Executive Benefits New Year’s Resolutions: Resolve. Benchmark. Redesign. Educate. Save.

Executive benefits plans, once a luxury for executives, have now become a necessity resulting from historically low savings rates, limits on how much can be saved in qualified plans and limits on social security for the highly compensated.  Here are some New Year’s Resolutions to enact now and anytime you want to ensure you’re doing what is necessary to help attract, retain and reward top performers.

In short:  Resolve.  Benchmark.  Redesign.  Educate.  Save.

Offer an executive benefits program
Crazy as it may seem, many companies still do not offer executive benefits programs.  While over 80% of large public and private employers (2,500+ employees) offer non-qualified programs, less than 50% of mid-market (500-2,500 employees) and less than 25% of small market (less than 500 employees) offer such programs.  In an era where pension plans are rarely offered, highly compensated employees need something to supplement 401(k) and social security or they will not be able to maintain their pre-retirement lifestyle.  Further, the ability to defer federal and state taxes, avoid capital gains, dividends and the new 3.8% tax on investment income, make non-qualified plans even more imperative.

Beat the competition
Unless you have done a peer review recently, you better be sure the competition does not offer a more attractive plan than you do.  These plans are compensation.  Offering a plan that is below par is like paying your top performer less than the competition.  It’s only a matter of time before that costs the organization.

Offer compelling plan designs
Offering a program is step one but if that program is not designed properly, plan perception and participation will be low.  You want to get and give the most for each dollar so if you are offering a plan, consider these features:

  • Company match – extend 401(k) match to executive plan
  • Pre-tax deferred retention/sign-on bonus – executive must work minimum number of years
  • Pre-tax performance bonus – company paid if performance criteria met
  • Ability to defer at least 75% of compensation
  • Eligibility beyond just the C-suite
  • In-service distributions – ability to elect to be paid out in as little as three years from deferral date
  • Post-retirement distributions – ability to take distributions over as many as 10-20 years
  • Investment lineup covering all market sectors including alternative investments
  • Attractive fixed rate alternative 3%-4% plus death benefit (if informally funded with COLI)

Educate your people…in person
Unless someone is proactively reaching out to contact the plan eligibles and talk with them directly over the phone or in person, plan participation may be like the proverbial tree falling in the forest.  We believe in the 25-25-50 theory.  25% of people understand the plan and will participate no matter what.  25% of people will never participate no matter what.  The needle mover is the 50% of people who will not take action because they do not understand the plan and will not take the time unless they are contacted directly.

Informally fund the plan
While most companies informally fund and secure their non-qualified plans, some still do not.  For public companies, many ratings agencies and analysts consider unfunded non-qualified liabilities to be debt.  Further, waiting to fund these liabilities puts the burden of payment on future owners and shareholders which makes the company less attractive.

Many companies that do informally fund their plans continue to incur large tax costs resulting from taxable gains on assets used to informally fund their programs.  If you would like to reduce the cost of the program, explore whether you can reduce cost through informal funding using tax-advantaged corporate owned life insurance (COLI).  If you already use COLI, be sure that you do regular audits to ensure you are using the most current, cost-efficient COLI products designed to address today’s economic factors and designed to be flexible enough for tomorrow’s.  One large COLI and BOLI carrier recently announced that effective February 1, 2014, cost of insurance rates will be increased for EXISTING policyholders due to persistently low interest rates.

Data shows that 81% of people do not keep New Year’s resolutions!

Being in the minority 19% ensures that your company, ownership, shareholders and most of all, your top executives will be better off.

Nonqualified Deferred Compensation (NQDC) Plan Audits – Much More Than Just Compliance

If you’re an employer reading this, you’re already tuned in to the importance of fiduciary responsibility.  You get “the risk” of not doing frequent due diligence in terms of plan compliance.  That reason, on its own, should be compelling enough to take action.  However, there are other equally compelling reasons for including more than just compliance in a due diligence review of your non-qualified deferred compensation (NQDC) plans.

A review is not complete if it does not consider the impact of the plan on the bottom line, it’s effectiveness in attracting and retaining key talent, its ability to mitigate impending tax increases and drive robust plan participation.  A complete due diligence review looks at your organization’s unique business situation and asks:

  • Is the plan compliant with current regulatory requirements?
  • Is this plan helping plan sponsors reach their goals?
  • Is this plan helping plan participants reach their goals?
  • Is the communications program driving enrollment?
  • Can the cost of the plan be reduced?
  • What is the impact of the informal funding strategy and alternatives?

Is the Plan Compliant?
Regulatory compliance is a many-headed hydra of challenges and headaches.  It is the last thing anyone wants to think about, yet a critical component of a NQDC plan design and operations.

Since 2004, employers have been living with Section 409A of the Internal Revenue Code, added to the American Jobs Creation Act.  This provision and the regulations and rules issued by the IRS interpreting it tell employers what they cannot do in their NQDC plans.  It’s a long list of “no’s:”

  • No distributions before six months following separation from service
  • No deferrals of gains realized from exercising company stock options
  • No use of offshore trusts, or trusts that place assets outside the reach of creditors
  • No provisions that eliminate the “substantial risk of forfeiture” aspects of the plan, whereby employees acknowledge that their deferred compensation assets are at risk should the company have financial difficulties, because they are subject to the claims of general creditors
  • No changing deferral elections during the plan year outside of open enrollment
  • No unscheduled withdrawals
  • No acceleration of scheduled distributions

The year-to-year challenges to employers in observing these rules are immense as business conditions change, executives come and go, and changes are made to existing plans or new plans are added.  This is on top of the regular administrative burden of getting annual notice and election forms out to executives on a timely basis and making sure they are completed and returned.

Is the Plan Design Structured to Meet Your Unique Business Goals?
Don’t undermine the success of your NQDC plan by taking a “set it and forget it” approach.  Benchmarking of your NQDC plan’s design and effectiveness in aligning executives’ interests with key business objectives enables you to assess your position versus your competition in attracting and retaining your highly valued employees and make any necessary improvement.

Considerations may include “Sweeteners” to attract talent and/or “Golden Handcuffs” to retain talent including:

  • Adding or increasing employer contributions (match/performance bonus)
  • Increasing executive capacity to defer
  • Enhancing investment menu with offerings having more market exposure, principal protection, and fixed rate returns
  • Allowing distributions as early as three years from deferral date or up to post-retirement
  • Sign-on or retention bonuses that vest after period of years
  • Lump sum distribution only provisions for executives who go to a competitor
  • Payments for as long as 20 years post-retirement if minimum retirement eligibility requirement met

Is the Funding of the Plan Correct for Your Organization?
Analyzing current plan design and informal funding strategy for effectiveness, efficiency and compatibility with corporate philosophy is very important.  Are there alternative approaches that would work better?

If the employer informally funds NQDC liabilities through taxable securities (e.g., mutual funds), corporate-owned life insurance (COLI) or company stock, a financial evaluation or funding study offers critical clarity regarding:

  • Cash considerations
  • Tax impact – How do tax costs impact P&L and cash flow (current and future corporate tax position)?
  • Cost of capital in evaluating these types of arrangements
  • Sensitivity with respect to P&L exposure
  • Whether benefit security is real or perceived – What is the appropriate funding level?

Is There Effective Communication & Education?
Highly valued executives can’t truly know the worth of your NQDC plan unless it is clearly and consistently communicated to them.  A comprehensive review of enrollment levels and overall communications strategies can yield a refreshed level of engagement.

Effective messaging is especially urgent and compelling in view of recent developments.  The American Taxpayer Relief Act of 2012 increased income tax rates, investment income tax rates and capital gains tax rates for top earners.  Savings rates have decreased and life expectancies are growing.

Now you know.
Now you have the important, holistic perspective of why NQDC due diligence is about more than just compliance.  NQDC due diligence is an opportunity to measure the performance and effectiveness of a significant investment your organization is making in your key executives and your overall business plan.  As with most forms of investment, NQDC plans are not so different in that active monitoring and assessment are vital to achieving the best possible results.

A Key Executive Benefit You Can Afford

Over the course of an employees’ tenure, the chance of being disabled is much greater than the chance of dying. While your company likely provides Long Term Disability (LTD) insurance in some form that meets the basic needs of most of your organization, it is likely not enough to replace an adequate percentage of your executives’ and highly compensated employees’ income. In fact, the parameters of most standard LTD policies will leave most executives with only 15% to 45% of their pre-disability income for reasons such as:

Salary-only protection:  Most group plans protect up to 60 percent of salary, with no protection for other compensation such as bonuses, commission, incentive plans and retirement savings.

Benefit caps:  Group LTD plans typically have benefit caps based on more moderate income levels, which may limit the amount of income replacement more highly-compensated employees can receive.

Taxes:  Benefits from an employer-paid plan, like the usual group LTD plan design, are taxable, so the actual income replacement may be significantly lower than expected.

Portability:  Group LTD plans are often not portable if an employee leaves the company.

For example, a typical employer-paid group LTD with a 60% replacement rate and monthly cap of $10,000 would cover compensation up to $200,000. As compensation climbs above $200,000, replacement percentages decline. At $400,000 of covered compensation, the replacement percentage falls to 30%.

Providing supplemental LTD or the opportunity to purchase supplemental LTD at a group discounted rate is a valuable and key benefit to attract and retain top talent to your organization.

As the employer, you can pay the premium for your eligible employees or offer supplemental LTD as a voluntary benefit (or the opportunity to “buy up”) at a reduced group rate. If the employer pays the premium for the supplemental LTD, the benefits are considered taxable income, significantly reducing the income benefit. If the employee pays the premium, “buying up” or in the form of a voluntary benefit, the benefits are not taxable.

By supplementing your group plan’s LTD, you can offer highly compensated employees an extra layer of protection that provides greater income replacement. This integrated coverage is a good solution because it provides a group LTD plan for all employees at a reasonable cost, as well as supplemental disability insurance that offers any eligible employee permanent individual coverage with some value-added features not typically found in LTD plans.

In addition to protecting employees’ total compensation and closing income replacement gaps, other benefits of supplemental LTD typically include:

  • Option for up to 100 percent income replacement coverage for catastrophic disabilities
  • Opportunity to exchange an individual disability policy for a long term care policy after age 60
  • Custom designs that complement most group LTD plans
  • Fixed employer-sponsored discounted premium (up to 35 percent) and non-cancellable coverage to age 65
  • Individually owned permanent disability coverage

Employers and employees value offering and getting “more with less.”

As the employer, you may find multiple advantages and efficiencies from offering supplemental LTD, such as:

  • Helps attract and retain top talent
  • Enhances the competitiveness of your benefits package without directly increasing your costs
  • May stabilize overall rates
  • Claims experience for supplemental LTD does not impact basic LTD rates

Employees value the benefits of:

  • Security of a higher net income during a disability
  • Portable coverage even if the employee changes jobs
  • Discounted, fixed premiums
  • No medical exams or lab work required
  • Easy payroll deduction

The value of integrating group LTD and supplemental LTD is clear. It’s a long-term benefits solution that can stabilize group LTD plans, limit risk and volatility, and offer high-income earners the income replacement and enhanced coverage that better matches their needs.

Your benefits consultant can review your options with you, present various funding scenarios for mitigating risk and cost, and assist with communication and enrollment. Some of the questions you will want to address are:

  • What forms of compensation does the plan cover?
  • Does your plan cover base salary only?  Bonus? Commissions? Incentive plans? Retirement savings?
  • Are these other forms of compensation a significant portion of total compensation?
  • What is your maximum monthly benefit?
  • Does your maximum monthly benefit leave some of your more highly compensated employees covered at a much lower replacement percentage?

To learn more about supplemental LTD, please contact us.