Non-Qualified Deferred Compensation
(Also see Qualified Retirement Plans)
There are two main types of non-qualified deferred compensation plans: Supplemental Executive Retirement Plans (SERPs) and Deferred Savings Plans. Both of these options share several common characteristics; however there are also important differences between the two. For example, eligibility for both plans may be based on the employees’ salary, position, or both. With a deferred savings plans employees are required to contribute their own earnings. With the Supplemental Executive Retirement Plan, executives receive their compensation directly from the company.
To supplement existing qualified plans, Non-qualified deferred compensation plans are used by businesses. Companies have recognized many positives associated with non-qualified deferred compensation plans. One big advantage to non-qualified deferred compensation plans is that they escape the non-discrimination rules imposed on qualified plans. That means businesses can offer the plan to a select group of employees, making it a more cost-effective benefit than a qualified plan and administrative costs are lower as well because the plans are exempt from the U.S. Department of Labor’s reporting requirements.
Supplemental Executive Retirement Plans (SERPs)
SERPs generally are structured to mirror defined-benefit pension plans that promise a stated benefit from the employer at the time of retirement. SERP benefits may be calculated multiple different ways. For example employers may choose to pay their chosen participants retirement a flat dollar amount for an agreed-upon number of years. Another arrangement would be when a percentage of an employees’ salary, multiplied by their years with the company is paid out at retirement; Or even a fixed percentage of their salary at for a set number of years is paid out at retirement.
Companies have a few options of funding SERPs. They can fund through general assets at the time of the employee’s retirement, by Sinking Funds, or by utilizing corporate-owned life insurance (COLI). COLI is generally proven to be the most efficient structure; this is particularly true in the event of an untimely demise due to the insurance aspect completing the plan funding.
Businesses that utilize the Sinking Fund method allocate money on an annual basis to a fund that will cover benefit payments as they come due. This money can be invested by the company as it sees fit, but it is nonetheless earmarked for retirement payments.
When using the COLI funding method, businesses buy life insurance plans on those participants that they wish to compensate. Each company pays the premiums on the purchased policies, and as each participant retires, the firm pays out his or her benefits from operating assets for a previously established period of time. The key benefit for the business owner under the COLI arrangement is that his or her business would be designated the sole beneficiary of the insurance policy proceeds, all proceeds are considered tax-free. At the executive’s death, your company is reimbursed for some or all of the costs of the plan, including the actual benefits paid, the insurance premiums, and the loss of the use of your company’s money for other purposes. Please note that the company will not receive a tax deduction for its contributions to a SERP until the director or executive actually receives the benefit payments. For businesses using qualified compensation plans, they receive tax deductions in the current year.
Deferred Savings Plans
Deferred savings plans are similar to 401(k) plans in that affected employees are allowed to set aside a portion of their salary (usually up to 25 percent) and bonuses (as much as 100 percent) to put into the plan. This money is directly deducted from employee paychecks, and taxes are not levied on the money until the employee receives it.
Executives with deferred savings plans have a variety of payout options to choose from. One option is to set up regular post-retirement payouts for five to ten years after retirement, with the choice of arranging for short-term deferrals to help them pay for a new house, college education for dependents, and other expenses. If an executive enrolled in this type of plan dies or is fired from the company prior to retirement, he or she (or their family) receives a lump-sum payout of their benefits. It should be noted that a nonqualified deferred compensation plan will not be protected from creditors if the company that created them files for bankruptcy.
If you are interested in more information regarding Non-Qualified Deferred Compensation Plans, please contact our office at (301) 590-0006.