Why Employers Use Nonqualified Deferred Comp Plans

As the federal income tax structure is being re-tooled yet again, employers are evaluating the use of nonqualified plans as a strategy for positioning the organization’s executives to save more effectively for retirement. Why employers use nonqualified deferred comp plans includes benefits both for the organization and for its executives, although, when you think about it, shouldn’t it always be true that what is good for the company is also good for its leadership team and vice versa?

There’s a Gap at the Top

The restrictions imposed on how much workers can save in pre-tax dollars for their retirement create a savings gap for highly compensated executives (HCEs). The gap is the difference in what it would cost to maintain or approximately sustain an HCEs present lifestyle and the amount the executive will draw in social security benefits plus the amount the executive is permitted to save through a qualified plan.

Saving through a 401(k), (one of the most widely used types of qualified plan) includes the following limits on pretax deferral of compensation for 2021:

• A wage-earner whose annual compensation is $95,000 can contribute 20.5% of that earnings on a pretax basis to a 401(k).
• A wage-earner whose annual compensation is $150,000 can contribute 13% of that earnings on a pretax basis to a 401(k).
• And wage earners at $300,000 per year can only contribute 6.5% of their earnings, or 3.9% of their earnings if their annual compensation reaches $500,000.

The gap is evident. Without the use of a nonqualified deferred compensation (NQDC) plan, a highly compensated worker is challenged to save efficiently for retirement.

A Winning Strategy

Organizations that can offer key talent opportunities to bridge a executive’s retirement savings gap immediately gain a competitive edge over organizations that leave executives to figure out their financial challenges on their own. A well designed non qual deferred comp plan differentiates an organization from its competitors.

Recognizing that employees are a company’s most valuable asset, an employee-centric NQDC plan can be a powerful tactic to help companies attract, retain, and reward talented workers.

A well-designed NQDC Plan:

• Is customized to meet specific objectives of the organization and/or its executives
• Is not restricted by the kinds of limitations placed on qualified plans or the limitations of social security.
• Permits executives to save toward pre-retirement goals such as their children’s college educations or a vacation home or travel
• Allows the company to have a retirement-related performance-based compensation strategy.

Not only are changing tax laws a reason for employers to revisit the structure of their nonqual plans, the changing economy and the availability of new investment strategies are another  motivation for organizations to work with an experienced executive benefits advisory team.

If your organization does not offer its top talent a nonqualified deferred compensation plan, you have to question, “why not?” And if it does, now is the time for review and evaluation to see if your company can improve its plans while potentially lowering their costs.