A flexible method of providing additional compensation to your key people.
It’s hard for small businesses to stay competitive today. Competition for the best and the brightest employees, even in tough economies, is always challenging, particularly when compensation funds are limited.
A deferred compensation plan can prove to be an attractive compensation option and a retention tool that can help keep your best employees with your company.
Have it Your Way
Why should you consider deferred compensation plans for your key executives? Qualified plans – such as pension and profit-sharing plans – are by design, uniform, nondiscriminatory, and benefit employees as a whole. Nonqualified deferred compensation plans do not have to comply with the requirements of Internal Revenue Code (IRC) Sec. 401(a) including nondiscrimination, eligibility, funding, and vesting requirements.
You, as the employer, can offer a deferred compensation arrangement to any of your highly compensated or managerial employees, and structure the plan in a way that meets your needs, as well as those of your employees. You are also under no obligation to fund the plan with current assets, investments, insurance, or annuity vehicles. Simply put, in a deferred compensation plan, the employer promises to pay a fixed amount of compensation to an employee at a specified time in the future.
What’s in it for Your Key Employee?
Qualified plans sometimes fall short of helping to provide for the financial future of highly-compensated executives. In 2021, 401(k) plans have a combined employer/employee annual maximum contribution of $58,000 (for employees under age 50), or 100% of the employee’s compensation, whichever is less.
That amount may be insufficient to meet the executive’s financial planning goals, or to help ensure the maintenance of his or her standard of living at retirement. Nonqualified plans have no annual or lifetime limitation, allowing the employer the flexibility to structure the type of plan that will be attractive to key executives. In addition, the deferral of payment of taxes can sometimes play a key part in an executive’s financial planning strategy.
Deferred Compensation: Something for Everyone
Of course, not all key executives will be attracted by deferred compensation plans. Executives covered under deferred compensation plans taxed on the employer’s contribution, in the year in which there is actual or constructive receipt (usually the time of payout). You, as the employer, can choose the vesting schedule. The benefits can be immediately vested, can vest over a number of years, or can vest only upon retirement.
Younger employees may prefer to have their compensation right away, and may be unwilling to wait for a deferred benefit that might:
- Never come;
- Be subject to changing tax laws; or
- Tie them to their current employer, thus limiting their future career mobility.
In the case of corporate mergers and acquisitions, you may need to tie key employees to the newly merged entity, in order to help ensure continuity of business operations (including income generation).
For example, deferred compensation can be offered to key employees of the acquired entity. These grants and options can be offered to any class of employees (officers, for example) and/or specified individuals whose continued employment is critical to continued operations. The plan can be structured so that continued employment, for a specified period of time, is a requirement for exercising any stock grants or options.
A deferred compensation plan can be a flexible, cost-efficient, and tax-deferred method of providing additional compensation to your key executives, without causing you to set aside current assets, or otherwise fund the plan until such time as the benefits are paid out.
A deferred compensation plan is a “reward” you can promise today and, unlike most benefits, pay for later.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor.
This article was prepared by FMeX.
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