Is your company offering enough benefits to executives and other highly compensated employees to give them a shot at a large enough retirement nest egg, or to get them to stay at the company longer?
Nonqualified deferred compensation plans (NQDCPs) can be an important component of an effective executive compensation and benefits package.
NQDCPs allow highly compensated employees to defer a greater percentage of their compensation (and current income taxes) than is allowed by the IRS in a qualified retirement plan like a 401(k).
It’s not often we hear about CFOs or other executives being unable to retire because they haven’t saved enough money. Most financial planners would say successful retirees need an 85% or higher replacement ratio — in retirement the assets saved need to deliver 85% of what the last year's paycheck.
But qualified plans like 401(k)s allow an executive or highly compensated employee to defer only up to $22,500 in pretax income in 2023. “The math just doesn’t work,” said Anthony Greene, senior vice president of business development at NFP, a specialist in executive compensation and benefits. “You can’t physically save enough.”
CFOs and other C-suite executives in the mid-market in particular are often too busy running their companies and haven’t always thought about this, Greene told CFO. If they’re in their mid to late 40s, on a personal finance basis they've been worried about other things — raising a family, saving for college, or buying a house, he said.
“It’s not unusual that I’m sitting with a mid-market CFO and they say, ‘I’m crushing it, I’m maxing out my 401(k).’ But they’re making $350,00 a year – that’s not going to get them retired,” said Greene.
Executive Retention Features
Retaining top talent is another reason to consider NQDCPs. These programs can defer not just salaries but also annual bonuses, performance-based compensation, and director’s fees and retainers to help reduce the individual’s tax bills. The money grows tax-free until distribution.
Because these plans are highly flexible, an employer can do things such as have a signing bonus vest over three years, said Greene. Some plans designed by NFP allow the participant to delay an upcoming vesting if they are happy in their job and plan to stay. Others have features like conditional elections around bonuses, said Greene. “You can even create an ‘if-then statement’ — if my bonus is $20,000 or less, I want it all to be distributed. But I want every dollar over $20,000 to be deferred.”
Deferred compensation can also create what Greene calls “silver handcuffs” because when a highly compensated employee is saving their own money in an NQDCP, they cannot roll the money into a 401(k) or an IRA if they leave the company — the balance is distributed and taxed as ordinary income.
Of course, for a CFO or other executive that participates in these plans, that can be a downside.
In addition, the language in the regulations that the balances in these plans have to be at substantial risk of forfeiture can give potential participants pause, said Greene. “If an organization does go bankrupt, or becomes insolvent, this plan has to go in front of the bankruptcy judge before it can distributed.”
The key is communication about the plan, said Greene. According to a client study by NFP, they often are underutilized. While initial adoption might be somewhere between 40% and 50% of those eligible, with good communication participation rates go up over 50%.
Beyond the C-Suite
The key for CFOs and other execs to remember is that these plans are not just for the C-suite anymore. A company may be able to have 15% to 20% of its employees eligible for a highly compensated plan, said Greene.
One other advantage of these plans is that they’re cash-based instead of share-based. “The group that’s moving into the highly-compensated [category] right now, their memories of the stock market are not that good,” said Greene, given they entered the market around the time of the financial crisis and have seen a lot of “wild gyrations” in stocks. “So I’m having a lot of conversations with plan sponsors around why they think they need to use cash.”
Finally, just because an NQDCP will benefit a CFO or other finance executive, they shouldn’t shy away from recommending them when benefits shopping, said Greene.
“I’m working with a large LLC and the owner owns the company and has a lot of employees who don’t own anything and the CFO is trying to get one of these plans in place,” he said. “It can be an interesting conversation with the owner. But most owners understand … that these programs are truly mutually beneficial to ownership and leadership.”