Attitudes and Practices in the Executive Benefits and Deferred Compensation Marketplace
In the fall of 2006, MullinTBG and PLANSPONSOR magazine co-sponsored a survey of 1,500 employers to learn more about current attitudes and practices in the nonqualified benefits marketplace. The 355 survey respondents comprised a broad representation of the American economy, ranging from multibillion-dollar public companies with more than 100,000 employees to small private companies with fewer than 100 employees (see Figure 1). More than two dozen industries were represented (see Figure 2) by companies ranging from small businesses to Fortune 100 giants, with annual sales from under $10 million to over $40 billion (see Figure 3).
Each responding company took time to provide valuable feedback and reflect on what was important to their leaders and other key talent in the areas of executive benefits and deferred compensation. This article highlights current nonqualified benefits trends â what is prevalent, what is changing and how effectively these plans are meeting the needs of sponsoring companies and the employees who participate in them.
Nonqualified Benefits Offered
Nearly all respondents offer key employees both group life insurance and group long-term disability plans. While protecting against life or health catastrophes may seem an obvious strategy, respondents also recognize the value of providing nonqualified plan benefits to key employees for the purpose of saving significant tax-deferred amounts for the future.
Of the 355 respondents, 352 offer some type of nonqualified plan, such as a supplemental retirement plan (commonly called a SERP) or stock plan (phantom, restricted or options). Nonqualified deferred compensation plans (NQDCP) are extremely prevalent, sponsored by more than 85 percent of all respondents. This popularity may stem from a key NQDCP differentiator â plan participants agree to defer a portion of their own compensation in exchange for their companyâs promise to pay future benefits, as opposed to most other types of nonqualified plans in which sponsoring companies foot the entire cost.
Although nonqualified plans are common, a companyâs size has some bearing on the decision to implement such a plan. Companies with annual revenue of more than $1 billion offered these types of plans almost 90 percent of the time, versus just over 79 percent of smaller companies.
Large companies have long been the trendsetters in using nonqualified plans to win the war for top talent. The ability of these plans to attract, retain and reward executives may be vital for industry-leading companies whose highly valued employees are, more than ever, prime targets for companies looking to raid a competitorâs human capital. And, given the general popularity of NQDCP at companies with revenue under $1 billion, growing enterprises appear to understand the need to implement strategies that give them a competitive advantage as they vie with industry giants for the best people.
Rationale for Offering an NQDCP
Survey results show that when asked their primary reason for offering an NQDCP, employers are split almost equally between the need to attract and retain top management talent and their desire to provide key managers and leaders with a way to accumulate retirement savings. Restoring lost 401(k) contributions and providing a vehicle for preretirement savings are also considerations.
Compared with the overall group, smaller companies (less than $1 billion in annual revenue) are more concerned with the ability of an NQDCP to restore 401(k) contributions lost due to various Internal Revenue Service and plan-testing limitations. Larger companies, however, view the NQDCP as a way to increase overall savings by providing both pre- and post-retirement savings opportunities. Regardless of company size, respondents feel that attracting and retaining key talent is of utmost importance.
Reasons Given for Not Offering an NQDCP
Of the nearly 15 percent of respondents that do not offer an NQDCP, 85 percent do not plan to. The reason most frequently given is lack of demand from key employees for a deferral opportunity. Another reason is that such a plan does not fit respondentsâ corporate culture. A small number of replies cite considerations such as regulatory compliance, accounting challenges and the administrative burden.
Plan Participation
Survey respondents report a broad range of participation rates in NQDCP, from less than 3 percent of the eligible population to a high of 100 percent (see Figure 4). Average plan participation is 52.6 percent, and plans are administered for as few as two participants to as many as 3,500. Generally, the smallest plans (fewer than 10 participants) have the highest participation rates (80 to 100
percent). Yet some of the largest plans
in the survey also show extremely high rates of participation (more than 70 percent). This may be due to the fact that
85 percent of these larger plans offer a company match, which strongly suggests that the match provides additional incentive to participate.
In fact, other survey data indicate that the rate of participation in an NQDCP correlates strongly with whether or not the company offers a match. Of 115 respondents who provided information on both participation rates and company matches, the survey data show 62 percent average plan participation when the company offers a match, versus an average 40 percent participation where there is no match.
Survey respondents rank plan education and communication, plan flexibility and investment options among the most important factors employees consider when weighing whether to participate in a company-sponsored NQDCP. Internet access to plan information and benefit security, including informal funding, were cited as less important.
Active employees between 40 and 65 years old are most likely to participate in an NQDCP. Active employees over the age of 65 and those under 40 are the least likely to participate. This statistic may raise a note of concern for employers beginning to grapple with the effect of baby boomers exiting their workforce. To retain this increasingly scarce talent segment, companies will need to design plans with features more attractive to younger key managers and ensure that eligible employees are thoroughly educated about the importance and benefits of long-term participation.
To encourage plan participation, sponsors generally provide an attractive crediting rate and/or a broad choice of investment tracking funds among which participants can allocate their deferrals (nonqualified deferrals are not actually invested in the tracking vehicle). The overwhelming crediting choice (81 percent) is tracking benchmark fund returns, either stand-alone mutual fund returns or investment option returns, inside a corporate-owned life insurance (COLI) product. Running a distant second (25 percent) is tracking an index (e.g., Moodyâs Corporate Bond Index). Although the majority of both large and small organizations choose benchmark funds as their primary source crediting option, the data indicate that smaller companies are less likely to opt for an index target and are more likely to choose mutual funds than their larger counterparts.
NQDCP Effectiveness
When asked how effective their NQDCP is in achieving its objectives on a scale from 1 to 10 â with a score of 6 or higher considered âmeeting expectationsâ â respondents give their plans an average rating of 6.8. Smaller companies report a higher level of satisfaction with their plans, compared with the overall group.
Of the 22 percent of respondents whose plans failed to meet expectations, the most frequently cited shortcoming was overall plan features (50 percent), followed by inadequate plan communication to eligible employees (39 percent). Issues with plans that have no security device or are too complex to understand are cited less often.
Informal Funding and Benefit Security
Informal funding can serve to offset a companyâs growing plan liability. For participants, knowing their company has utilized informal funding to secure future benefits may help instill confidence in the planâs long-term viability. Companies with an NQDCP recognize this twofold value, with 71 percent choosing to informally fund their plans.
The largest companies, in particular, realize the benefits of informal funding (more than 75 percent) and are equally likely to use corporate-owned life insurance and mutual funds (each being used by 36 percent). Of the surveyâs smaller company respondents, more opt for mutual funds first (56 percent), with COLI and cash tying for second (24 percent).
To provide participants with a level of benefit security, 75 percent of respondents employ a rabbi trust, which is created to provide some assurance that future benefit obligations will be satisfied in situations other than bankruptcy. Most of the remaining respondents use no security vehicle at all.
Changes to Plan and Benefits as a Result of 409A
The American Jobs Creation Act of 2004 created IRC Section 409A, which requires all types of deferred compensation plans to adhere to certain rules in order to maintain their tax-advantaged status. Final clarification of 409A rules was still pending at the time of the survey; however, plan sponsors were required to operate plans in âgood faith complianceâ prior to final guidance. Upon examination, many companies found that their plans would require changes in order to maintain compliance with Section 409A.
More than 180 companies responded to the surveyâs question about changes they made to their NQDCP as a result of the new legislation (many chose multiple answers). Of these respondents, approximately two-thirds adopted the new form and timing of distribution and election requirements. More than half of this group grandfathered prior deferrals and established a new plan for post-2004 deferrals.
The data indicate that the remaining choices were far less compelling to plan sponsors. Only 18 percent of companies grandfathered prior deferrals for retired and nonactive participants and applied 409A to active participantsâ prior and future deferrals; 8 percent terminated their prior plan and established a new plan; 6 percent simply eliminated elective deferrals; and 7 percent chose âother,â which included write-in responses such as having added the plans after the new regulations were established (thus, being compliant) and holding off on changes until they heard from outside counsel regarding final 409A guidance.
Selection of an NQDCP Provider
Among six ranking criteria offered, plan sponsors found the greatest value in providers with the highest quality of service and recordkeeping systems and the most nonqualified plan expertise. The survey indicates that companies assign more importance to experience and ability than price.
Summary
NQDCPs continue to be very popular tools for attracting and retaining management as well as providing retirement savings opportunities for key employees. As the volume of baby boomers exiting the workforce continues to escalate, companies need to structure these plans to increase their employeesâ understanding and participation. This will be crucial for retaining top talent to create value over the long term. Even in the key executive ranks, education about plans is critical to their usage. Participants want to understand how nonqualified plans coordinate with qualified plans (such as 401[k]) and function most effectively as part of an overall financial planning strategy. The data from this survey supports the logical conclusion that an NQDCP provider that delivers crucial communications and educational support to participants is important to plan sponsors, who choose to work with these vendors based primarily upon quality of service and record keeping, along with specialized knowledge and experience.
