Nonqualified deferred compensation plans (DCPs) are a strong incentive to both attract and retain key executive talent. These plans allow participants to defer compensation and warehouse cash on a pretax basis without the limitations of 401(k)s, which have a current maximum deferral limit of $23,000* per year.
Nonqualified benefit plans are not governed by the Employee Retirement Income Security Act of 1974 (ERISA), meaning that it is not mandated for them to be funded. However, without funding, these plans expose companies to negative P&L impact, which of course means that funding them is in the best interest of companies and their plan participants.
The Benefits of COLI (Nontaxable Securities) vs Taxable Securities
| Taxable Securities | COLI | |
|---|---|---|
| Ability to asset allocate without tax cost (no transaction costs) | X | ✔ |
| Ability to de-risk investment portfolio without cost | X | ✔ |
| Ability to recover plan costs via upstreaming of cash flow | X | ✔ |
| Ability to provide life insurance benefits to plan participants | X | ✔ |
| Ability for earnings to grow income tax-free (as long as assets are not surrendered) | X | ✔ |
| Ability to create positive P&L impact when utilized in concert with an executive benefit plan | X | ✔ |
| Ability to secure an asset structure whose costs are fixed relative to assets under management and investment gains | X | ✔ |
| Ability to secure a future income tax-free receivable via death proceeds, effectively increasing yields and plan economics | X | ✔ |
| Ability to take liquidity without tax cost | X | ✔ |
| No asset allocation limitations | X | ✔ |
| Ability to access institutional money management | ✔ | ✔ |
| Favorable accounting treatment (ability to mark-to-market) | ✔ | ✔ |
| Ability to deduct investment losses | ✔ | X |
Performance Comparison – Taxable Securities vs. COLI
Note: Based on year 20 performance.
Two funding options can be used to informally fund these benefit plans
- Nontaxable securities, such as corporate owned life insurance (COLI)
- Taxable securities, such as mutual funds, CDs, exchange-traded funds (EFTs), etc.
Plan Administration for COLI vs. Taxable Securities
| Taxable Securities | COLI | |
|---|---|---|
| Transaction Fees | Yes | No |
| Short-Term Trading Fees | Yes | No |
| Wire Transfer Fees | Yes | No |
| Trustee AUM Fees | Yes | No |
| Restrictive Trading Limitations1 | Yes | No |
| Additional Trustee Expense2 | Yes | No |
| Portfolio Maintenance Administration Challenges3 | Yes | No |
| Minimum Trade Requirements | Yes | No |
| Minimum Balance Requirements | Yes | No |
1 COLI assets may be reallocated any trading day up to twice a month, depending on the carrier. Taxable securities may be limited to trading up to once every 90 days.
2 No assets under management fees with the use of non-taxable securities – COLI.
3 Challenges are due to minimum share trades and liquidity requirements.
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.