PLANSPONSOR - June/July 2019 - 49

have been selected for a long-term time
horizon may not fit the objectives of the
NQDC plan and its participants. "
Jake Downing and Jenny Neilsson,
partners in law firm Seyfarth Shaw
LLP's employee benefits and executive
compensation department in Chicago,
agree that the DC-mirror approach is
common-the most common investing
approach they see among NQDC plans.
They note that, for many employers,
choices about the structure of the NQDC
plan will tie back to an effort to attract and
retain key executive talent. As Downing
and Neilsson explain, if a plan sponsor
is talking about putting aside money for
future executive compensation during a
time of corporate uncertainty-e.g., an
acquisition is on the horizon-the rabbi
trust may be helpful. But if the sponsor is
simply seeking to provide enhanced retirement
benefits that will not subject the
qualified retirement program to nondiscrimination
testing issues-e.g., a lowmargin
retailer wants to better support
the retirement savings efforts of top executives-the
mirror-401(k) plan investment
menu makes sense.
Steele points to the example of an
executive deferring compensation to be
paid out in several annual installments
starting within five years, say to meet
anticipated college or moving expenses.
The long-term mutual funds populating
a streamlined DC plan menu might not
be the most sensible investments, in this
case. With this in mind, she says, a second
NQDC menu approach is to craft an
" executive menu " that has been expanded
to solve the issues aforementioned.
The executive menu may have more
short-term-focused funds or more sophisticated
alternative investments than found
on a DC plan menu. Another potential
benefit of the executive menu is that
specific risk-based or time-based assetallocation
models can be offered that fit
the needs of the highly compensated.
" There are pitfalls to the expanded
menu as well, including the same
tracking issues related to the DC-mirror
menu, " Steele says. " These may be exacerbated
by the additional options. And
participants in NQDC plans, who are
supposedly more sophisticated investors,
may still make the same mistakes as
other plan participants, such as returnchasing
or market-timing. "
" The leading question will be what
is the purpose of offering nonqualified
deferred compensation in the first place? "
Downing says. " Is this a highly negotiated
benefit for one or just a few people,
where you can communicate with all of
them very easily and directly and they
can be collaborative about the design
and the distributions? In that case, a
more complex but tax-efficient corporateowned
life insurance arrangement [COLI]
could make a lot of sense. "
According to Steele, tax considerations
will indeed lead some plan sponsors
to " informally fund " an NQDC plan
by way of a COLI. This arrangement allows
the employer to receive the death proceeds
from an insurance policy, income-tax-free,
assuming participants are given the
proper notices and the growth in the policy's
cash value is not subject to income tax,
she says. Wanting the liabilities and assets
to match, sponsors and insurers will limit
participants to a menu of highly curated,
insurance-eligible funds within the particular
COLI product. Upon retirement, the
executive receives the income, which the
IRS and state tax as ordinary income.
" An insurance-based menu approach
has some challenges, as well, " Steele says.
" Investment options tend to be narrower
and may exhibit more retail-like pricing.
This is particularly true for registered
COLI products, but not as much with
private-placement COLI products. In addition,
using these funds may complicate the
flow of data for administration, reporting,
participant communications, account
values, liability management, etc. "
In practice, a plan sponsor may take
one of these approaches or do something
different-potentially much simpler, for
example just offering a flat, guaranteed
return on deferrals.
" If you have a deferred compensation
plan with very simple deferral and distribution
options, there is not a lot of need
for investment complexity, " Steele adds.
" However, if you have a plan where you
are looking to manage distributions over
a number of years, or to offer different
types of investments to the executives to
meet their unique personal goals, that
may require a more complex menu. "
Downing and Neilsson point to
another, formerly common, NQDC
" investment " approach that has faded
from popularity-the guaranteed flatreturn.
With this approach, the plan
sponsor foregoes the idea of notional
investing and instead pledges a specific
return not tied to a theoretical portfolio-
e.g., 5% or 8% annually. This approach is
sometimes meant to help younger executives
who choose to defer compensation
for shorter-term purposes besides supplemental
retirement income.
" This is potentially going to benefit
people who are planning to buy a house,
or perhaps to cover kids' college costs, "
Downing says. " They know they will have
a specific future need for the income, and
their main goal is to defer the taxes. In
these cases, it can make sense to use the
guaranteed-return approach. "
Review All Vehicles
Scott Copeland, director of corporate
services for Keel Point LLC in Huntsville,
Alabama, says there has been a great deal
of interest in various types of NQDC plans
over the past 24 months, due largely to the
fact that labor markets have been so tight.
" The different funding vehicles all
have positives and detractors, " he says.
" However, I would suggest employers
review the new options without prior bias.
Insurance products have come a long way,
and the institutional options historically
restricted to the largest companies have
made their way downstream. "
Copeland adds that NQDC plans
offer enormous amounts of flexibility
for recruiting and retention.
-John Manganaro
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