Executive Compensation Making it Work and Getting it Right. An Overview of Non-Qualified Deferred Compensation Plans

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1 Executive Compensation Making it Work and Getting it Right An Overview of Non-Qualified Deferred Compensation Plans

2 What We ll Cover What are Executive Compensation Plans? Why Would a Co-op Have Such a Plan? What Options are Available, What Does NRECA Offer, and What are Common Pitfalls? 2

3 WHAT ARE EXECUTIVE COMPENSATION PLANS? 3

4 Qualified vs Non-qualified Plans Qualified Plans 401(k)/403(b) plans Traditional pension and cash balance plans Non-Qualified Plans Any other arrangement that pays compensation in a year after it is earned Not all participants need the same benefit 4

5 What is a Non-qualified Plan Non-Qualified Plans Cover a Broad Range of Plans Severance arrangements Employee bonus programs Transaction payments Executive deferred compensation The list goes on 5

6 WHY WOULD A CO-OP HAVE AN EXECUTIVE COMP PLAN? 6

7 Retirement Readiness As income levels rise, the gap increases between what is needed for retirement and what is supplied by a combination of Social Security benefits and qualified retirement plans Source: socialsecurity.gov, U.S. Department of Labor, Assumes 45-year-old individual with two times current salary saved in a qualified plan continuing to make maximum contributions until retirement, which occurs at age 65. 7

8 Uses of Executive Compensation Plans Defer Additional Compensation 457(b) Plan Other top hat 409A plan Reward/Attract/Retain Key Employees Employee bonus plan Long-term incentive plans Retention bonus programs Supplement or Restore Qualified Plan Benefits Supplemental Executive Retirement Plans (SERP) Excess Benefit Plans 8

9 WHAT OPTIONS ARE AVAILABLE AND WHAT DOES NRECA OFFER? 9

10 Executive Compensation Plan Basics Co-op Tax Status Determines Plan Type Limited Eligibility Most plans must be limited to a select group of management or highly compensated employees Some plans can be offered to rank and file employees Plans Generally Cannot be Funded ERISA Coverage Exempt from most ERISA requirements, such as nondiscrimination testing Still must comply with certain requirements 10

11 Big Picture: Rules and Pitfalls Rules Written plan document required Payments must be tied to certain date or payment event Plan document governs operation Eligibility restrictions apply Pitfalls Inadequate plan documentation Document contains impermissible payment event Plan not administered according to document 11

12 Cost of Errors Not As Easy to Correct 409A Non-Compliance = No Happiness Entire benefit is taxed to executive in first year of non-compliance (even if it won t be paid for 10 years) Plus interest on that tax owed Plus 20% penalty on the amount deferred AND, if you didn t report it correctly, accuracy and other related penalties 12

13 PLANS FOR DEFERRING ADDITIONAL COMPENSATION 13

14 457(b) Plan Options Who Can Sponsor Tax-exempt entity Governmental entity Type of Sponsor Matters Tax-exempt plan Limited to a select group of management or highly compensated employees Money cannot be held in trust (other than Rabbi trust) Not eligible for rollover Governmental plan Money must be held in trust Eligible for rollover 14

15 457(b) Plan Options Contributions May be employer or employee contributions; limits apply ($18,000 in 2017 plus catch-up) Not more than 100% of compensation Independent of 401(k)/403(b) plan deferrals Distributions Must have a payment event Required minimum distributions Start date may be deferred 15

16 NRECA 457(b) Plans (Tax-Exempt Co-ops) Why co-ops adopt Low co-op cost Executives defer maximum to 401(k), but insufficient for retirement Potential pitfalls Timing and amount of deferrals Participant taxation Distribution timing RMDs Catch-up contributions (special vs age 50) 16

17 Other Top Hat (409A) Plan Options May be sponsored by taxable entity Contributions May be employer or employee contributions Independent of 401(k)/403(b) plan deferrals Distributions Must have a 409A-compliant payment event Must elect time/form of payment at participation start 17

18 NRECA Top Hat (409A) Plans (Taxable Co-ops) Why co-ops adopt Low co-op cost Executives defer maximum to 401(k), but insufficient for retirement Potential pitfalls Participant taxation Distribution timing Changes to distribution timing Missed distribution date 18

19 PLANS FOR REWARDING OR RETAINING 19

20 Long-Term Incentive Plan (LTIP) Goals: Align incentives with strategic objectives Retain employees for some period Long-term Incentive Plan Objectives and Rules Establish objectives and rewards Determine vesting Generally co-op contributions only No dollar limit on contributions Strict payment timing rules 20

21 Long-Term Incentive Plan (LTIP) Example The board desires to increase revenues by at least 10% over the next 5 years They want to incentivize the Executive Director to accomplish this goal or, better yet, exceed it ABC Co. adopts an LTIP If revenue increases by 10% for 5 consecutive years, CEO is credited with $40,000 If revenue does not increase by 10% for 5 consecutive years, no benefit is payable CEO must remain employed for 2 years beyond crediting date to receive payment 21

22 NRECA Performance Incentive Plans Tax-Exempt Co-ops Performance Incentive 457(f) Plan Only distribution option is lump sum at vesting date Taxable Co-ops Top hat plan with performance incentive component Multiple distribution options 22

23 NRECA Performance Incentive Plans Why Co-ops Adopt Can be used for select group of management or to retain key personnel to complete a specific project Employee must reach the time frame or goal in order to receive payment; can have multiple vesting dates Common Co-op Pitfalls Participant taxation Distribution timing Improper acceleration of vesting date Missed distribution date 23

24 PLANS TO RESTORE QUALIFIED PLAN BENEFITS 24

25 Excess/Restoration Benefit Plan Qualified Plans Have Limits on Contributions Deferrals ($18,000 in 2017, $24,000 if at least 50) Compensation ($270,000 in 2017) Annual additions ($54,000 in 2017) Solution: Excess/Restoration Benefit Plan Used to fully or partially restore qualified plan benefits that are limited 25

26 Excess/Restoration Benefit Plan Example: Limits Thwart the Company s Intention Company intends to give everyone 1:1 match up to 7% of W-2 Compensation Amazing CFO Earns $275,000 in total W-2 Compensation Defers $18,000 in 2017 Company wants CFO to get $19,250 match (7% of $275,000) CFO only receives $18,000 match (1:1 on $18,000 deferrals) 26

27 Excess Benefit Plan Excess Benefit Plan Makes Up Difference CFO s Qualified Plan Benefit $18,000 match (1:1 on $18,000 deferrals) CFO s Excess Plan Benefit $1,250 to make up for missed match opportunity Some companies require additional deferrals to receive match Others just make up the match as though the employee would have deferred enough to receive the full match. Total Benefit = Company s Intention 27

28 NRECA Executive Benefit Restoration Plan (Tax-Exempt and Taxable Co-ops) Used to fully or partially restore qualified plan benefits that are limited Most often used to restore benefits restricted in the co-op s defined benefit plan (e.g., RS Plan) Benefits limited to extent compensation > $270K in 2017 Other benefit restrictions (Section 415) To attract a CEO if co-op does not offer a defined benefit plan 28

29 NRECA Executive Benefit Restoration Plan (Tax-Exempt and Taxable Co-ops) Rules Benefits paid through co-op contributions only No dollar limit on contributions Vest and pay plans (for tax-exempt co-ops) Strict payment timing rules Common co-op pitfalls Participant taxation Distribution timing Changes to distribution timing or vesting date Missed distribution date 29

30 CONCLUDING THOUGHTS 30

31 Plan Administration Co-op is Plan Administrator and Plan Sponsor Personnel to administer Rules can be difficult to navigate Executive Comp Plan Corrections Very limited correction options Cost of errors fall on participants 31

32 Bottom Line Executive Comp Plans Offer Great Benefits Fairly flexible in design Can provide additional benefits to HCEs Good incentives But Must Be Established & Maintained Properly Stakes for non-compliance are high When considering the plan, must take this into account Allocate appropriate resources to the plan 32

33 Questions? Kelsey N.H. Mayo Poyner Spruill LLP Tolsun N. Waddle NRECA