The plans allow participants to save for retirement in excess of qualified plan limits.
- They can be used as retention tools.
- They help comprise a competitive benefits package
- They help replace benefits lost by IRS restrictions.
- They can assist in motivating employees.
These plans are exempt from most of the ERISA requirements which gives the employer the option of being selective as to which HCEs are invited to participate. Providing the plan is a nice incentive for key employees to defer their own compensation, but there are additional ways to enhance the incentive.
Discretionary employer contributions offer flexibility
NQDC plans can be designed to receive only discretionary employer contributions in addition to participant deferrals. Employers might make discretionary contributions to address multiple corporate objectives. For example, an employer may make matching contributions to the plan at a level equal to what participants would have received in the qualified plans had there been no limits due to failed testing restrictions.
From a practical point of view, this ‘restoration match’ contribution simply brings the level of benefits for key employees to the same level as other employees at the company. A second example may be when an employer wants to reward a specific group of key employees for tenure or service to the company. This design can also provide different matching levels for different groups of key employees.
Since discretionary employer contributions to NQDC plans are not subject to the coverage and testing rules of qualified plans, the employer can also offer enhanced “performance based” incentive contribution programs. This is when specific corporate targets are communicated to levels of senior management, and contributions made to the plan in relation to successful achievement of these goals.
As an example, think about a sales group that the employer wants to ensure gains market share. A market share goal might be communicated with a commitment to place a bonus into the employees’ accounts in the NQDC plan if achieved by leaders of the sales group.
Employers can also design vesting schedules as part of discretionary employer contributions to assist with retention goals in addition to a reward element. Vesting money over time is typically used to retain valuable employees.
Retirement importance of NQDC plans recognized
Both employers that sponsor NQDC plans and their key employees participating in them overwhelmingly recognize their value in retirement savings. Educating both audiences about the retirement gap, particularly in times of future tax and economic uncertainty, introduces the role this employee benefit solution can play. In addition, it offers a powerful tool for employers to help meet the objectives of recruiting top talent and retaining and rewarding key employees.
Historically NQDC plans were only utilized by larger publicly-traded companies. But today, due to administrative service improvements and efficiently designed institutional financing options, these plans are being designed for all sizes and types of organizations. The “mainstreaming” of these plans reinforces the popularity in providing retirement benefits for key employees.
As you look to expand the role of retirement income planning for highly compensated clients, don’t overlook the potential role that nonqualified deferred compensation plans offers. Delivering valued benefits through employers to their key employees is an efficient way to both serve your clients and grow your practice. NQDC plans allow multiple audiences to achieve greater success with retirement income planning and future retirement readiness.