Benefits of nonqualified deferred compensation plans for companies and their executives

Nonqualified plans can help navigate unexpected tax burdens

For highly compensated employees (HCEs), tax season can be a complicated matter. In this article, we’ll explore how a nonqualified deferred compensation plan (NQDC) can complement the benefits offered through a tax-qualified 401(k) plan.

Offering key, higher-earning employees a competitive retirement savings package is a major factor in attracting, rewarding, and retaining key talent. Traditional 401(k) plans are the usually the primary retirement option for most companies—and for good reason. The benefit security and tax advantages of a 401(k)  plan are hard to beat. However, administering a corrective distribution of excess contributions due to the 402(g) limit, which restricts the amount an individual can defer into a 401(k) plan during the year, as well as nondiscrimination test results, often leave both human resources (HR) departments and HCEs dissatisfied with the forced reduction in savings.

Aside from the very common occurrence of top earners maxing out their 401(k) contributions early in the year, another big issue with traditional 401(k) plans is failed nondiscrimination testing, which can create administrative burdens for HR departments and an unwelcome surprise for top-earning employees. As noted above, a key consequence of failed testing is the issuance of corrective distributions, which occur when a company must return a portion of the contributions made into a 401(k) by HCEs. This results in tax implications for the employees and additional headaches for company HR representatives. In fact, within the last three years, 15% of companies* have reported that their executives received refunds, or corrective distributions, from 401(k) or other plans.

Leverage nonqualified trends for your business.

Access NQDC Trends Survey Report

Benefits (and costs) of safe harbor plans

Safe harbor 401(k) plans offer a respite from nondiscrimination testing and have been utilized by employers to encourage employee participation, thus helping them save more for retirement. However, the benefits come at a cost, including:

• Mandatory minimum matching or nonelective contributions  
• Immediate vesting of employer contributions, which can remove the retention/seniority incentive for recent hires and potentially result in increased expenses associated with training new employees 
• The need to hire more executive-level talent with higher compensation packages as the company grows larger and more profitable, which can result in benefit programs that do not comprehensively address the needs and employer objectives for all employees

The following table illustrates the potential, hypothetical costs associated with a safe harbor 401(k) plan over a period of five years, based on a company with 1,000 participants and $50 million in its 401(k) plan:

Naturally, the longer the hypothetical company above sponsors a safe harbor 401(k), the more the financial obligations shown in the table will grow.

Advantages of pairing safe harbor and NQDC plans

As a potential complement, NQDC plans can: 

• Supplement employer credits targeted to a select group of management personnel or HCEs that addresses the employer’s specific compensation and retention goals for an individual or the group, without the constraints on vesting or contribution levels that apply to tax-qualified plans
• Allow participants to offset corrective distribution amounts from the 401(k) plan with NQDC deferrals of current year salary, thus restoring the participant’s retirement savings objective
• Eliminate ERISA fiduciary exposure of the members of the board of directors or their delegates in administering the plan
• Allow flexibility regarding financing of plan benefits, as participant accounts are paid from the general assets of the employer 

Key takeaways:

1. The 15% of companies* stating that their HCEs received some kind of corrective distribution over the past three years presents a viable opportunity to discuss how a nonqualified plan can effectively supplement a 401(k) to provide a comprehensive benefit solution. Fifteen out of every one hundred companies may need your help. 
2. NQDCs can help reduce complaints from employers dealing with the consequences of corrective distributions because the affected employees can easily defer the amount of those distributions into the NQDC. 
3. NQDC plans can be customized for retention and seniority in a way that fully vested safe harbor 401(k) plans cannot.
4. NQDC plans are flexible and customizable, allowing employees to tailor their deferral amounts and payout schedules to fit their individual financial goals and needs—while employed and in retirement-- and without exposure to tax penalties for distributions prior to age 59 1/2.

Finding a NQDC partner you can trust

Newport is a market leader in the nonqualified area. With more than 40 years of experience and a team of dedicated professionals who are well-versed in every aspect of the business, Newport is essentially a one-stop-shopping repository for tailored and comprehensive nonqualified solutions.

We provide every service needed to make NQDC administration and participation as easy as possible, including: plan consulting and design; participant communications; informal financing strategies; distribution processing; trust services and a participant and sponsor online experience designed specifically for nonqualified plans.

With tax deadlines fast approaching, now may be the best time to consider a Newport NQDC. We will work with you (and your clients) every step of the way until we’ve arrived at the optimal retirement solution.

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*Source: Access NQDC Trends Survey Report

This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before making any decisions. Newport Group, Inc., an Ascensus Company, and its affiliates do not provide tax, legal or accounting advice.