Informal Funding Alternatives

Transcription

1 Informal Funding Alternatives For Nonqualified Benefit Plans For use only with plan sponsors or administrators. Not for use at the participant level. All rights reserved

2 Introduction Many employers offer nonqualified benefit plans as part of a comprehensive benefit package. A nonqualified plan can provide attractive supplemental retirement benefits to executives who have contributed the maximum allowed to their qualified plan contributions. Although nonqualified plans cannot be legally funded and secured like a qualified plan (an example would be a 401(k) plan), assets can be informally set aside, to fund nonqualified benefits as long as the assets remain subject to claims of the company s general creditors. When examining funding options for a nonqualified benefit plan, there are three primary choices. Plan sponsors can leave the plan unfunded, purchase equities/mutual funds, or purchase tax-deferred Corporate Owned Life Insurance (COLI). Determining which choice is the best solution for your company will depend on a variety of elements, so a careful analysis of cost versus benefit should be performed. As part of Nolan Financial s Nonqualified Benefit Solution Process, we perform a comparison of the features and benefits of each available investment option. Since Nolan Financial is independent, it has the luxury of being able to provide its clients a wide range of options with increased cost efficiency. Nolan Financial works closely with our clients to understand their unique needs and then develops a solution to help meet their benefit program goals. Plan Nolan Financial s Nonqualified Benefit Solution Process Custom Plan Design Detailed Funding Analysis Plan Implementation Ongoing Plan Recordkeeping Successful Plan Management 2

3 Comparison Informal funding alternatives CORPORATE OWNED LIFE INSURANCE (COLI) EQUITIES 1 (MUTUAL FUNDS) UNFUNDED OVERVIEW Life insurance policy owned by the employer that insures the lives of its eligible executives with benefits payable to the employer The cash value is invested in sub-accounts/mutual funds and re-directed as per the investment choices made by the executive Employer makes investment contributions into mutual funds equal to annual Nonqualified plan contributions and uses withdrawals from account to fund pre-tax benefits The Employer simply pays the benefits out of corporate cash flow as they are due Any increase in cash surrender value above net premiums paid, flows through the P&L statement as income 2 Only realized gains can flow through as income on the P&L statement; unless fair value option is selected 3 ACCOUNTING & TAXATION The appreciation in COLI cash values is not taxed unless the policies are surrendered (even if values are reallocated among investment subaccounts with the policies) Realized gains and re-allocation among different investments will also trigger taxation (which can be substantial if executives frequently balance and re-allocate their investment choices) P&L expense will be higher since there is no gain on assets to offset benefit expense FUNDING CONSIDERATIONS Institutionally-priced COLI is a highly liquid funding vehicle and can be surrendered without any charge. Guaranteed Issue underwriting simplifies insurance enrollment without any medical exams Liquid investments that may be bought or sold at any time Employer does not have to set aside funds and deferrals can be invested back into the company May have short-term cash flow benefits, but offers lower benefit security to executives and could hurt perceived value DEATH BENEFIT/ RETURNS FROM LIQUIDATION Provides tax-free life insurance death benefits. Some of the tax-free death benefit may be allocated to the executive s beneficiaries With a large group of insured executives, the likelihood of some early deaths is greater and can provide significant cash inflows to help reduce the overall cost of the nonqualified plan Equities do not provide any death benefit Returns are entirely dependent on the investment performance At liquidation, previously unrealized gains are realized and taxable There are no death benefits associated with unfunded plans 1. This table assumes that mutual funds held to informally fund nonqualified plans are classified as Available for Sale, 2. FASB Technical Bulletin Accounting for Purchases of Life Insurance, 3. Statement of Financial Accounting Standards No. 159 ( FAS 159 ) - The Fair Value Option for Financial Assets and Financial Liabilities Informal Funding Alternatives 3

4 COLI A closer look at Corporate Owned Life Insurance Funding with COLI is best suited for profitable C-corporations with a nonqualified plan liability that is meaningful, relative to the size of the company. The favorable accounting treatment for COLI makes it especially attractive to public companies since the annual increase in COLI cash values above premiums paid provides a positive impact to the P&L statement. According to a recent survey of Fortune 1000 companies 4, approximately 61-68% of companies that fund their nonqualified plans do so with COLI. Some companies with larger nonqualified plan account balances may choose to implement a funding strategy that utilizes a combination of both COLI and equity investments. If a Corporate Owned Life Insurance policy is held until death, the proceeds are paid to the employer tax-free. COLI proceeds may be used to pay participant death benefits, provide key person insurance and/or reimburse the employer for costs of the nonqualified plan. 4. Executive Benefits A Survey of Current Trends, Clark Consulting,

5 Equities/Mutual Funds Providing some type of informal funding adds a level of security and assurance to plan participants. With this funding alternative, the Employer utilizes investment securities, such as mutual funds, to pre-fund future executive benefit liabilities. Executives often take comfort knowing the plan is informally funded. The key advantage of utilizing investment securities is that a very large selection of investment choices are available along with a high degree of flexibility in regards to liquidity. Employers can select several funds and even allow the executive s account(s) to be tied to the return of those funds. It is important to note that the Employer has to bear the cost of taxes on investment earnings, which may diminish the financial advantages when compared to other funding vehicles. Informal Funding Alternatives 5

6 Summary Informal funding options Determining which funding alternative is best for your company will depend on a number of factors. Plan Sponsors have three primary options when considering funding alternatives: leaving the plan unfunded, funding with Mutual Funds or funding with COLI. In some cases, it makes more sense to utilize a combination of funding vehicles to balance short-term and long-term liquidity needs and provide more flexibility. Leave the Plan Unfunded Benefits are paid out of cash flow when due - pay as you go Can detract from the participant s perceived value of the plan Fund with Equities (Mutual Funds) Employer can fund future benefit obligations which provides added assurance and security to participants Earnings flow through to the P&L statement, which can offset benefit liabilities Employer has to bear the cost of taxes on the investment earnings Fund with Corporate Owned Life Insurance (COLI) Employer can fund future benefit obligations which provides added assurance and security to participants Earnings flow through to the P&L statement tax-deferred, which can offset benefit liabilities Death benefit proceeds reduce funding costs, resulting in higher NPV cash flow gain to employer 6

7 Nolan Financial More than 25 years of experience with nonqualified benefits We will help you understand important funding considerations such as tax and accounting implications as well as participant concerns. Nolan Financial s mission is to supply our clients with the highest level of service at a reasonable cost. This is accomplished through our continued commitment to excellence, flexibility and our clients. Nolan Financial s sole focus is on nonqualified retirement and welfare benefits for senior executives and professionals. Since this is our sole focus, we have the ability to effectively administer a variety of plans for both for-profit and not-for-profit organizations, while remaining compliant with the latest legislation. Our creative approach to solving client needs is evidenced by the fact that no two plans that we design are the same. We approach each case from a fresh perspective and do not offer prepackaged solutions like many other firms in our industry. As part of Nolan Financial s Nonqualified Benefit Solution Process, we will perform a Detailed Funding Analysis, which includes: Research alternative solutions A comparison of the features and benefits of each available investment option A recommended solution and detailed explanation of each informal funding alternative Informal Funding Alternatives 7

8 Recognizing Performance Headquarters 6720-B Rockledge Drive, Suite 140 Bethesda, MD Michael E. Nolan - President & CEO nolanm@nolanfinancial.com Sales and Marketing Inquiries: General Office Phone: Service Centers: Bethesda, MD Nashville, TN Online: Associates of Nolan Financial Group are registered representatives of Lincoln Financial Advisors Corp. Securities offered through Lincoln Financial Advisors Corp., a broker/dealer. Insurance offered through Lincoln affiliates and other fine companies. Lincoln Financial Advisors, 8219 Leesburg Pike, #200, Vienna, VA Lincoln Financial Advisors Corp. and its representatives do no provide legal or tax advice. Nolan Financial Group is not an affiliate of Lincoln Financial Advisors Corp. CRN NF165-14