Featured Articles |
RCG Extras |
Join Our Mailing List |
§409A Final Regulations on Deferred Compensation Plans, This Time For Real - No More PostponementsTen Things You Should Do Before December 31, 2008William L. MacDonald
Now that proxy season is nearing an end throughout the public company world, it may be time to turn your attention back to the final run to compliance with IRC Section §409A. You may have begun this process in 2006 and 2007,only to have the IRS postpone the compliance deadline at the last minute each time, however, this time it’s for real. The IRS has made it clear that there will be no more extensions. The final deadline for compliance is December 31, 2008. The good news is that we know a lot more about the details of §409A, as we have been down this road before. Final compliance should be a little easier as we are now able to follow an established process and start from model language that has been developed. The good news is, the IRS has also created a self-correction program for §409A errors. Although §409A impacts many of your compensation arrangements, this article will focus solely on voluntary nonqualified deferred compensation arrangements. You should however, identify all your benefit plans and compensation arrangements that could be subject to IRC Section 409A (this is not as easy as it sounds, as §409A's reach is very broad), and determine the impact of the new rules on each plan, program, and agreement. There will be opportunities before year end to redesign each plan and agreement both to comply with the new rules and to give participants the maximum flexibility to plan for their futures. Nonqualified Deferred Compensation Plans (NQDC) are an important part of an executive’s total compensation package, allowing the 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 more flexibility than originally expected. This article will discuss ten things you should do before year end to add more flexibility and security to your plans (Chart I).
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:
Best Practices Best practice design features 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 now to get maximum value from your plan in 2008 and beyond.
10. Make Your Final Distribution Elections Before December 31, 2008 Section 409A is going to give you one more chance. You may have made previous deferral elections to 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 plan change. This relief provision only applies to 409A compliant plans. Example: In 2007 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 and/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 participants 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 an unlimited number 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.
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.
7. Consider 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 portfolios as an option in the investment menu. Few nonqualified plan administrators offer this best practice feature. When offered to participants, over 60% utilized the model portfolio options. Advantages include:
6. Review Benefit Security In most cases, companies that informally fund NQDC plans also place their assets in irrevocable grantor trusts referred to as Rabbi Trusts. These trusts protect participants from all contingencies, short of corporate 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 participant’s account against:
As stated earlier, no protection against bankruptcy exists. However, from a best practices standpoint, companies are implementing two additional safeguards.
5. Add Executive Roth Feature With the added benefit security issues and loss of flexibility under 409A, you should consider offering participants an “after-tax Executive Roth” arrangement that can provide non-taxable income at retirement and a benefit that is fully secured against the company’s creditor. This feature is not subject to 409A. The Executive Roth Plan (ERP) allows participants to defer a portion of their annual contributions (or to re-defer a portion of current balance) into the ERP. The ERP achieves its tax advantaged status through an institutionally-priced variable insurance policy not generally available to individuals. The policy has 100% cash value in year one, with no surrender charges. It offers more than sixty investment alternatives called subaccounts from fund managers such as American Funds, Fidelity, Franklin Templeton, and more. One of the disadvantages of an after-tax plan is the loss of the invested principal each year due to taxes (on contributions, not earnings). At the participant’s discretion, after-tax contributions to the plan can be supplemented by a tax restoration account internal to the insurance contract.
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 contributions 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. 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.
Conclusion Nonqualified deferred compensation arrangements are an important part of an executive’s overall wealth accumulation for retirement. Now that the rules have changed, and some of the key features that gave us more security and flexibility are lost, we need to determine how pre-tax nonqualified deferred compensation plans will work in concert with other strategies. Taking advantage of this window under 409A transition relief is important. You now have an opportunity to make final changes to your plan that will impact you for years to come.
Investors should consider the investment objectives, risks and charges and expenses of the contract and underlying investment options, risks carefully before investing, The prospectus contains this and other information about the investment company and must precede or accompany this material. Please be sure to read it carefully. The opinions, estimates, charts and/or projections contained hereafter are as of the date of this presentation/material(s) and may be subject to change without notice. RCG endeavors to ensure that the contents have been compiled or derived from sources RCG believes to be reliable and contain information and opinions that RCG believes to be accurate and complete. However, RCG makes no representation or warranty, expressed or implied, in respect thereof, takes no responsibility for any errors and omissions contained therein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this presentation/material(s) or it contents. Information may be available to RCG or its affiliates that are not reflected in its presentation/materials(s). Nothing contained in this presentation constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any investment product. Investing entails the risk of loss of principal and the investor alone assumes the sole responsibility of evaluating the merits and risks associated with investing or making any investment decisions. Securities Offered Through Retirement Capital Group Securities,
|
