Find Opportunity In Making Sure Your Clients Have Enough To Retire

Accumulated values can be used to supplement the employees retirement income. To follow a 401(k) format and provide an incentive, the employer can also match the deferral through an additional tax-deductible match.

Defined Contribution Deferred Compensation Plan. Another popular nonqualified plan design is the defined contribution deferred compensation plan. This employer-sponsored plan allows select key management or highly compensated employees (HCEs), who are limited in their ability to defer dollars to the companys qualified plan, an option of deferring additional income to a nonqualified plan on a pretax basis. The plan can also allow the employer to make discretionary matching and/or profit-sharing contributions to select employees accounts.

Many plans today look and feel very similar to a 401(k) plan because the executive can self-direct his contributions among multiple hypothetical investment options. The employees hypothetical account grows or decreases in value based on the performance of the accounts.

With this plan, participation must be limited to a select group of management or HCEs. This requirement–known as the "top hat" requirement–is necessary to minimize ERISA requirements. To qualify, the plan must also be unfunded, which means benefits are paid solely from the general assets of the employer. Confidence that the employer will be able to meet the obligation is a key factor for the employee. If these requirements are met, the employer only needs to file a letter briefly describing the plan with the Department of Labor within 120 days when the plan is adopted to meet ERISA reporting and disclosure requirements.

In contrast to bonus arrangements, the defined contribution deferred compensation plan provides current tax advantages to the employee. The employee can defer salary on a pretax basis. Therefore, no "tax bonus" is needed from the employer. For the employer, however, this means the tax deduction is delayed. The business will get its tax deduction when the benefit is paid out.

Defined Benefit Deferred Compensation. A defined benefit deferred compensation plan is a fringe benefit provided by an employer for one or more key employees. The employer selects the employees who receive the benefits in addition to their current earnings and other fringe benefits. Additional benefits typically are not in lieu of a raise, bonus or commissions, and the employee is not reducing his or her current compensation. The same top-hat requirements apply to this form of nonqualified deferred compensation plan.

This plan generally provides for a retirement benefit of a certain amount per year for a certain number of years (or for life) based on salary projections. This plan design was the plan of choice in the 1980s, lost favor in the 1990s, but is making a comeback because it offers a fixed benefit. With todays volatile market, a fixed benefit is a real plus to employees focused on meeting their retirement objectives.

In both defined contribution and defined benefit nonqualified deferred compensation plans, the employer makes a contractual promise to pay benefits. Any assets the employer has purchased to informally finance the benefits remain employer assets and are subject to the employers creditors. The employee is in the position of a general creditor of the employer. There are a variety of techniques to minimize the risk, but to avoid taxation prior to receipt of the benefit, the employee must remain a general creditor of the employer.

The retirement gap is a real problem for many of your clients. You can play a key role in helping them identify and fill their retirement gap.

, JD, CLU, is director of advanced markets, Principal Life Insurance Company, Des Moines, Iowa. He may be reached via e-mail at [email protected].

Reproduced from National Underwriter Edition, May 19, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.