Ten Things You Should Do By Year-End To Get Maximum Value!

Deferred Compensation Legislation (409A): A Quick Guide to Improve the Results of Your Nonqualified Plan

Nonqualified Deferred Compensation Plans (NQDC) are an important part of an executive's total compensation package, allowing the executive an opportunity to save money on a pre-tax basis with none of the government limitations imposed on the company's 401(k) plan. Retirement plans deemed to be tax "qualified" under ERISA include the Defined Contribution Plan, Defined Benefit Plan, and 401(k) plan amongst others. The limits governing how much a person may contribute to a 401(k) plan make it only marginally valuable to highly-compensated executives. To address this inequity created by qualified plan limitations, companies can offer savings plans considered "nonqualified" which refers to their exemption from ERISA's (the Employee Retirement Income Security Act of 1974) requirements for qualified plans. The new law (409A) offers them more flexibility than expected.

Effective and Thorough Plan Design

NQDC plans help companies to attract, retain, and reward key employees. Before designing a plan, a sponsoring company should prioritize the objectives found in best practice plan designs:

• Attract
• Retain
• Reward

Best Practices

Recently, best practices design features, found in state-of-the-art NQDC plans have found increased acceptance. Simply put, best practices refer to a standard of planning and implementation that is beyond average, one that encompasses a range of contingencies to offer a level of exceptional quality in benefits planning. All NQDC plans are not equal, so companies preparing to design or redesign NQDC plans will find it highly beneficial to adopt the following ten best practices design guidelines: These are 10 things you should do by year-end to get maximum value from your plan.

10. Make Your Final Distribution Election Before December 31, 2008.

Yes, 409A is going to give you one more chance. You may have already made previous elections to defer and receive benefit payments in the future, however, under the new regulations you will be able to make one final change, even if that accelerates payment. Participants may change payment elections (both as to time and form) without resulting in an impermissible subsequent deferral on acceleration. This relief provision only applies to 409A compliant plans. Example: In 2005 you elected to defer your bonus until retirement which is expected to be 15 years from now. You also elected to take payments over a 10 year period. Before the end of 2008, you will have an opportunity to change your election (either time or form). You may want to elect a shorter time frame as you can always re-defer at a later time (discussed later).

9. Take Advantage of Distribution Flexibility.

Most deferred compensation plans were designed with short-term distribution options, giving the participant an opportunity to defer compensation for short periods of time for expenditures such as a child's education. Plan administrators used a "class year" approach to accomplish this, mainly due to system constraints. These "class year plans" have created unlimited numbers of accounts, payment dates, and form of payments making administration more complex than it needs to be.

Best practice plans use a "bucket" approach to simplify the class year approach. The "bucket" approach can not only simplify your plan, but allow more flexibility.

• Each year's deferral can be allocated to one or several "buckets"
• Re-deferral opportunity exists (minimum 5 years)
• In-service distribution options exist (see example below)

409A will allow you to re-defer any of your payments for a minimum of 5 years, as long as you elect to re-defer one year before the original distribution is scheduled. No limit is placed on the number of redeferrals. Another best practice feature is to allow a partial lump sum at retirement. This helps to reduce your creditor exposure during retirement.

8. Review Your Investment Fund Selection.

The single most important design decision of a NQDC plan is the construction of the investment menu. The investment menu decision not only impacts an executive's deferred compensation balance, it also impacts the company's cost. Three factors drive investment performance in NQDC plans.

Asset Allocation - 90% of investment performance will come from proper asset allocation modeling. Make sure your plan has the right asset classes and that your administrator has a system for monitoring them.

Manager selection - One of the most overlooked areas. Not only do you need the right asset classes, but you need to identify top performing investment managers and have a system to monitor them. If your company is funding the NQDC plan with corporate-owned life insurance (COLI), make sure you're not paying unnecessary manager fees that are a result of additional charges by the insurance company to fund management fees. As an example you may be paying 30 bps* for an S&P Index when the alternative is 14 bps*. Best practice plans start first with building the investment menu and selecting managers. Then, if COLI is used by the company, they place their selected managers into the COLI product. They could make a major difference to your account balances and overall to the company's cost.

* basis points

Tax Efficiency - This is the major advantage to the NQDC for the participant. The NQDC plan gives participants a higher equivalent rate of return than investing with after-tax dollars to achieve a return equivalent to tax-deferred savings. After-tax savings would need to be an average of 50% higher returns, which means a participant would need to be more aggressive with investment decisions.

And finally, the company needs "tax efficiency" in how it holds the asset on its balance sheet. Many companies have purchased COLI, however, there could be major savings to the company too. If this area hasn't been reviewed in the last 18 months, there could be improvement based on new pricing. Savings may be enough to provide, or increase, a company match.

7. Look at Asset Allocation/Risk-Based Model Portfolios.

Having the right investment menu and best-in-class managers is one thing, but who has the time and experience to manage their account properly? A rising trend is to use risk-based model portfolio construction. Few nonqualified plan administrators can offer this best practice feature. When offered to participants, over 60% utilized the model portfolio construction.

Advantages include:

• Participants delegate asset allocation to a professional
• Portfolios are customized for each plan
• Portfolios utilize best-in-class managers following a rigorous manager selection and weighting process
• Rebalance monthly
• No additional cost or fees to utilize

6. Review Benefit Security.

In most cases, companies that informally fund NQDC Plans also place their assets in irrevocable trusts referred to as Rabbi Trusts. These trusts protect participants from all contingencies short of bankruptcy. The Rabbi Trust received its unusual moniker because the case leading to its legal creation was brought by an actual Rabbi. Rabbi Trusts will protect the participants' assets (account balance) against:

• Change of control
• Change of heart (management defaulting)
• Change in financial condition (short of bankruptcy)

As stated earlier, no protection against bankruptcy exists. However, from a best practices standpoint, companies are implementing two additional safeguards.

Fiduciary Clause - This provision puts the "fiduciary responsibility" for interpreting the plan in friendly hands, rather than with an "administration committee" that can change after a change in control (COC). This can add protection in the event of a COC or dispute with management.

Moglia Rabbi Trust - If your Rabbi Trust doesn't have the "moglia language" it may be behind the times in benefit security. A Rabbi Trust more than likely has assets subject to the "claims of the company's creditors". Add just a little more protection with the moglia language which is "subject to the claims of unsecured general creditors". The general credit line may be shorter than the secured creditors, as was the case in Bank of America N.A. v. Moglia [330 F.3d 942 (7th CIR 2003)] case.

5. Determine Who Should Be Eligible.

One of the major advantages of NQDC plans is that the company can be "selective" in determining who should be eligible. In fact, because the plan is "nonqualified" the company may only offer this plan to a "select group of highly compensated and/or management personnel" in order to not be subject to onerous reporting, filing, and fiduciary responsibility found in "qualified" plans like the 401(k). One area of increased prevalence has been to add highly compensated sales people as well as middle management to the plan.

4. Determine Amounts to Defer.

NQDC plans can allow participants to defer most of their salary, bonus, commissions, and long-term incentives. Best practice plan designs allow 80-90% of salary and 100% of other compensation (i.e., signing bonuses and relocation packages) to be deferred.

3. Set Timing of Deferrals.

409A has allowed more flexibility in this area. Participants need to make their elections for salary deferrals in the calendar year prior to earning the salary. However, we have more flexibility with "performance-based" bonus compensation. The new law allows the election to be made "up to six months prior" to the end of the performance period. Therefore, on calendar year plans, elections can wait until June 30th of the year the bonus is earned. The following chart illustrates the new provision.

The timing of the bonus deferral could also be advantageous to long-term performance plans. As long as deferral elections are made 6 months prior to the end of the performance period the bonus can be deferred.

2. Consider A Company Match/Contribution

Companies that match participants' deferrals have higher participation levels. However, such a match has a company cost. Company matches can help the company attract, retain, and reward its most valuable asset, key people. If your company is funding its plan with mutual funds or COLI, you may have the dollars you're looking for right under your nose. It may be well worth an evaluation of your current funding if you have not done so in the last 18 months. In fact, RCG's process guarantees to find savings if a plan is two years old or more. If savings are not found, RCG will refund 100% of its consulting fees. The dollars saved can reduce the shareholder's cost or be used to offer a company match.

1. Review Plan Administration

Last, but not least, you should review how the company administers the plan. An "unbundled" review could not only find cost savings, but is typically a more effective system. Unbundled means separating plan funding from plan administration.

Who is Retirement Capital Group?

Retirement Capital Group (RCG) is one of the nation's leading executive benefits consulting firms. RCG takes a fresh approach to designing, funding, implementing, and administering nonqualified executive benefit plans. One thing that dramatically increases the flexibility of your plan design, significantly reduces the cost and complexity of managing your assets and administration, and delivers a single point of contact is an "open architecture" business model approach.

RCG's consultants, led by industry leader William L. MacDonald, RCG's founder, has numerous years of experience designing plans for hundreds of Fortune 1000 companies. RCG's business model gives it a competitive advantage over most of the industry