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Attract and Retain Top Talent: Offering Deferred Compensation Plans As A Benefit

June 22, 2009

Even during this period of unprecedented layoffs, attracting and retaining top executive talent is still crucial. An appealing compensation package may be just the ticket, and deferred compensation can be an important part of that package.

Two basic choices

In considering compensation, companies have two options: qualified deferred compensation (QDC) plans or nonqualified deferred compensation (NQDC) plans. Both can benefit your top employees. The major difference between the plans is how they affect your business.

QDC. These plans, such as 401(k)s, are standard retirement planning tools for most of a company’s workforce and provide a current tax deduction for the employer. Plan assets are secured from claims of the employer’s general creditors. There are, however, some drawbacks. The employer must include, with some exceptions, all employees, and extensive government reporting is required.

NQDC. Only a select group of management or highly compensated employees may participate in these types of plans. If properly designed, employees don’t pay taxes on the contributions or earnings until received, and governmental reporting requirements are limited. On the other hand, employers can’t take a current tax deduction for NQDC contributions, and any assets set aside for informal financing of the “promise” must be subject to claims of the employer’s general creditors.

Although NQDC plans offer more flexibility in terms of tax-deferred executive compensation, they must also comply with Section 409A — a portion of the tax code designed to prevent Enron-type abuses of executive compensation.

Strict compliance rules

Sec. 409A applies to all employers that provide an arrangement where an employee can defer income until a future year. Traditional NQDC arrangements, such as advance deferral elections of cash compensation and phantom stock plans, must abide by the strict compliance rules of Sec. 409A. In contrast, plans that provide no actual deferral of income — incentive stock options and restricted stock, for example — aren’t covered under the rules. Under Sec. 409A rules, the election to defer compensation must, with limited exceptions, be made the year before the compensation is earned. Special rules apply to the timing of deferral elections applicable to certain performance-based compensation. (Consult your tax advisor for more information.) After an NQDC agreement is reached, Sec. 409A imposes substantial restrictions on a company’s ability to change the timing or form of payment.

Companies that fail to comply with these rules place their executives at risk of being taxed for all future benefits before the benefits are received. A stiff 20% penalty tax, plus interest, also applies. Each of these penalties falls on the executive (rather than the employer), placing the burden on those receiving plan benefits to ensure that that plan is in compliance.

Work with a pro

With good planning, there are still ways to design compensation packages that will help you attract — and keep — top talent. The best strategy is to determine how you want your plan to operate, and then work with your tax and business advisors to design a plan that’s right for your company.

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