Fixed Rate Nonqualified Compensation Plan
As employers review their executive benefit packages in 2019, one old-fashioned plan design might come into vogue. That is the Fixed Rate Nonqualified Deferred Compensation Plan.
For years, employers have offered their executives the opportunity to defer salary, bonus and equity compensation as a way to manage personal income tax, both now and in the future. Traditionally, the deferral plan would offer investment options that would mirror the Company’s 401(k) investment choices, typically stacked with mutual funds.
Recent volatility in the Equity Markets have caused many individuals to see their retirement balances decimated as they opened up their December 31, 2018 statements. Although the new year started off with a promising January, educated investors know that a brief or long bear market can wipe out gains.
In 2019, many economists are predicting that the U.S. economic growth will slow. The Federal Reserve Bank of Atlanta estimated that GDP growth slowed to 2.8% during the fourth quarter of 2018. Despite the strong U.S. economy in 2018, the Stock Market had its worst year since 2008. The Dow Jones Industrial Average fell 5.6%, the S&P 500 dipped 6.2%, and the NASDAQ was down 4%. Most of these losses occurred in one month of the year.
Employers in a Nonqualified Deferred Compensation Plan agree to pay retirement or survivor benefits in exchange for the executive’s deferral of current compensation. By foregoing current income, executives defer tax until retirement and earn tax deferred interest on their investments. Executives (or their beneficiaries) pay income tax when they receive the benefits, and employers deduct the benefits as they are paid. Most of these plans use mutual funds to drive account value growth.
One available investment option in a nonqualified plan is a fixed rate option, where all assets are credited with a fixed annual crediting rate determined by the employer. With increased volatility an employer and executive should consider their retirement timeline and investment risk tolerance. By utilizing a fixed rate, the employer will eliminate the potential risk associated with the volatile market on its executive account balances, especially as they close in on retirement.
Even though some things are unexpected and no one can be prepared for what may actually happen, precautionary steps can be taken insuring that all is covered in other aspects of the business such as securing key executives. Making decisions now in executive compensation plans will ensure a smoother process in the future if things take a turn.