An executive benefit plan where an executive can elect to defer, pretax, an unlimited amount of compensation [e.g., salary, bonus and/or commissions] and can elect to receive that compensation plus any earnings as a distribution at a future time.
Deferred compensation grows tax deferred and the plan is not subject to discrimination testing like qualified retirement plans.
From the company’s perspective, these compensation deferrals are viewed as a future “promise to pay” and are typically structured with an offsetting asset to ensure minimal or no P&L impact to the company sponsor. These assets are often held in trust.
409A Direct provides consulting services in designing, implementing, and funding new DCPs, as well as ongoing administration for plans through our platform. We also audit existing plans to assess the competitiveness, appropriateness of their design, administration and financing with the goal of minimizing plan costs for the company and maximizing benefits for executive participants.
Cumulative After-Tax Payouts
The Cumulative After-Tax Payouts hypothetical comparison graphic illustrated to the right demonstrates the power of pretax compounding of deferrals invested on a tax deferred basis. The bars on the left indicate the future value of compensation assuming no deferral (taxes paid on compensation earned including earnings). The bars on the right illustrate the future value of deferred compensation invested on a tax-deferred basis.
For illustrative purposes only. Actual results may vary.
Cumulative after-tax payouts assume 3.8% tax on investment income associated with the healthcare reform legislation.
Assumes executive age of 45, 10 annual deferrals of $50K, a hypothetical net rate of return of 8%, and 20 annual payouts beginning at age 65 (note: payouts in the DCP are taxable when taken).
Blended tax rate assumes 37% in years 1-5, 45% in years 6-10 and 50% in years 11+.
Benefits to the Company
- A highly visible benefit Provides deferral opportunity with minimal or no impact to corporate earnings
- Cost recovery for the corporation Accumulate funding dollars on a tax-favored basis
- Remain competitive within the industry
- Helps improve executive retention and attraction of executive talent
- Maximize 162(m) deduction
Benefits to the Executive
- Pretax wealth accumulation opportunity for executives
- Allows pretax deferrals of salary, bonus, severance
- Restores benefits lost due to 401(k) limits Provides participants with flexible payout options (e.g., retirement, separation, specified date, etc.)
- Allows executives to select from a variety of investment funds including a fixed rate of return Provides a survivor benefit pre- and post-retirement
- Benefits are secure as deferred dollars are held in trust by an independent third party given a change in control, change in heart or the company’s inability to pay
- Plan balance is beyond the reach of creditors or judgments of the executives
| 401(k) vs DCP | 401(k) | DCP |
|---|---|---|
| No Limitations of Pretax Contributions | X1 | ✔2 |
| Ability to Access Account Prior to Age 59½ without Penalty | X | ✔ |
| Ability to Re-Defer Once Elections Have Been Made | X | ✔ |
| Ability to Asset Allocate Accounts Differently Based on Payout Path | X | ✔ |
| Ability to Make Company Contributions without Limit | X | ✔ |
| Ability to Defer RSUs and PSUs | X | ✔ |
| Tax-Deferred Growth | ✔ | ✔ |
| Flexible Distribution Options at Retirement | ✔ | ✔ |
| Variety of Investment Fund Options | ✔ | ✔ |
| Hardship Distributions | ✔ | ✔ |
| Plan Assets Protected from Change of Control and Change of Heart | ✔ | ✔ |
| Ability to Maintain Account Balance After Termination | ✔ | ✔ |
| Loans from Plan | ✔3 | X |
| Plan Assets Protected from Company Insolvency | ✔ | X |
1100% of total compensation can be deferred into the plan less deductions for benefits and FICA.
2$23,000 is the maximum contribution which may be further reduced due to discrimination testing; employees over the age of 50 are allowed a $7,500 catch-up contribution.
Nonqualified deferred compensation plans must follow the guidelines of Internal Revenue Code Section 409A. This tax code section covers the timing of nonqualified plan elections, funding, distributions and documentary compliance requirements. Please consult with the appropriate professional regarding your individual circumstance.
Securities offered through Lion Street Financial, LLC. (LSF), member FINRA & SIPC. Investment Advisory Services offered through Lion Street Advisors, LLC (LSA). LSF and LSA are not affiliated with 409A Direct, an affiliate of Mezrah Consulting. LSF, LSA, Mezrah Consulting and 409A Direct do not offer legal or tax advice. Please consult with the appropriate professional regarding your individual circumstances.