Opportunities Abound In Non-Qualified Deferred Comp

What is non-qualified deferred compensation? A non-qualified deferred compensation plan is typically a written agreement between an employer and employee to defer certain compensation to be received by the employee. The highly flexible technique provides meaningful benefits to select employees and allows the employer control in plan design to, among other things, determine benefit levels and which employees are covered.

The plan is "non-qualified" because it intentionally fails to qualify for an income tax deduction when the employer enters into the agreement. The plans are also "informally funded." This means that the employer makes an unsecured promise to pay additional income to the employee at a future date.

Employers frequently use life insurance to provide a future source of funds in a non-qualified deferred compensation plan. The technique is fairly simple. When the plan is being put in place, the employer purchases a permanent life insurance policy on the employee. The policy provides part or all of the employers funds to pay the deferred compensation to the employee, as well as tax deferral on policy earnings.

It is also significant to note that unless life insurance is used to fuel the plan, investment gains on funds set aside will be taxable to the company. The cash value inside a life insurance policy, however, grows on a tax deferred basis (subject to possible corporate alternative minimum taxes).

Despite the dramatic ongoing changes with split dollar, an "endorsement" arrangement should typically be used with a non-qualified deferred compensation plan. Since the employer is already informally funding the plan with cash value life insurance, it may as well use an endorsement plan to provide the executives beneficiary with an income tax-free pre-retirement death benefit.

Finally, it is particularly important that the insurance carrier with whom you choose to work offer products with features designed for this market. In particular, a company implementing a non-qualified deferred compensation arrangement will prefer insurance contracts with high surrender cash values in the early years. In addition, make sure the carrier provides a turnkey marketing kit, offers specimen documents, preferred third-party administration, customized illustration capacity and advanced sales support to assist you in your efforts.

As in any complicated planning technique, the producer should take the time to immerse him or herself with in-depth information and analysis of the concept. The benefit will be well worth the cost.

As the baby boomers begin to hit the golden years, and as employers will be looking for ways in which to attract, retain and reward the dwindling supply of workers, they will be looking to you for solutions. Spending time learning the non-qualified deferred compensation market will not only allow you to provide a valuable service to a lucrative market, but you might also find some great new cheese.

Daniel J. Munroe, JD, CLU, is director of advanced marketing for MONY Partners, Hartford, Conn. He can be reached at [email protected].

Reproduced from National Underwriter Edition, June 23, 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.