Due to the restrictions on qualified plans, especially for higher compensated executives, employers are increasingly turning to nonqualified plans to recruit, retain, reward and retire key employees. These plans fall under the descriptions and rules provided in Internal Revenue Code §409A and include popular plan types such as traditional, nonqualified deferred compensation (NQCD) and Supplemental Executive Retirement Plans (SERPs). For both arrangements, the employer makes a contractual promise to pay an employee compensation in the future in exchange for their employment and, sometimes, meeting performance goals.
In order to meet the future compensation obligation(s), employers most often purchase cash value life insurance policies. The attractive tax benefits typically make life insurance the most efficient asset a company can own to informally fund nonqualified plans. Among these benefits are tax-deferred growth, tax-free distribution and an income tax-free death benefit which can meet several plan goals.
Experts in executive benefits, the team at the Cowart Group designs nonqualified strategies that function either as defined benefit or defined contribution plans.
Under a defined benefit nonqualified plan, the contract between the employer and participant explicitly lists, or defines, the future compensation benefit. An appealing attribute of a defined benefit plan is the flexibility for how the defined benefit might be earned or distributed. Such flexibility can take into account years of service and performance and provide options for payout under a long-term disability or death of the participant.
Here are some examples of contractual, nonqualified defined benefit promises:
- If the executive remains in employment for at least ten years, the company will pay the participant, at age 65, $100,000 a year for 20 years.
- For each year the executive remains in employment after five years, the company will pay the participant, at age 65, an additional $20,000 a year for 20 years.
- For each year of employment that the participant achieves established performance goals (as listed), the company will pay, at age 65, an additional $25,000 a year for 10 years.
Most agreements also include payment triggers for death or long-term disability that can either pay a lump sum or a stream of payments immediately or at a date or age in the future.
The Cowart Group works with its corporate clients in establishing defined benefit plans that meet the needs of both the employer and the participant.
Under a defined contribution nonqualified plan, the contract between the employer and participant describes the ability for both parties to contribute to the plan, how those sums can growth in value and the conditions under which the accumulated contributions can be distributed.
Some defined contribution plans are structured where only either the employer or executive make pre-tax contributions. Others permit a combination of contributions by both. As with defined benefit plans, the formula laid out in the plan agreement for contributions under a defined contribution plan is flexible and can also take into account years of service and performance as well as including triggers for payment under a participant’s death or long-term disability.
Here are some examples of contractual, nonqualified defined contribution plans:
- For each year of employment, the employer will contribute $50,000 to the plan with payment commencing on the participant’s 65th birthday for 20 years.
- For each year of employment, the participant is given the option to defer up to 75% of their salary with payment commencing on the participant’s 65th birthday for 25 years.
- For each year of employment, the employer will match any deferral made by the participant up to 75% of the participant’s salary with payment commencing on the participant’s 60th birthday for 25 years.
The employer can also select how the contribution plan balance grows. A flat rate of return such as 5%, for example, might be listed. The rate of return could also mirror indices such as the S&P 500 or other investments chosen like those in a 401(k) plan. Some employers may link the contribution plan balance to the growth rate of a company’s public or private ownership shares.
Another distinction of nonqualified defined contribution plans is that an employer can set a vesting schedule on its portion of the contribution. For instance, for every year the participant remains with the company, 20% of the employer’s contribution balance vests.
Navigating how to design and implement a nonqualified defined contribution plan is a focus of the executive benefit planning specialists at the Cowart Group.
The Power of Cash Value Life Insurance
Employers most often choose to purchase cash value life insurance from which to take distributions to meet qualified plan payments. Unlike other asset classes such as stocks, funds or even ‘hard assets’ such as real estate, life insurance offers the employer not only tax-free growth on premiums but the ability to take tax-free loans and withdrawals. These distributions are then used to make compensation payments to the participant where the employer receives a tax-deduction.
If the participant dies during either their employment or during their payment phase, a life insurance policy will pay an income tax-free death benefit to the employer who, in turn, can use those proceeds to make promised death payments under either a defined benefit or defined contribution plan.
Perhaps one of the most least communicated attributes of using life insurance is an employer’s ability to structure a policy to recoup all of a plan’s costs, including the time value of money used to pay premiums from the policy’s death benefit. Effectively, by purchasing cash value life insurance, a company can eliminate the cost of providing a nonqualified plan to its key employees. No other asset class provides this capability.
The Cowart Group is a leader in using cash value life insurance policies designed for the large, corporate market for small and mid-sized employers. These ‘corporate-lite’ policies reduce costs, often remove surrender charges and, under certain circumstances, can even be placed without medical underwriting.
Everyone Is Happy
By offering employees the ability to save above and beyond a qualified plan, an employer is able to recruit the best talent, retain and reward them and see them comfortably retire. The financial professionals with the Cowart Group provide tailored financial solutions to families and businesses that count on our experience and dedication to their success. Our aim to deliver quality advice derives from our relationships with insurers, our underwriting advocacy, and technology resources. We provide strategies and solutions designed to assist our clients in benefiting from and optimizing existing and changing government regulations.