Whether you own a small, medium, or a large business, in today’s economy finding and keeping the best employees can be difficult. All business owners would like to believe that providing a great work environment where everybody enjoys working should be enough to hire and retain qualified employees that want to grow in your business year after year.
Let’s face it. The times are changing with each new generation. Workers today don’t think as their grandparents did. Getting a decent job with decent pay and a pension that you can retire on is no longer the norm. Workers today are a little reluctant to put in the time and effort when the only reward is a pension that may or may not support a lifestyle you have dreamed of in retirement.
No, they want more and they want it fast. Yes, a paycheck is important to 21st-century workers, but so are benefits and the ability to accumulate wealth while spending thirty years or more years making driving profits for the company.
You may be thinking (especially if you own a “mom and pop” small business) that retirement plans like 401(k)s and profit sharing plans are for the big guys, but they’re not. Setting up a deferred compensation plan can help you compete with other employers who will likely try and poach your employees. You can give the people you’ve spent a lot of money to train a very good reason to stick with you.
What is a Deferred Compensation Plan?
Simply put, deferred compensation is when an employer takes a portion of an employee’s compensation and sets it aside and then paid to the employee at a later date like retirement. By joining a deferred compensation plan, the employee can defer the tax liability until such time that a payout is received from their employer and earn interest on the portion of income that’s been deferred.
There are two categories of deferred compensation, a qualified plan, and a non-qualified plan. The primary difference between these plans is how they are regulated and the plan that you choose should be based on your company’s goals and needs.
What is a Qualified Deferred Compensation Plan?
The qualified deferred compensation plan is a pension plan that is strictly governed by ERISA. These plans typically include 401(k), 403(b), and 457 plans. There are a number of requirements that must be met to satisfy ERISA so they’ll qualify for favorable tax treatment by the IRS. Although ERISA, like most government regulations, can be complicated, the primary rules that must be followed are straightforward.
- The plan must be offered to all employees (not independent contractors) of the company.
- The deferred compensation must be set aside for the sole benefit of the employee.
- Employee contributions are capped by law.
What is a Non-Qualified Deferred Compensation Plan?
A non-qualified deferred compensation plan doesn’t have to meet the requirements of a qualified plan and thus is more cost effective for a small business. With the non-qualified plan, the employer can compensate a select group of employees. Since the employer can discriminate who the plan will be offered too, the employer can reserve the plan for key employees and managers.
A non-qualified plan can become a great tool for recruiting and retaining key employees and help to dissuade them from being poached by competitors. A non-qualified deferred compensation plan will allow the employer to offer an additional vehicle for employees to save for retirement without the restrictions on contributions and vesting.
For the purpose of this article, we’ll discuss the benefits of a non-qualified deferred compensation plan using Indexed Universal Life Insurance as the savings vehicle.
Using Indexed Universal Life for Non-Qualified Deferred Compensation?
For small businesses who wish to establish a non-qualified deferred compensation plan that is unencumbered by ERISA and therefore allows you to offer a financial benefit to retain key employees and managers, Indexed Universal Life insurance can be the vehicle to finance these non-qualified plans. Using life insurance makes setting up the plan simple and straightforward.
- The business will purchase Indexed Universal Life insurance (IUL) on each key employee and the employee defers a portion of their compensation into the plan (policy).
- The employee is allowed to choose how the funds in the policy are invested by selecting from a menu of indices (investment options), and then the gains in the cash value account will grow tax-deferred.
- The employer is allowed to make additional contributions into the plan but not required to do so.
- The enrolled employee is 100% vested in the plan according to their contributions and the earnings they produce, but the employer has the option to subject any contributions they make to a vesting schedule that provides a “golden handcuffs” component to their plan.
How do Employers Benefit from Non-Qualified Deferred Compensation Plana?
How does the Employee Benefit from a Non-Qualified Deferred Compensation Plan?
Why use Indexed Universal Life Insurance?
Indexed Universal Life insurance acts as a flexible funding vehicle for wealth accumulation. When a business uses IUL for a non-qualified deferred compensation plan most all administrative aspects are simplified for the employer and employee. IUL allows for the employee to enjoy and capture the benefits of the stock market without actually being in the stock market. Here’s what sets the IUL apart from traditional funding vehicles:
- No annual maximum on contributions
- No annual maximum on income
- Safe and productive because of the Cap and Floor in the contract
- Multiple selections of market indices to choose from
- Interest income is tax-deferred
- Accumulates substantial wealth for retirement income
- Provides a death benefit for surviving loved ones
A Non-Qualified Deferred Compensation plan funded with Universal Life Insurance can be the most efficient tool to ensure that key employees remain with the company and provides a method to attain the employee loyalty that small businesses need to stay competitive.
If you feel that a deferred comp plan is more than you want to administer, you can always look at funding your personal LIRP or life insurance retirement plan. There are no IRS limits on contributions and you can take income at any age. You don’t have to worry about ERISA requirements either, this is a personally owned plan and you will not need to include your employees.