Learn More About Non-Qualified Plans

Transcription

1 Learn More About Non-Qualified Plans Presented By: Chris Martin Senior Vice President Chuck Bracht Vice President, Managing Director Jeff Kay Assistant Vice President, Account Manager Amanda Wielk Assistant Vice President, Account Manager

2 Today s Agenda What is a Non-Qualified Plan? Comparison with Qualified Plans Advantages of Non-Qualified Plans Design Considerations Types of Non-Qualified Plans Funding Alternatives Summary Questions 2 Page

3 Non-Qualified Plans Plan may cover only a select group of managers or certain HCEs Often referred to as top hat plans Exempt from most ERISA rules unfunded benefit Subject to forfeiture and general creditors Plan assets are considered general assets of employer Avoid constructive receipt Comply with IRC 409A 3 Page

4 Comparison with Qualified Plans Similarities Compensation is deferred on a pre-tax basis Participant deferrals and investment returns are exempt from federal and most state income taxes until distributed Employer may provide matching or other contributions Differences Plans are exempt from reporting and compliance requirements of ERISA under top hat exemptions Cannot be rolled over into an IRA or qualified plan Cannot borrow from plan Employer cannot deduct benefits until actually paid to participant 4 Page

5 Advantages of Non-Qualified Plans For the Employer Not subject to IRC limits permits flexible design Attractive recruiting tool in the face of shrinking executive talent pool Effective retention device Ability to pick and choose select group of participants If structured properly, a highly-valued benefit to participants at low cost to Employer Benefits that can be performance-based Compensation element that addresses competitive pressures 5 Page

6 Advantages of Non-Qualified Plans For the Employee No limit on pre-tax employee deferrals or employer contributions Participants may be allowed to direct the investment of their deferral balances Wide variety of options, including those generally not available in qualified plans Distribution timing and form of benefit can be tailored to the employee s specific needs, such as: Attainment of age and service goals Specified Date, for example for college tuition Normal or early retirement 6 Page

7 Plan Design Considerations Participant eligibility Covered group must be a select group of highlycompensated or management employees Contribution alternatives Employee income deferral only Employer decides which compensation components are deferrable Employer contributions 401(k) restoration, discretionary, etc. Both employee income deferral and employer contributions Vesting 7 Page

8 Key Design Elements Crediting Method Interest Multi-fund 401(k) style most common Account Structure One account ( bucket ) Separate buckets for each Plan Year Distribution options can be flexible Can enhance participant comfort with general creditor status Changes in distribution elections are subject to limits under current law 8 Page

9 Types of Non-Qualified Plans Defined Contribution types more prevalent Wrap Plans Mirror Plans Excess Plans 457(b) and 457(f) for non-profit employers Defined Benefit style Supplemental Executive Retirement Plan (SERP) 9 Page

10 Wrap Arrangement Contributions initially made to NQ Plan Determine maximum allowed in 401(k) ADP/ACP testing at year-end Transfer HCE contributions from NQ to 401(k) Employee deferrals and match can transfer 10 Page

11 Mirror Plan Similar to 401(k) Wrap Plan Stands alongside traditional 401(k) Often offers similar or same investment options Allows select group to defer without limit 11 Page

12 Excess Plan Also known as an overlay plan Contributions coordinated with the qualified 401(k) Typically begin once qualified plan limits are reached each year 12 Page

13 Funding Alternatives Non-qualified plans (including deferred compensation plans) are technically unfunded under ERISA Participant account balances are general liabilities of the Employer Employer establishes a deferred tax asset on the books to recognize the future benefit of a tax deduction when the benefit is actually paid Participants are unsecured general creditors with respect to their plan account balances 13 Page

14 Funding (cont d) Employer may optionally informally fund non-qualified plan liabilities by acquiring assets Typically invested to mirror participants accounts, providing for close asset-liability matching Assets can be invested in any mix of securities Employer may establish a Rabbi Trust * to protect assets from being used for purposes other than paying benefits Any assets acquired to informally fund non-qualified plan liabilities are general corporate assets Subject to the claims of corporate creditors Whether held outright or in a Rabbi trust * Irrevocable corporate grantor trust 14 Page

15 Funding Trends Majority of plans today are informally funded because: Liabilities are larger Proportion of retirement benefits from non-qualified plans is very high for senior executives Multi-fund design may result in high volatility for employer if unfunded, a potential P&L impact not related to operations Trend toward tax-sheltered funding Based on a recent survey, 87% of Fortune 1000 that fund plans utilize tax-sheltered funding 15 Page

16 Informal Funding Arrangements Three basic options for non-qualified plan liabilities Unfunded Pay As You Go Funding with Taxable Assets Typically mutual funds Funding with Tax-Sheltered Assets Typically mutual fund-like portfolios in the thinnest possible life insurance wrapper 16 Page

17 Pay As You Go Tax Cost on Deferral Tax Savings on Benefit IRS Deferrals Benefits Company Participant or Beneficiary 17 Page

18 Taxable Informal Funding Tax Cost on Deferral Tax Savings on Benefit IRS Deferrals Benefits Company Tax on Yield Deposits Taxable Yield The issue Participant or Beneficiary Withdrawals Mutual Funds 18 Page

19 Tax-Sheltered Informal Funding Tax Cost on Deferral Tax Savings on Benefit IRS Deferrals Benefits Company Premiums The Key Tax-Sheltered Yield Withdrawals Participant or Beneficiary Loans Death Benefits COLI 19 Page

20 Corporate-Owned Life Insurance (COLI) COLI is a specifically-designed institutionally-priced product used to informally fund liabilities of nonqualified plans Often private placement product Allows companies to purchase mutual fund-like portfolios within the tax shelter of life insurance To obtain maximum tax leverage, policies must be in compliance with IRC Section 101(j) 20 Page

21 COLI (cont d) Generally designed with the minimum amount of life insurance possible Maintain maximum tax advantages Minimize insurance costs Employer is policyowner, premium payer, and beneficiary of COLI policies Insured Participant generally has no direct interest in policy 21 Page

22 Funding Alternatives 35,000 foot view Taxable Funding Tax-Sheltered Funding* Yield 9.00% 9.00% Less Tax** -3.51% 0.00% Less Insurance Cost 0.00% -0.48% Net Yield 5.49% 8.52% Advantage 303 bps * COLI ** Assumed corporate tax rate: 39% 22 Page

23 After-Tax Cost (Gain) Cost Comparison of Non-Qualified Funding Alternatives (One Participant) 1,500,000 1,000,000 Combined Benefits and Funding 500,000 0 (500,000) (1,000,000) Total NPV (1,500,000) (2,000,000) Unfunded Taxable Assets COLI 23 Page

24 Annual P&L Cost (Gain) Annual Proforma Accounting After-Tax Benefits and Funding 100,000 50,000 0 (50,000) (100,000) (150,000) (200,000) Year Benefits COLI Composite 24 Page

25 How USI Can Help With Your Non-Qualified Plan Evaluate design alternatives Draft the plan Establish informal funding mechanism Develop administrative procedures and forms (enrollment and election) Communicate with participants Comply with IRS and DOL requirements, including IRC 409A 25 Page

26 Questions? Contact: Chuck Bracht, Chris Martin, Or 26 Page