Companies Focus on Elective Deferred Compensation

April 9, 2014 (PLANSPONSOR.com) – When it comes to executive retirement arrangements, a recent study reveals a continued emphasis by U.S. companies on elective deferred compensation.

Towers Watson finds that such arrangements allow executives to control the timing of the taxation of incentive payouts and are therefore seen as a critical component of the overall executive wealth accumulation opportunity.

The study of executive retirement benefit practices during 2013, “Executive Retirement Benefits: Recent Actions and Design Considerations,” examines the design and prevalence of non-qualified retirement plans in U.S. organizations. Topics covered include the types of plans offered, the level of benefits provided to a typical executive and the prevalence of key benefit provisions.

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Although the percentage of U.S. employers that sponsor non-qualified defined benefit retirement plans (NQDBs) continues to decline, reflecting the closing or freezing of many broad-based DB plans, most of the organizations queried for the study (71%) continue to provide some type of employer-paid arrangement. This includes NQDBs or non-qualified defined contribution plans (NQDCs). On average, these plans deliver an additional 5% to 7% of earnings in annual retirement income to the typical mid-level executive.

The study finds that for 2013, the majority of organizations (72%) also provided elective deferral arrangements (EDAs) without any employer matching contributions. While the percentage of organizations offering EDAs has declined slightly in recent years, these plans remain the most prevalent type of non-qualified retirement arrangement.

According to study, these plans are taking on added importance for many high-level workers and many organizations are putting more emphasis on communicating to their executives that the EDA is a significant part of their long-term capital accumulation opportunity. However, Towers Watson notes that proposed tax reforms submitted recently to Congress could decrease the tax advantages of non-qualified deferred compensation programs.

The study also finds that:

  • About half of the organizations that continue to sponsor employer-paid non-qualified plans (DB or DC) offer pure “restoration” benefits only (i.e., the minimum level of benefits necessary to restore those lost as a result of statutory limits on benefit levels or the amount of pay that can be taken into account in benefit formulas). True supplemental executive retirement plans (i.e., plans that provide benefits in excess of pure restoration) continue to be more prevalent among organizations that sponsor NQDB plans.
  • NQDB plans are more likely to include annual incentive compensation in determining benefits than are NQDC plans in calculating employer contributions.
  • While most non-qualified retirement plans cover broad groups of executives, 20% of the organizations studied provide supplemental individual retirement benefit arrangements for one or more of the named executive officers. These one-off arrangements are generally designed to compensate mid-career hires for any loss in benefit value due to their change in employment.
  • In terms of income replacement, the median level of retirement benefits (including from qualified and non-qualified plans and Social Security) provided for an average mid-level executive is 30% of total cash earnings at age 62 and 37% at age 65.
  • Although there’s no requirement to disclose whether and how nonqualified plans are funded, data from the study shows that 17% of organizations with NQDB plans and 23% of those with NQDC plans use some type of funding vehicle to secure their non-qualified retirement plan arrangements. The most commonly disclosed funding vehicle is a “rabbi” (or grantor) trust. Although the publicly disclosed data is limited, the study suggests that company interest in funding non-qualified liabilities continues to be high and that 50% or more of organizations that sponsor these plans set aside some assets to secure the benefits, often using company-owned life insurance or mutual funds.

The study also reveals that the ongoing shift toward DC approaches for broad-based populations has not translated into a corresponding shift in employer contributions toward non-qualified arrangements for executives. This is evidenced by a net decline in non-qualified employer-paid plan sponsorship, according to Towers Watson. Employers may be using other reward elements (e.g., enhanced long-term incentives) and expanded elective deferral opportunities to compensate for the reduction in traditional employer-paid non-qualified retirement benefits, although the study notes there is no specific data on the extent to which such replacement is taking place.

The study focused on the executive retirement practices in 352 organizations and compares the current state (through mid-year 2013) with research findings from 2009 and 2011, based on company proxy disclosures.

More information about the study, including where to download it, can be found here.

Plan Assets Moving Away from Fixed Income

April 9, 2014 (PLANSPONSOR.com) – Defined contribution (DC) plan participants reduced their holdings in fixed income and increased allocations to U.S. small-cap and mid-cap equities in 2013, while target-date funds continued to increase as a top asset class, says a recent analysis.

According to the second annual edition of Northern Trust’s Defined Contribution Tracker, target-date funds (TDFs) drew 14.6% of asset flows into retirement plans as tracked by the firm in 2013, the strongest flows of any investment category. It was the second year of strong flows into TDFs, which made up 15.7% of all assets in the Northern Trust universe of DC plans, the second-largest share of any category.

“Target-date funds have dominated asset flows in our Defined Contribution Tracker, benefiting from their status as the preferred qualified default investment (QDIA) in most DC plans,” says Jim Danaher, managing director of defined contribution solutions at Northern Trust, based in Chicago. “With the increased adoption of automatic enrollment and other automated features, we anticipate that target-date funds will continue to experience strong growth, eventually accounting for the majority of DC assets.”

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Northern Trust’s Defined Contribution Tracker analyzes data from a universe of nearly 100 retirement plans in the United States, representing more than 1.7 million participants and $225 billion in assets with daily valuation serviced by Northern Trust.

Along with a trend toward TDFs, the tracker shows that many participants continue to shift between asset classes from year to year. Fixed income saw outflows of nearly 11% in 2013, for example, after the category had inflows of 9.2% in 2012. U.S. mid cap and small cap drew 6.3% and 4.4%, respectively, in new flows in 2013 after losing assets the previous year.

The tracker also noted the following:

  • International equities drew 9.3% net flows in 2013, a second consecutive year of inflows. Yet participant portfolios continue to exhibit a home country bias, with an 82% to 18% split between U.S. and non-U.S. equities compared with the approximately 50% to 50% breakdown within major world equity indexes.
  • Within the U.S., participants demonstrate a bias toward small- and mid-cap equities with strong flows to those asset classes and minimal (0.8%) inflows into large-cap stocks. U.S. large-cap equities still represent the largest asset class held by participants, with 24.4% of assets, but participant portfolios are actually underweight for large caps relative to the market capitalization weights of U.S. equities.
  • With significant outflows in 2012 and 2013, company stock decreased at the fastest rate of all categories, as plan sponsors look at ways to effectively reduce the concentrated positions in individual securities that exist in participant accounts.
  • A closer look at target date funds reveals that plan sponsors are favoring solutions that utilize passive or index funds, with 58% implementing all passive and another 25% using a blend of active and passive funds.

“The Defined Contribution Tracker provides a glimpse into how participants are investing and can yield insights into investor behavior when matched up with market events,” says David W. Fox Jr., head of corporate and institutional services in the Americas for Northern Trust. “More importantly, this tool demonstrates how plan sponsor actions, such as adding pre-mixed options like target-date funds and focusing on company stock, can help participants construct more diversified portfolios as they invest for retirement.”

Northern Trust Corporation is a provider of investment management, asset and fund administration, banking solutions and fiduciary services for corporations, institutions and affluent individuals worldwide. More information can be found here.

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