With mergers and acquisitions (M&A) activity hitting record highs despite recent stock market volatility, companies that may be targets or acquirers must take a second look at their nonqualified retirement benefit plans.
Those benefit plans should include employment agreements that may require employers to fund or set aside assets to finance them. The establishment of such plans and financing vehicles may be a condition before closing an M&A transaction. Consequently, employers should engage experienced, trusted service providers to ensure they reap the full benefits of nonqualified plans for themselves and their employees, especially if they become engaged in a strategic transaction.
Nonqualified plans can be an effective tool for attracting and retaining talent—whether employers need to build a new plan from scratch or upgrade an existing plan to accommodate new senior employees and benefit obligations. Nonqualified deferred compensation plans’ limitless contributions provide employees with an additional method to save for the future beyond what a 401(k) allows.
Here are some factors employers should consider before adopting or reviewing an existing nonqualified plan:
Get the Full Nonqualified Plan Experience
Nonqualified plans are attractive to both employers and employees because of their flexibility and design concerning funding strategies. These plans give employers the ability to offer an additional retirement benefit to participating executives while simultaneously taking advantage of informal financing without having to tie up capital, as is the case with qualified plans.
However, some of the larger nonqualified plan providers offer bundled services that don’t fully take advantage of the flexibility and tax benefits that nonqualified plans provide. Instead, many of these providers merely offer the same investment options as 401(k)s known as “mirror plans” and often require employers to set aside assets that would fully “fund” the nonqualified plans. As an alternative, unbundled providers leverage innovative and highly scalable technology to offer the same seamless experience with all the expected benefits and flexibility of a nonqualified plan.
“These unbundled providers are not tied to investment managers or specific products,” said Cynthia Dash, general manager for Matrix Financial Solutions. “Many have the depth of experience and expertise needed to provide a comprehensive, independent approach—and ultimately an optimal retirement plan solution.”
Choose the Option That’s Right for You
Once a company finds the right provider(s), it must choose the nonqualified plan and financing strategy that’s right for it, which can depend on whether a plan sponsor is developing a benefit program for an individual or a group of senior staff. Deferred compensation plans, permitting deferrals of executive bonuses, and other compensation are popular for employers because those contributions are tax deductible. These nonqualified plans are also attractive to key leaders because they will not be taxed on their compensation until there is a future payout or other constructive receipt of the participants’ account.
Another option to consider during this period of increased M&A activity is the use of a rabbi trust—so named because a rabbi and his congregation were the first to win Internal Revenue Service approval for use of this structure. Rabbi trusts, also referred to as grantor trusts, are used to hold set-aside assets to pay plan benefits and may be either revocable or irrevocable based on the needs of the grantor. This type of trust can help protect employees from a “change of heart” by a company that may want to use set-aside assets to pay plan benefits to meet other obligations or that may not want to pay the original intended benefit to participants at all. Depending on its design, an irrevocable rabbi trust will not permit the employer to use trust assets for any purposes except payment of plan benefits.
Often, changes in firm ownership following an M&A transaction known as “change in control” will result in employers’ taking on new staff and obligations—and, in some cases, creating a “fire drill” for management when some plan service providers resign during this critical time.
Check State Laws to Maximize Tax Incentives
One of the final steps a company can take to ensure its nonqualified plan and financing vehicle are as mutually beneficial as possible to the company and participants is to evaluate the tax benefits of its provider’s home state or other legal location. This may be especially important for companies using corporate owned life insurance (COLI) as their informal financing vehicle when plan participants are living in high-tax states but is worthy of examination for all companies because state tax laws vary so widely.
Colorado, for example, may offer insurance premium tax discounts on COLI when a trustee holding the COLI (such as in a rabbi trust) and/or the insurance carrier issuing the policy is domiciled in the state. This type of incentive could provide companies with tax savings while potentially increasing the total benefit to the employees and the organization. It’s important that companies call on their service providers to examine jurisdictional tax implications in order to design the most advantageous program.
With 65% of corporate executives expecting the M&A market to strengthen over the coming months, now is an ideal time to look into establishing or fine-tuning nonqualified plans. Because nonqualified plans can be structured flexibly to meet the needs of employees and employers, they are an ideal tool for attracting and retaining high-quality talent. Having service providers that are independent and that offer depth of expertise and experience in their respective areas is optimal in achieving a successful incentive program for companies and their key employees.
Michael Hlavin is the Vice President at Matrix Financial Solutions, a Broadridge company.