Post-Recession, EOLI Sales Are On The Mend

Contributing to the market recovery is a favorable regulatory environment. Reflecting a view widely shared among experts interviewed by NU, Schiff says the recently finalized Internal Revenue Code section 409A, governing NQDC plans, has been a "good thing" for the industry. The reason: The code has clarified how businesses can structure the plans without running afoul of IRS scrutiny that could render the plans invalid and result in financial penalties.

An outgrowth of the 2004 American Jobs Act, 409A codifies rules for the design and operation of NQDC plans. The payment of benefits, for example, is permitted only following certain distribution events (e.g., the death, retirement or disability of a key executive). And the plans must follow restrictions on both the timing of deferrals and changes to distribution elections. The legislation also prohibits plan language that accelerates benefit payments, such as withdrawal (or haircut) provisions.

As a result of the requirements, the design of SERPs and NQDC plans changed as plan sponsors revised their arrangements to comply with the new statute and related regulations. But most of the adopting firms are mid-size to large businesses that have the financial wherewithal to deal with the cost and complexity of plan administration, observers say.

For many small businesses, alternatives to EOLI-funded NQDC plans, notably Section 162 executive bonus arrangements, are more attractive because they're exempt from 409A. Chartered financial consultant Elizabeth Samson, Beverly Hills, Calif., says that she's doing a brisk business marketing these plans. Though funded like deferred comp arrangements by the employer, the plan policies are owned by the executives. The benefit to employers: They get a tax-deduction when benefits are paid.

Michael Nolan, who has compared Section 162 bonus and NQDC plans under the current tax regime, observes also that executives enjoy a "substantially higher" pre-tax and after-tax income when receiving a bonus plan. This advantage, combined with a lower cost of administration, makes the plans especially attractive among pass-through entities–S-corps., limited liability companies and partnerships–that treat the business's income as that of the individual owners or investors.

But Nolan says that NQDC plans are a superior employee retention tool.

"If the goal is to keep executives loyal for the long term, then nonqualified plans are the better option because you're not paying out the benefit right away," says Nolan. "I think we'll continue to see an increase in the adoption of bonus arrangements among small businesses and EOLI-funded deferred comp plans at medium to large public and privately C-corporations."

Richardson agrees, saying the expertise required to administer NQDC plans should not deter advisors prepared to specialize in a promising market niche.

"Once the eligible participants are identified, the fun begins with designing a plan," Richardson says. "Don't let 409A intimidate you. Within that complex set of rules is a fairly open playing field."

To be sure, not all businesses are funding their NQDC plans with EOLI. NYLEX's clients use EOLI-type (institutionally priced) contracts that are owned by the plan participants, says Schiff. The policies thus are portable, afford executives protection from employers and creditors, and let them draw against the cash value through loans and withdrawals on tax-free basis.

"These contracts effectively provide the after-tax benefits of a Roth IRA," says Schiff. "The policy values grow tax-deferred and can be accessed tax-free. Employee-owned contracts also appeal to executives who are hesitant about funding a deferred plan, because they believe they'll be in a higher tax bracket when they take the money out and have to pay tax on the benefit."

However structured, sources say, new and revamped executive comp plans are increasingly being tied to performance metrics, such as growth in gross sales. Typically, says Schiff, a percentage of the compensation is based on overall company results, but at least 60% of pay will hinge on the executive's own performance.

To insure the plans perform as expected, many firms since the recession have adopted a more conservative investment orientation, using whole life, universal life and (depending on cash flow needs) term life from AAA carriers to fund their EOLI plans, according to sources. The more conservative tilt has been in evidence, too, among businesses that continue to use market-driven variable and variable universal life contracts.

"Businesses still want variable life policies to fund non-qualified executive comp arrangements, but since the downturn, many have been directing more premium dollars to the contracts' fixed accounts," Nolan says. "Other firms are offering synthetic fixed accounts: They bear the investment risk of the variable policies and guarantee a certain rate of return to executives. These arrangements are quite popular among our clients."