Learn how to balance the interests of shareholders, executives, and creditors in a nonqualified deferred compensation (NQDC) plan with these strategies.

"For example, you can link the amount or timing of NQDC payouts to certain financial or operational metrics" Financial triggers were used by Enron to distribute their NQDC plan before they went bankrupt in Dec 2001. By 2004, we had IRC 409A in place to penalize participants in plans where distributions were accelerated. IRC 409A violations impact the participant, not the plan sponsor, and trigger Federal and state income taxes, late filing fees and penalties, and an excise tax of 20%. If financial metrics trigger distributions, the participant would forfeit 70-80% of their benefits to tax penalties.

A popular design feature in an NQDC program is to allow for scheduled withdrawal accounts, which provide liquidity from an NQDC plan for the participant while actively employed, and this liquidity is not subject to additional IRS penalties and taxes when accessed prior to 59 1/2. These types of accounts are useful to help fund financial life events prior to retirement (e.g., funding a child's college tuition).

How do you balance the competing interests of shareholders, executives, and creditors in a NQDC plan?

Nonqualified deferred compensation (NQDC) plans are a popular way for employers to reward and retain key executives by allowing them to defer a portion of their income and taxes until a future date. However, designing and managing a NQDC plan can be challenging, as it involves balancing the competing interests of shareholders, executives, and creditors. In this article, we will explore some of the factors and strategies that can help you achieve this balance.

1 Benefits of NQDC plans

NQDC plans offer several benefits for both employers and employees. For employers, they can provide a flexible and cost-effective way to attract and motivate top talent, without increasing the current compensation expense or diluting the equity. For employees, they can offer a significant tax advantage, as they can defer their income and taxes until they are in a lower tax bracket or have lower income needs. They can also customize their payout options and investment choices to suit their personal goals and preferences.

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2 Risks of NQDC plans

NQDC plans also come with some risks that need to be carefully considered and managed. For employers, they create a long-term liability that can affect the balance sheet and cash flow. They also expose the company to potential legal and regulatory issues, such as compliance with Section 409A of the Internal Revenue Code, which sets strict rules for the timing and form of NQDC distributions. For employees, they face the risk of losing their deferred income if the company goes bankrupt or defaults on its obligations, as NQDC plans are unsecured and unfunded promises to pay. They also have limited access and control over their deferred income, as they cannot withdraw or modify their deferral elections without triggering penalties and taxes.

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Kurt Snyder

Helping business leaders build contemporary & strategic benefit programs for their companies and valued people.
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A popular design feature in an NQDC program is to allow for scheduled withdrawal accounts, which provide liquidity from an NQDC plan for the participant while actively employed, and this liquidity is not subject to additional IRS penalties and taxes when accessed prior to 59 1/2. These types of accounts are useful to help fund financial life events prior to retirement (e.g., funding a child's college tuition).

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3 Balancing the interests of stakeholders

Given the benefits and risks of NQDC plans, how can you balance the interests of shareholders, executives, and creditors? Here are some possible strategies:

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4 Aligning the plan design with the company goals

One way to balance the interests of shareholders and executives is to align the plan design with the company goals and performance. For example, you can link the amount or timing of NQDC payouts to certain financial or operational metrics, such as earnings per share, revenue growth, or customer satisfaction. This can create a win-win situation, as it can incentivize the executives to achieve the company objectives and reward them for their contributions, while also aligning the plan cost with the company value and cash flow.

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Noel Anderson, NQPA

VP Executive Benefits at Madison Brokerage
(edited)
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"For example, you can link the amount or timing of NQDC payouts to certain financial or operational metrics" Financial triggers were used by Enron to distribute their NQDC plan before they went bankrupt in Dec 2001. By 2004, we had IRC 409A in place to penalize participants in plans where distributions were accelerated. IRC 409A violations impact the participant, not the plan sponsor, and trigger Federal and state income taxes, late filing fees and penalties, and an excise tax of 20%. If financial metrics trigger distributions, the participant would forfeit 70-80% of their benefits to tax penalties.

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5 Diversifying the plan funding and security

Another way to balance the interests of executives and creditors is to diversify the plan funding and security. For example, you can use a variety of funding methods, such as corporate-owned life insurance, mutual funds, or trusts, to reduce the reliance on the company's general assets and cash flow. You can also use different security mechanisms, such as rabbi trusts, secular trusts, or split-dollar arrangements, to protect the deferred income from creditors or other claimants, while complying with the tax and legal requirements.

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6 Communicating the plan benefits and risks

A final way to balance the interests of all stakeholders is to communicate the plan benefits and risks clearly and transparently. For example, you can provide regular and detailed information to the shareholders about the plan's impact on the financial statements and the company's obligations. You can also educate the executives about the plan's features and options, as well as the potential tax and legal consequences of their decisions. You can also inform the creditors about the plan's funding and security arrangements, and how they affect their rights and claims.

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Paula Reising

People Operations Management | Systems Implementation | Employee Relations | Talent Acquisition | Workforce Planning | Compensation & Benefits | Succession Planning | Staff Recruitment & Training | Performance Management
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Communication is the key to any effective compensation strategy. Compensation can attract and retain top talent that will produce a competitive edge in fast growth industries. But without a simple and pervasive communication strategy, the benefits of the compensation program will go unnoticed. Make sure that executive leadership and HR professionals throughly understand and can communicate the plan before implementation.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How do you balance the competing interests of shareholders, executives, and creditors in a NQDC plan?

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1 Benefits of NQDC plans

2 Risks of NQDC plans

3 Balancing the interests of stakeholders

4 Aligning the plan design with the company goals

5 Diversifying the plan funding and security

6 Communicating the plan benefits and risks

7 Here’s what else to consider

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