Creating the right compensation and benefit strategy can be one of the most critical steps to ensuring any businesses lasting success. In fact, in many cases the achievement of any business can often be determined by the strength of its key employees. A key employee plays a massive role in the organization and keeping those valuable resources happy can cause them to be dedicated, engaged, happy and connected to the company long term. More engaged and loyal employees are a great recruiting tool, too.
Businesses that lose key employees might be drawn to a competitor that offers superior benefits. Many business owners wonder if there was a way to create a compensation plan to help recruit and retain these key employees, making sure they do not find employment elsewhere. Offering the right benefits can make all the difference.
If you have not heard of Non-Qualified Deferred Compensation (NQDC) plans, let me be the first to introduce the concept. Different companies and owners have different needs, and your benefits package should reflect that and there is no more unique and flexible retirement plan than an NQDC plan. A business may have key employees who may need help with retirement income. Or, perhaps right now a business owner is more interested in keeping key employees from going to a competitor. There are so many things an NQDC plan can do, summarized best in the Four R’s:
It doesn’t matter if your organization is a for-profit restaurant or a tax-exempt nonprofit. Each NQDC plan is structured to achieve the unique goals of the sponsor organization. Some offer NQDC plans offer tax benefits for your business, other plans are designed for the plan participant. You may create an NQDC Plan that allows for participant deferrals, discretionary employer contributions, or both. These plans are both discretionary and extremely flexible unlike 401(k) plans which can be very costly and restrictive on employer contributions to one class of employee or another.
Regarding employee retention, the NQDC plan offers several unique attributes not available in typical plans specific to when a plan participant has a right to the employer contributed money in the plan. A vesting schedule is put in place to match the desired incentive of the organization. When thinking about the right vesting schedule it is easy to see how NQDC plans can be referred to as “Golden Handcuff” plans as ultra-long term vesting schedules could be put in place to make sure the best employees stay for the long term.
Financing these plans can also be done creatively which is very different than their 401(k) cousins. How key employees’ benefits are paid in the in the future can vary. NQDC plans allow a company to finance the plan however it works best for the organization’s bottom-line goals. Common financing techniques and detailed models help illustrate what is possible to make an informed decision. These are four common ways a company finances a NQDC plan on an annual basis when making contributions to employees:
- Company cash, using company cash-flow
- Taxable investments, such as mutual funds
- Corporate-owned life insurance (COLI)
- Dual-financing, with a combination of taxable investments and COLI
Okay, this seems great, but how does this work for a typical business? A typical plan design for an NQDC plan could work and look something like this:
- Employer identifies its most key employees and can freely discriminate who can participate in the plan.
- Employer creates an incentive plan to provide clarity on a reasonable annual NQDC employer contribution. Perhaps a formula on a percentage of company growth year over year? A sales target and an amount of sales or profit over a certain number goes into the plan in the form of an NQDC contribution? The options are as limited as a business owners’ imagination.
- If the plan is funded, the contribution goes into the employee account and invested as the employee sees fit choosing from a mutual fund lineup just like a traditional 401(k) plan that they may already be used to.
- In this case listed above, the employer WOULD NOT be able to deduct the money contributed into an employee NQDC account. The employer deduction is delayed until the money comes out in the future.
- The employee DOES NOT get taxed on the money in the account which is very favorable for them.
- The money would be invested in a corporate owned life insurance policy and grow without taxes owed.
- The business would have a death benefit in the event of an untimely passing of their key employee which can come in handy should something unfortunate occur.
- When the employee takes money out of the NQDC plan down the road, the business can then deduct the amount taken out as paid salary to the employee.
- The employee then picks up the distributions as ordinary income.
The above list is for illustration only. An actual NQDC plan has many options, wrinkles and considerations. Before considering a plan like this, you must absolutely consult your Henry+Horne tax advisor in addition to an implementation expert to fully understand all of the unique features of an NQDC plan and make sure it is compliant with Section 409A of the Internal Revenue Code.
A successful business provides financial well-being to the owners and its employees. The proper compensation and benefits strategy for key talent help the company protect it. A well designed NQDC plan can be put together to help achieve any one of several objectives:
Protect your business– Plan for the future with buy-sell and business-transfer strategies for closely held companies, key-employee benefits, and key-person protection. An NQDC plan can be part of a foundational effort to make this happen.
Protect your employees– Recruit and retain good people with key employee benefits, qualified retirement plans, and group benefits.
Protect your lifestyle– Maintain your family’s current standard of living with life insurance and disability income insurance, and help meet lifetime objectives through legacy and estate planning.
Michael Carlin, AIF®
1 – 2017 Trends in Nonqualified Deferred Compensation, conducted by Principal