Non-Qualified Deferred Compensation (NQDC) Plans: Practical and Profitable
While recently enacted IRC Sec. 409A has added a layer of complexity to NQDC plans, these plans remain viable, particularly Supplemental Executive Retirement Plans (SERPs), and particularly for closely-held businesses rather than large public companies. SERPs are “salary plus” plans whereas deferral plans are “salary reduction” plans. SERPs can be a powerful tool for attracting, rewarding, and retaining key employees at a time when other incentive arrangements have become less attractive and often more difficult to implement. They are also still useful for the stockholder-employees themselves, but less so for controlling shareholders.
To be fully effective, SERPs need to have funds standing behind them. This does not mean funding in the formal sense, because that would defeat the tax deferral benefit of SERPs; rather, these plans should be “informally” funded so that there is always a substantial risk of forfeiture. The most common form of informal funding is Corporate Owned Life Insurance (COLI). For large public companies, special COLI policies have been developed. For closely-held businesses, however, regular individual policies are most effective. These should be cash-rich policies such as Whole Life, well-funded current-assumption Universal Life, Indexed Universal Life, or Variable Universal Life.
Many view the world of NQDC plans as overly complicated. This is not really the case, however, and we at Provada are prepared to help those of you with clients who are the owners of their own businesses to work successfully in this arena. In these difficult times, many view the sale of a business-owned life insurance policy to fund a SERP to be “the perfect sale”. Don’t overlook this potentially lucrative market.