Deferred Compensation Plans

If your business is thriving in today’s competitive business marketplace, it’s likely because of a few mission-critical players in your organization. You know the types: the go-getters, the winners, the difference makers, the keepers, the next generation of owners, the best-of-the-best employees, the ones that are hard to get and even harder to keep. Current compensation and benefits keep them happy, productive and motivated. But what keeps them there for the long run? The company needs to offer them a powerful incentive such as a benefits package based on performance, stability and even ownership.

Non-qualified deferred compensation (NQDC) arrangements can help you attract, retain and reward your most valuable and “mission-critical” employees. They are designed by the company to help their key employees grow and flourish with the company. They can also allow for flexibility and customization. The “art” of designing company compensation arrangements is in understanding the laws of taxation, the power of tax deferral and the power of tax-deferred investing.

Unlike a tax-qualified arrangement, which is non-discriminatory, a non-qualified arrangement can be discriminatory. A company should select only those key employees they want to protect and reward, designing payment schedules that emphasize those aspects of compensation they wish to incent. A Non-qualified Deferred Compensation (NDQC) plan is an arrangement where an employer promises to provide compensation to an employee in the future, typically at retirement. The employer can use the plan to provide extra benefits to key employees over and above the limitations on qualified plans such as 401k and profit sharing plans. These arrangements provide “golden handcuffs” on the key employees to the extent that employees who terminate prior to vesting are not entitled to any benefits under the plan.

There are three key pillars in a secure financial planning foundation: protection (smart risk management), growth (creation of wealth) and preservation (asset protection and estate planning). Without proper protection planning, all of your visions of a secure future for you and the generations to come can be easily toppled.

How the Deferred Compensation Arrangement Works?

  1. The company enters into an NQDC agreement with the individual or a group of employees. We’ll help you draft the arrangement documents.
  2. The company then selects and applies for life insurance on the employee with a face amount sufficient to cover all promised death and retirement benefits, as well as optional additional amounts, subject to the plan design. The company is the life insurance policy’s sole applicant and owner, pays all premiums, and retains all rights of ownership.
  3. When the key employee retires, the company can use life insurance policy cash values, dividends, or loans to make the agreed upon payments to the retiring employee.
  4. the company may opt to keep the policy intact after retirement and pay the employee from company revenues. Upon the employee’s death, the company receives the death benefits income tax free, recovering the expense of payments made to the family.
  5. If the employee dies before all payments are made, the employee’s dependents receive the balance of payments. If the employee dies before retirement, lump sum death benefits are paid to the company. The deceased employee’s family would then receive benefit payments subject to the terms of the agreement.
  6. Subject to some limitations, the company takes tax deductions for payments made to the employee or beneficiary. All NQDC payments (taxed as income to the beneficiary) are subject to income tax as and when they are received.
  7. The agreement is terminated when all payments have been made.

Benefits to the Company

  • Retains valued employees until their retirement or specified date.
  • Attracts top executives.
  • Values in a corporate owned life insurance are assets of the company and can be used to offset the impact of benefit liabilities.
  • Coverage may be transferable to either the executive or a replacement executive.

Benefits to the Executive

  • Shifts income from peak productive years to later years where income taxation may be lower.
  • Unlike a traditional increase in compensation, pretax dollars are used to fund the arrangement.
  • Salary may continue to dependents in the case of a premature death.
  • Can supplement pensions and profit sharing arrangements by creating an additional source of retirement income.

When is an NQDC Arrangement Right for Your Company?

  • When you want to provide a deferred compensation benefit to an executive or group of executives but the cost of a qualified arrangement would be prohibitive due to a large number of non-executive employees who would have to be covered.
  • When you want to provide additional deferred compensation benefits to an executive who is already receiving the maximum benefits or contributions under the company’s qualified retirement arrangement.
  • When you want to provide certain key employees with tax-deferred compensation under terms or conditions different from those applicable to other employees.
  • When an executive or key employee wants you to create a before-tax, automatic and relatively painless program that uses tax savings to “leverage” the future benefits.
  • When you need to solve the “3R” (recruit, retain or retire) problem.
  • When your closely held company needs to attract and retain non-owner employees, but the equity-based compensation packages (company stock and stock options) that these employees would expect to receive if they were employed by a publicly held company are not possible.

A Non-qualified Deferred Compensation (NDQC) arrangement is relatively easy to set up and administer but you may require experienced advisers to establish and manage it for you. We have set up and are managing thousands of Split Dollar, Deferred Compensation, Defined Benefit and other Executive Bonus Plans across the country for the last 17 years for everyone from sole proprietorship to large corporations. Please call (877) 972-3262 or contact us for the further information.

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