Companies Focus 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.

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.