One of the most important and yet often misunderstood executive compensation tools is nonqualified deferred compensation. While nearly all mid- and large-size public companies have such a plan in place, many could be more systematically and effectively informing executives about the plan provisions.
This would help many executives to better plan for retirement and to more fully understand and appreciate the role of nonqualified deferred compensation. Most companies have instituted plans to help retain executives. Thus, more systematic and effective communications that result in a higher number of eligible employees participating in plans help retain quality executives, thus reducing turnover costs.
As this is the time of year when many companies begin planning for annual in-person and/or webinar meetings with executives about nonqualified deferred compensation, there are a number of steps that should be considered.
Keep things simple. Most executives feel they can only spare 20 minutes or so for this presentation. It is best to recognize this and plan on shorter meetings, with a more basic overview. Detailed information can be provided as part of a kit. There should also be service professionals from the executive benefit plan provider available at the executive’s convenience for further discussion.
A central point is tax deferral. Deferred compensation plans can help to reduce tax liability in the deferral years. Often, the executive will pay a lower tax rate in the distribution year(s). This should be a central message at the annual meeting.
Plans can help with other life events. Many plans have provisions where executives can make withdrawals for significant life events such as college educations. In addition, participants may be able to schedule distributions three years after deferrals, which for many executives provides important financial flexibility. These provisions should also be highlighted.
Review plans in relationship to stock compensation. When executives receive or expect to receive a high amount of stock compensation, it may be an ideal time to increase participation in the deferred compensation plan. This can be very helpful for tax planning and overall financial planning.
Know distribution dates and options. Many deferred compensation plans offer several distribution dates from the time of an initial deferral. Executives who understand these alternatives, the amounts they have already deferred, and how those deferrals have changed in value can better ensure the funds are distributed at the ideal times.
Consider a fixed-rate vehicle. For many executives, particularly those approaching retirement, it is important to have deferrals go to steady, fixed-rate vehicles. Companies should inform executives of this alternative if they have it and, if they don’t, consider implementing it.
Gauge retirement replacement income. Even if executives fully participate in qualified 401(k) plans, many will receives less than 20% of their pre-retirement income from 401(k) plans and Social Security. Executives should be able to determine how much deferred compensation they are likely to need to avoid such a shortfall.
Continuous communication is important. Beyond the annual non-qualified deferred compensation meeting, companies should be prepared to help executives understand these plans throughout the year as they are central for financial planning.
By taking these steps and being responsive to executives’ concerns, many companies will be able to cost effectively retain and attract quality executives, while helping these executives prepare for important financial challenges.
Mike Corry is a senior consultant and serves on the executive committee of The Todd Organization, which helps companies design, finance, and administer executive benefits.