Nonqualified plans – Executive Decision

This tip from Plan Adviser points to a study showing the number of middle managers participating in non qualified plans jumped from 17 percent to 36 percent in order to cover gaps in 401k funding. If an employer you advise is considering extending nonqualified plan benefits, check out these tips from Plan Adviser on offering guidance.

– Eric.

The Need for More Scrutiny

Many employers have decided to step up their reviews of their nonqualified plans in general, to see if they should change to reflect the employer’s current needs and realities. “They want to maximize the value of the plan, but minimize the complexity,” Dorton says. Some employers have frozen their defined benefit plan in the past couple of years, and want to figure out whether the nonqualified plan should change as a result. The broader issues in executive compensation focus on lengthening the time horizon and deferring compensation into equity, which has left executives increasingly long in company stock, says Scott Olsen, a Pricewaterhouse-Coopers LLP Principal.

“Sponsors are looking at the plans to see if there are ways to streamline or simplify them,” says Donn Hess, J.P. Morgan Retirement Plan Services’ Head of Product Development. “Nonqualified plans have tended to not get the same level of scrutiny (from sponsors) that qualified plans do.”

That is changing. “There is emphasis on greater governance of just about every kind of compensation plan,” Olsen says. “It is getting the attention of the board, the compensation committee, or the audit committee, as these obligations get greater and become more important to executive-compensation disclosure.”

Plan-Design Changes

A lot of employers want to reevaluate nonqualified plan eligibility, Dorton says. The Principal study found a large increase in the number of middle managers participating in these plans, at 36% versus 17% previously. “They are the ones who have the gap where they cannot quite save enough in the 401(k),” he says, adding that the past few years have made them more aware of their potential retirement shortfalls. More employers have evaluated whether to let nonqualified-plan participants do in-service distributions, he says, so they can get a payout at a pre-determined date before retirement. “That gives people more ability to do financial planning,” he says. “It is a way for them to take advantage of the tax-deferred nature of a pre-tax plan, and save for material events in their lives.” In 2010, Principal and the Boston Research Group found that 21% of employers had fewer than 10 employees eligible to participate in their nonqualified plan, while 24% said 10 to 24 were eligible, and 56% said 25 or more.

Deciding To Mirror

“Some employers are deciding whether they want the plan to mirror the qualified plan,” Hess says. “What is driving the conversation is that, if you are offering it to a broader swath of employees, you probably need to simplify the plan.”

The trickiest issue: deciding whether to use the same investment options. Mirroring “always has been the easiest way to handle plans from a communication point of view, and a rationale point of view,” Olsen says. “Otherwise, it can look like just an executive perk.” Inevitably, some executives want more options, he says, but “adding additional things does not always enhance the value of the benefit. A lot of things are temporal and do not stand up to hindsight.”

Nonqualified investments increasingly need to pass muster with plan sponsors. “There is a lot more scrutiny on the investment lineups of these plans,” Dorton says. “Now, there is more of the investment oversight that we see in qualified plans.” Companies are more likely to have a committee overseeing the plan and evaluating it regularly; sometimes that committee also handles the qualified plan, and sometimes not. He does not have statistics on that, but says Principal has had increased requests for formal investment-review information supplied to a committee.

However, there is an argument for not mirroring investments. The choice of nonqualified plan investments “tends to be fairly anemic and of marginal value,” Gottlieb says. “Sometimes it is the same as the 401(k), which is doing a disservice to the higher earners. Nonqualified plans should be a real, true value, a wealth-creation value.” Many of these plans need investments not available through the 401(k), he thinks: higher-quality investments and more diversification into areas such as emerging markets and alternative investments. “Alternative investments are probably the best thing to put in a nonqualified plan,” he says. “The best alternative investments can outperform just about everything else, and they are geared toward long-term investments.”

Using Corporate-Owned Life Insurance

NQDCs are unfunded plans, but 60% of Principal’s sponsors completely or partially finance them, Dorton says. As for financing method, 47% use corporate-owned life insurance (COLI), and 28% use mutual funds.

Ten or more years ago, employers did not use COLI much in these plans, since the market lacked enough high-quality products and many sponsors did not fully understand them, Dorton says. However, the products improved in subsequent years, and more CFOs and financial departments got familiar with them, he adds.

“We saw a swing from employers using almost no corporate-owned life insurance to using a whole lot,” Hess says. However, some have since deemphasized COLI, Olsen says, “because, in many cases, it did not work out as people hoped.”

Now, employers carefully evaluate the use of mutual funds or COLI, Dorton says, and one size seldom fits all employers. Sponsors want to figure out if their current strategy makes sense. “They might have too much, or they might not have enough [COLI],” he says.

“They are making sure that they understand that investment vehicle,” Hess says, “and they are making sure they are using the right amount.”

Beefing Up Education

Employers have started questioning their previous assumption that people do not need much nonqualified-plan education because these high-ranking executives have lots of investment savvy. “A high level of compensation does not necessarily equate to a high level of knowledge about investment matters,” Hess says. “They may not be making the most optimal choices.”

Focus has increased on participant behavior in these plans. For instance, some executives contribute to an NQDC plan and set it for distributing money when their children reach college age, to pay for their higher education. While some like the flexibility, this does not help them with their long-term retirement­ savings, Hess says, and drawing the money out pre-retirement also effectively erases the tax benefits. Or executives may contribute to their nonqualified plan before their qualified plan, a questionable decision since that balance is less secure if the employer subsequently fails.

These key employees tend to keep very busy, Dorton says, so Webinars and online tools they can access at any time work well as educational approaches. Advisers also have a good opportunity to offer one-on-one help to executives to come up with their nonqualified-plan strategy. “Then, we suggest that participants follow up each year,” he says, “and see if this is still the track they want to be on.”

Full article here.

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About thebenefitblog

Eric is a Producer at Lockton Insurance Brokers, Inc., the world’s largest privately held commercial broker. Eric has over 23 years of experience in the insurance industry and has spent the last 11 years with Lockton. Eric specializes in Health & Welfare Benefits, Retirement Planning, and Executive Benefits. Eric's clients utilize his expertise in the areas of Plan Due Diligence, Transaction Structure, Fiduciary Oversight, Investment Design, Compliance and Vendor negotiation to improve the operational & financial outcome for each client. The Benefit Blog is a place to share that expertise and industry news.
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