Why Executive Retirement Savings Plans Benefit from NQDC
Executive retirement saving plans may receive less attention than the retirement readiness of a company’s workforce. NQDC plans help balance this disparity in saving opportunities.
How Qualified Plans May Be Failing to Serve Executive Retirement Savings Goals
In their role as retirement benefit plan sponsors, many companies recognize that equipping employees with tools to help workers save more effectively is a win for the employee and a win for the company. When companies help workers reduce or alleviate worries about their future financial stability, typically by offering a qualified plan, employers free their team to focus on the job at hand. The results often include increased job satisfaction and greater productivity.
But Who Is Looking Out for the Team at the Top?
Companies, in general, are paying increasingly better attention to the retirement readiness needs of their valued workforce. Executive retirement saving plans, however, may receive less attention. Perhaps there is a perception that highly compensated employees (HCEs) don’t need retirement plan education or that “saving is easy” when you earn a higher salary.
Ironically, the limits imposed on qualified plan savings work against the savings objectives of the team at the top—a company’s “franchise players,” HCEs, and key executives. Even the HCEs themselves may not realize they need additional tools and strategies to help them avoid the retirement savings gap that, as a higher-wage earner, they likely experience.
How Much Retirement Savings is Enough?
For many years, standard wisdom has said that if workers save the equivalent of 70 to 80 percent of their annual salary for each year of their retirement, they will be sufficiently prepared and “retirement ready.”
But many workers question this rule of thumb, wondering if 70 percent of pre-retirement earnings will be sufficient. With travel and a bucket-list of interests and goals, dialing lifestyle back by 30 percent can seem like an uncomfortable plan.
Now factor in an inflationary economy, the possibility of high medical expenses, and the reality that actuarial projections could be off base for any individual, with a fit and healthy retiree living years beyond the norm. How much retirement savings will be sufficient to cover any or all three scenarios?
Limitations on Qualified Plans Hurt Executive Retirement Savings
Compounding the problem of high-wage earners saving “enough” for a comfortable and fulfilling retirement, whatever they determine enough to be, are the limitations on qualified plan savings. These limitations cap the amount of pre-tax earnings that a worker can save through a qualified plan, such as an IRA, 401(k) plan, or 403(b) plan.
For example, based on regulated 2022 limitations, a worker can contribute up to $20,500 to a 401(k) plan or $27,000 if the worker is over age 50. The cap on contributions is fixed, which means that an HCE may be able to save on a pre-tax basis, only a small percentage of earnings, and that the more the individual earns, the lower that percentage becomes.
The chart below shows how workers earning $100,000 annually can potentially save on a pre-tax basis, up to 27% of their annual income toward their retirement through a qualified plan. In contrast, workers earning twice as much, $200,000 annually, can only save up to half as much at 13.5% of their yearly earnings. And workers earning $400,000 annually can save an even smaller percentage at only 6.75% of their annual salary.
Information is based on 401(k) limits as established by the Department of the Treasury, IRS for 2022 and published November 17, 2021. https://www.irs.gov/newsroom/irs-announces-changes-to-retirement-plans-for-2022
Limitations on Social Security Benefits Hurt Executive Retirement Savings
In combination with their retirement plan, most people count on their social security benefits to provide a portion of their retirement income. Again, the greater the individual’s earnings, the less by percentage he or she will receive upon retirement in social security retirement benefits.
A worker who earned $50,000 annually and faithfully contributed the maximum amount allowed to a qualified savings plan can retire at the age of 67 and will draw, thanks to social security and retirement savings, approximately 95% of the amount that worker was earning before retirement.
By comparison, a worker who earned $450,000 in annual compensation and who also contributed the maximum amount permitted to a 401(k) plan will, when retiring at age 67, draw from a qualified plan plus social security, less than 30 percent of the amount the worker was earning annually before retirement.
Assumptions: Employee, age 45, contributes 10% of pre-tax salary to a qualified plan. Plan sponsor matches $0.50 of the first 6% contributed. The employee’s salary increases 3% per year and contributions up to the maximum allowed by law. Contributions grow tax deferred at 7% annual interest. At age 67, the employee’s account balance is paid out in 4% installments. Values shown include income from Social Security and historical contributions to a 401(k) but assume no other sources of income. Past performance cannot predict future results. Source: PLANSPONSOR & Prudential: Why Employers Should Care About the Cost of Delayed Retirements.
How a Nonqualified Deferred Compensation Plan (NQDC) Can Help Fill the Gap
Understanding the savings opportunity gap takes us back to the question, “who is looking out for your organization’s team at the top?”
A nonqualified deferred compensation plan is purposefully intended to offer organizations a strategy for alleviating the savings opportunity imbalance. With continuity of leadership having never been more important for organizations, rewarding and retaining key executives can be critical.
Here are only a few of the ways an NQDC plan can support the savings objectives of HCEs.
- A nonqualified deferred compensation plan positions plan participants to save pre-tax contributions beyond the limits of a qualified plan.
- Depending upon how a nonqualified plan is structured, distribution options can provide valued flexibility, providing plan participants access to their savings before they reach retirement age.
- NQDC plans can be linked to performance goals.
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