Table of Contents: 2 The Clock is Running Out on ยง409A
Only 30 Days to Capitalize on Transition Relief
Written By: William L. MacDonald Chairman, President & CEO Retirement Capital Group, Inc.
4 The Age of Prosperity is Over Written By: Dr. Arthur B. Laffer Vice Chairman Retirement Capital Group, Inc.
6 The Value of Pragmatism
How to Evaluate and Select Nonqualified Plan Providers
Written By: William L. MacDonald Chairman, President & CEO Retirement Capital Group, Inc. Bo Lee Vice President Retirement Capital Group, Inc.
The Clock is Running Out on §409A I
Only 30 Days to Capitalize on Transition Relief
n an NBA championship game, every second on the clock counts. A sudden block, a welcomed shot from ‘downtown’ determines the game. At this moment, timing is key in the world of nonqualified plans. It is the fourth quarter and there are fewer than 30 working days left on the clock to take advantage of §409A transition relief before IRC §409A becomes reality. And, like a Phil Jackson moment, you need to make some game-changing decisions to ensure your retirement and wealth accumulation years are winning. Compliance with IRC Section 409A becomes law on December 31, 2008; its arrival has created a tremendous burden for many executives and their employers. However, there is transition relief period. Given the recent election year and potential for tax changes, facing down the deadline of §409A presents a few excellent opportunities for gain.
One Last Chance Let’s assume that you have made elections to defer a portion of your income, and receive benefit payments in the future. Under the new regulations, however, you are permitted to make one final change, even if that accelerates payment. Participants may change elections (both as to time and form) without resulting in an impermissible plan change. Notably, this relief provision only applies to §409A compliant plans. By way of example, let’s say that you elected to defer your bonus in years 2006 and 2007 until retirement, expected 16 years from now. You also elected to take
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payments over a 15-year period, to take advantage of interest accumulation on your unpaid balance. Before December 31, 2008, barely one month from now, you have an opportunity to change your election (either time and/or form). You may want to elect a shorter time frame because as you can always redefer at a later date.
Distribution Flexibility Most deferred compensation plans were designed with short-term distribution options, giving the participant an opportunity to defer compensation for short periods of time for expenditures such as a child’s education. Plan administrators used a “class year” approach to accomplish this, mainly due to administrative system constraints. These “class year plans” have created an unlimited number of accounts, payment dates, and form of payments which has overcomplicated administration. Best practice plans use a bucket approach to simplify the class year approach, and allow more flexibility. Here’s how: • Each year’s deferral can be allocated to one or several buckets • You can have a separate asset allocation for each bucket • Re-deferral opportunity exists (minimum 5 years) • In-service distribution options exist (see example below) • Consider after-tax Roth type (The Executive Roth Strategy or ERS) The following chart helps you to visualize these opportunities.
The Clock is Running Out on §409A Participant: Age 40
2 Children, Ages 13 & 11
Base Salary: Bonus: Salary Deferral: Bonus Deferral: Deferral Amount: Deferral Amount: Total Deferred:
$175,000 $100,000 12% 20% $21,000 $20,000 $41,000
Review Investment Fund Selection The single most important design decision in constructing a NQDC plan is the investment menu. It has the power to impact an executive’s deferred compensation balance, and cost to the company. Three factors drive investment performance in NQDC plans:
your plan has the right asset classes and that your administrator maintains a proper system for monitoring results. Manager Selection Not only do you need the right asset classes, you also need to identify top-performing investment managers. Then, have a comprehensive system to monitor their performance. If your company is funding the NQDC plan with corporate-owned life insurance (COLI), be careful that you are not paying unnecessary manager fees, as a result of additional charges by the insurance company. For instance, you could pay 30 basis points (bps) for an S&P Index when the alternative is substantially less. Tax Efficiency A major advantage to the NQDC plan for the participant is tax efficiency. The NQDC plan gives participants a higher equivalent rate of return compared to investing with after-tax dollars. To be comparable, the return on after-tax savings needs to earn an average of 40 percent, and that is unrealistic. That’s why participants need to be more aggressive with investment decisions.
1. Asset allocation 2. Manager selection 3. Tax efficiency
Asset Allocation Ninety percent of investment performance comes from proper asset allocation modeling. Make sure www.retirementcapital.com
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The Age of
bout a year ago Steve Moore, Peter Tanous and I set about writing a book of our vision for the future entitled The End of Prosperity. Little did we know back then how auspicious its release would be last week. Pretty good timing, eh? Unfortunately, my worst fears are rapidly unfolding and the stock market is now projecting its own version of the end of prosperity. The dynamic, however, is truly deadly. Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production. Asset values fall sharply and wipe out those who borrowed and lent too much, thereby redistributing wealth from the foolish to the prudent. This process is the topic of Nassim Nicholas Taleb’s book Fooled by Randomness. In Joseph Schumpeter’s words it’s called “creative destruction.” When markets are free, asset values are supposed to go up and down, and competition opens opportunities for profits and losses. Profits and stock appreciation are not rights but are rewards for
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insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators, or shop owners. Good decisions should be rewarded and bad decisions should be punished, and the market does just that with its profits and losses. No one likes to see people lose their homes when housing prices fall and they can’t afford to pay their mortgages, nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But goodness knows the taxpayers had nothing to do with either side of the mortgage transaction. If the house’s value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple. www.retirementcapital.com
The Age of Prosperity is Over Stearns, AIG and others. But the government isn’t finished yet. House Speaker Pelosi and Senate Majority leader Reid—and yes, even Federal Reserve Chairman Ben Bernanke—are preparing for a new $300 billion stimulus package in the next Congress. Assuming that GDP stays flat the next two years – which is probably too optimistic given the current economic environment – and that between 10% to 50% of the above mentioned government promises are lost during the next two years, the net national debt to GDP will potentially increase anywhere from 55% to 72% (Table 1). Table 1 Projected Net Government Debt to GDP
But here’s the rub. Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to Potential Percent Loss on New both homeowners and banks, the governGovernment Commitments ment commits to buy mortgages and inject 10% loss 20% loss 30% loss 50% loss capital into banks, which on the face of it Net Government 55.3% 59.5% 63.7% 72.2% seems like a very nice thing to do. But unDebt to GDP fortunately in this world of ours there is no tooth fairy. And the government doesn’t Each of these government actions separately increases create anything, it just redistributes. Whenever the govthe tax burden on the economy and doesn’t do anything ernment bails someone out of trouble, they always put to encourage economic growth. Giving more money to someone into trouble, plus of course a toll for the troll. people when they fail and taking more money away Every $100 billion in bailout requires at least $130 billion from people when they work doesn’t increase work. in taxes, where the $30 billion extra is the cost of getting government involved. And if you don’t believe me, just And the stock market knows it. The stock market is forwatch how Congress and Barney Frank run the banks. If ward looking, reflecting the current value of future exyou thought they did a bad job running the Post Office, pected after-tax profits. An improving economy carries with it the prospects of enhanced profitability as well Amtrak, Fannie Mae, Freddie Mac, and the military, just as higher employment, higher wages, more productivwait till you see what they do with Wall Street. ity and more output. Just look at the era beginning with Some fourteen months ago, the projected deficit for the President Reagan’s tax cuts, Paul Volcker’s sound money, 2008 fiscal year was about 0.6% of GDP. What with the and all the other pro-growth supply-side policies. $170 billion stimulus package last March, the add-ons to President Clinton and Alan Greenspan added their efhousing and agriculture bills, and the slowdown in tax forts to strengthen what had begun under President receipts, the deficit for 2008 actually came in at 3.2% of Reagan. President Clinton signed into law welfare reGDP, with the 2009 deficit projected at 3.8% of GDP. And form, where people actually have to look for a job bethis is just the beginning. The net national debt in 2001 fore being eligible for welfare.He ended the “retirement was at a 20 year low of about 35% of GDP, and today it stands at 50% of GDP. But this 50% number makes no test” for social security benefits (a huge tax cut for elderly workers), pushed NAFTA through Congress against allowance for anything resulting from the $5.2+ trillion his union supporters and many of his own party memguarantee of Fannie Mae and Freddie Mac assets, or the bers, signed the largest capital gains tax cut ever which $700 billion TARP (Troubled Assets Relief Program). Nor does the 50% number include any of the asset swaps [ Continued on Page 11 ] done by the Federal Reserve when they bailed out Bear www.retirementcapital.com
Vol. 6 No. 4 • 5
The Value of Pragmatism How to Evaluate and Select Nonqualified Plan Providers
It takes a pragmatist to pick a plan provider. Ask the average person today what they think of the business world. The answer may be shot through with expletives. One financial rogue after another has been pilloried in the public’s mind. Not surprisingly, goodwill for corporate America is at a premium today. That’s why we are going to see a welcomed rise in pragmatism—those traditional principles of common sense, hard work and feet-on-the-ground practicality. For most of us, they never left. We are, after all, a nation built by pragmatists.
Survey of Current Trends (Clark Survey), 95 percent of respondents among the Fortune 1000 have an NQDC plan in place. Even within smaller organizations, these plans have become commonplace. Nonqualified plans provide a retirement benefit that in-demand executives seek out in their overall compensation plan. While NQDCs may not be the competitive advantage they once were, their absence in a benefits line-up is a decided disadvantage.
Significant improvements in plan design have made these arrangements “tax-deferred cash management accounts”, compared to archaic thinking of simply saving for retirement. Executives can now efficiently set aside money for retirement or fund life events such as putting children through college, eldercare, purchasing a vacation home or fulfilling a long held dream of distant travel. (Chart 1). Chart 1
In the field of executive benefits, the value of pragmatism has a major impact on the decision of plan provider and in deciding whether a benefit package is too rich, too lean, or too expensive. Restrictive qualified plans gave birth to nonqualified (NQDC) plans. These arrangements strengthen a company’s ability to recruit, retain and reward executives in the most practical way possible by helping them achieve retirement security.
95 Percent Prevalence Nonqualified deferred compensation (NQDC) plans have grown in prevalence in the last 20 years. According to Clark Consulting’s 2007 Executive Benefits: A
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Adding to the many advantages of nonqualified plans, highly compensated executives also have the flexibility to re-defer their account balances, pushing those dollars out until later years. This freedom emerged out of new regulations under IRS §409A. www.retirementcapital.com
The Value of Pragmatism Equally important, many improved plan designs also offer financial planning tools including custom riskedbased asset allocation portfolios. These custom portfolios allow the executive to put his cash management accounts and retirement accounts on auto-pilot, while delegating the ongoing monitoring and reallocation responsibility to trained professionals.
Typically, companies cannot add human resource personnel to handle the larger workload; therefore, systems must offer the capacity and capability to manage all aspects of the plan from funding strategy to individual participant accounts.
Improved plan design, however, also requires more responsibility on the part of the plan sponsor. There is increased complexity in plan sponsor reporting, and detailed participant account management. New regulations set an expectation that plan websites will deliver more robust functionality. Penalties attached to any violations of plan administration rules have grown steeper under Â§409A.
Unlike 401(k) plans, nonqualified plans are somewhat intricate, with many moving and interlocking parts. Companies are prudent to manage the NQDC plan, which is a promise of participant benefits, cleanly and separately from whatever funding strategy is applied to plan liability (Chart II).
Complexities of Plan Administration
When to Outsource With increased complexity and flexibility of plan designs, many companies have chosen to outsource their nonqualified plan administration and recordkeeping responsibilities rather than invest the capital and human resources necessary to develop this capability in-house. According to the Clark Survey, 49 percent outsource their plan administration to a third party administrator. But how do you find such an administrator and how do you know that it will be worth the added cost? Top management expects human resource personnel to use accessible and reliable systems for executives to manage their deferred compensation. Executives expect to manage their deferred compensation accounts on the internet as they do their 401(k) or brokerage accounts. Today, we work with ever larger groups of participants than in the past because companies are expanding these plans to levels below select groups at the top, adding to workloads. www.retirementcapital.com
Using Chart II as a mini-manual, letâ€™s follow the process. The executive first elects to defer his compensation and does so through a written agreement with the company. Within this agreement, the executive or participant can select from a range of hypothetical investment funds, similar to a 401(k) deferrals, but with one major difference. In the 401(k) plan, participant deferrals are deposited into a trust, and those assets are protected by ERISA (Employee Retirement Income Security Act). Alter [ Continued on Page 13 ] Vol. 6 No. 4 â€˘ 7
The Clock is Running Out on §409A [ Continued from Page 3 ] Finally, tax efficiency is essential to how the company holds the asset on its balance sheet. Many companies have purchased life insurance to shelter the taxable gains on mutual funds. If the COLI portfolio has not been reviewed in the last three years, there could be financial improvement based on new insurance pricing. Savings may be enough to provide, or increase, a company match.
Asset Allocation/Risk-Based Model Portfolios Even with the right investment menu and best-inclass manager, proper account management is timeconsuming, and is unlikely to be taken on by participants. We see a more efficient option in the use of risk-based model portfolios in the investment menu. Few nonqualified plan administrators offer this best practice feature. Yet, in our experience, more than 60 percent of participants use the model portfolio options when offered. Among its advantages: • Participants delegate asset allocation to a professional • Portfolios are customized for each plan • Portfolios utilize best-in-class managers following a rigorous manager selection and weighting process • Portfolios are rebalanced monthly
Review Benefit Security In most cases, companies that informally fund NQDC plans also place their assets in irrevocable grantor trusts referred to as Rabbi Trusts. These trusts protect participants from all contingencies, short of bankruptcy. The Rabbi Trust received its unusual moniker because the case leading to its legal creation was brought by an actual Rabbi. Rabbi Trusts protect participant’s assets (account balances) against: • Change in control • Change of heart (management defaulting)
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• Change in financial condition (short of bankruptcy) As stated earlier, no protection against bankruptcy exists. To address this issue and achieve best practices, companies implement one of these additional safeguards. Fiduciary Services Clause This provision puts the fiduciary responsibility for interpreting the plan in friendly hands, rather than with an administration committee that can change after a change in control (CIC). Simply, it offers added protection in the event of a CIC or dispute with management. Moglia Rabbi Trust If your Rabbi Trust does not feature “moglia language”, it could be obsolete as a benefit security. A Rabbi Trust more than likely has assets subject to the “claims of the company’s creditors.” With moglia language, which is “subject to the claims of unsecured general creditors,” you add more protection. The line of creditors may be shorter than that of secured creditors, as evidenced in Bank of America N.A. v. Moglia [330 F.3d 942 (7th CIR 2003)] case.
Add Executive Roth With added benefit security issues and reduced flexibility under §409A, it is advisable to consider offering participants an “after-tax Roth” arrangement that is not subject to §409A—one that can provide nontaxable income at retirement and that is fully secured against company creditors. The Executive Roth Strategy (ERS) allows participants to elect to defer a portion of their annual deferrals (or to re-defer a portion of current balance) into the ERS. An institutionally designed policy that is generally only available to corporate purchasers to fund the ERS, which results in its tax-advantaged status. What’s more, ERS is not generally available to individuals. The policy offers 100 percent cash value in year one with no surrender charges, and features more than sixty investment alternatives (subaccounts) from such fund managers as American Funds, Fidelwww.retirementcapital.com
The Clock is Running Out on §409A ity, Franklin Templeton, and more. One of the disadvantages of an after-tax plan is the loss of the invested principal each year due to taxes (on contributions, not earnings). At the participant’s discretion, after-tax contributions to the plan can be supplemented by a tax restoration account internal to the insurance contract. ERS is funded through an internal contract loan which functions in this way: • The loan charge is long-term debt rate (LIBOR plus 1.5% capped at the Moody’s Seasoned Corporate Bond rate) Current rate for November 2008 5.55%;
Setting Timing One silver lining to §409A is added flexibility in the timing of deferrals. Participants need to make their elections for salary deferrals in the calendar year prior to earning the salary. However, there is even more flexibility with performance-based bonus compensation. The new law allows the election to be made “up to six months prior” to the end of the performance period. Therefore, on calendar year plans, elections can wait until June 30th of the year in which the bonus is earned. The following chart illustrates the new provision.
• Policy loans are automatically deployed in participant-directed investment accounts such as equity funds; • The loan is a non-recourse loan with no required prepayment except through policy proceeds at surrender or death; and, there is no prepayment penalty.
The timing of the bonus deferral could also be advantageous to long-term performance plans. As long as deferral elections are made six months prior to the end of the performance period, the bonus can be deferred.
Consider Company Match/Contribution
Determining Deferrals NQDC plans can allow participants to defer the majority of their salary, bonus, commissions, and longterm incentives. Best practice plan designs allow the deferral of 80-90 percent of salary and 100 percent of other compensation including signing bonuses and relocation packages.
Companies that match participants’ deferrals have higher participation levels. Contributions do help companies attract, retain, and reward its most valuable asset, key talent. But matches carry a cost to the company. If your company is funding its plan with mutual funds or COLI, it is possible that you already have the funds to offset the expense of matching contributions. Evaluate your current funding if you have not done so in the last 18 months. You may be surprised to learn that you can save money, and use it to reduce shareholder expense or offer a larger company match. Vol. 6 No. 4 • 9
The Clock is Running Out on §409A
Review Plan Administration Above all, while you still have this window of opportunity before §409A, review how the company administers your NQDC plan. Do it post-§409A, as well. We urge you to closely compare plan funding against plan administration; there may be hidden cost savings to be gained. This “unbundled” review may well lead to a level of efficiency and effectiveness not present in your current system. In life as in business, time can be friend or foe. If we regard every day as the fourth quarter, we are in better position to maximize our opportunities. Don’t sit in the stands and lose your advantage. n
About William MacDonald
Mr. MacDonald founded Retirement Capital Group, Inc. (RCG) in San Diego in 2003, where he serves as Chief Executive Officer, and Chairman of the Company’s Board of Directors. He also founded Compensation Resource Group (CRG) in 1978. CRG was acquired by a NYSE company in 2000; Mr. MacDonald then presided as President and Chief Executive Officer of the executive benefits division until 2003. Mr. MacDonald has consulted on executive compensation and benefit issues for more than 20 years for numerous public and privately-held firms across a variety of industries, including a large number of Fortune 500 companies. He wrote a book Retain Key Executives published by CCH , and has authored numerous articles on the subject of executive compensation and benefits. In addition, Mr. MacDonald has been quoted frequently in The Wall Street Journal, The New York Times, and Bloomberg, as well as in a number of industry trade journals. A frequent lecturer, Mr. MacDonald has spoken on the subject of compensation and benefit planning to various organizations, including The Conference Board, World-at-Work, Forbes CEO Forum, and the Young Presidents’ Organization. For more information, please contact Amy Ripplinger at 858.677.5900 or visit www.retirementcapital.com.
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The Age of Prosperity is Over Figure 1 Inflation Adjusted S&P 500 (monthly, semi-log, September 2008 dollars, through Oct-08)
[ Continued from Page 5 ] exempted owner occupied homes from any capital gains tax, and finally reduced government spending as a share of GDP by an amazing 3 ½ percentage points (more than the next four best presidents combined). The stock market loved Clinton just as it had loved Reagan, and for good reasons. The stock market is obviously no fan of second term Bush, Pelosi, Reid, Bernanke, Obama or McCain, and again for good reasons. These issues aren’t Republican or Democrat, left or right, nor liberal or conservative. They are simply economics, and wish as you might, bad economics will sink any economy no matter how much they believe this time things are different. They aren’t. I personally was on the White House staff as George Shultz’s economist in the Office of Management and www.retirementcapital.com
Budget when Nixon imposed wage and price controls, the dollar was taken off gold, import surcharges were implemented, and other similar measures were enacted from a panicked decision made in August of 1971 at Camp David. I witnessed, like everyone else, the consequences of a panicked decision to cover-up the Watergate break-in. I saw up close and personal Presidents Ford and Bush Sr. succumb to panicked decisions to raise taxes and Jimmy Carter’s emergency energy plan, which included wellhead price controls, excess profits taxes on oil companies, and gasoline price controls at the pump. The consequences of these actions were disastrous. Just look at the stock market from the post-Kennedy high in early 1966 to the pre-Reagan low in August of 1982. The average annual real return for U.S. assets compounded annually was -6% per year for 16 ½ years. That, ladies and gentlemen, is a bear market. And it is something that you may well experience again. Yikes! Vol. 6 No. 4 • 11
The Age of Prosperity is Over And then we have this Administration’s panicked Sarbanes-Oxley legislation and of course the deer-in-theheadlights Ben Bernanke in his bungling of monetary policy.
witnessing the end of prosperity. n
There are many more examples, but none hold a candle to what’s happening right now. Twenty-five years from now what this Administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked or drunk, the consequences are rarely pretty. We are now About Dr. Arthur Laffer Arthur B. Laffer is the founder and chairman of Laffer Associates, an economic research and consulting firm that provides investment-research services to institutional asset managers. Since its inception in 1979, the firm’s research has focused on the interconnecting macroeconomic, political and demographic changes affecting global financial markets. Dr. Laffer’s economic acumen and influence in triggering a worldwide tax-cutting movement in the 1980s earned him the distinction in many publications as “The Father of Supply-Side Economics.” One of his earliest successes in shaping public policy was his involvement in Proposition 13, the groundbreaking California initiative that drastically cut property taxes in the state in 1978. Years of experience and success in advising on a governmental level have distinguished Dr. Laffer in the business community as well. He currently sits on the board of directors of several public companies, which include Vivendi Environmental (V), PacifiCare Health Systems (PI-ISY), MasTec Inc. (MTZ), Neff Corp. (NFF), Nicholas-Applegate Growth Equity Fund (NAPGX), and Oxigene Inc. (OXGN). He also sits on the board of directors or board of advisors of a number of private companies including: ProFlowers, Plyent.com, Synectics Technology, Proponent Sofiware, Interelate, Enverity, Restaurants International Group, MSC.com, ValuBond, Sonic Telecom, VirtualCom, U.S. Script and Castle Creek Capital. Dr. Laffer is a founding member of the Congressional Policy Advisory Board, a select group of advisors who assist in shaping legislative policies for the 105th, 106th, and 107th United States Congress. Dr. Laffer was a member of President Reagan’s Economic Policy Advisory Board for both of his two terms (1981-1989). He was a member of the Executive Committee of the Reagan/Bush Finance Committee in 1984 and was a founding member of the Reagan Executive Advisory Committee for the presidential race of 1980. He was formerly the Distinguished University Professor at Pepperdine University and a member of the Pepperdine Board of Directors. He also held the status as the Charles B. Thornton Professor of Business Economics at the University of Southern California from 1976 to 1984. He was an Associate Professor of Business Economics at the University of Chicago from 1970 to 1976 and a member of the Chicago faculty from 1967 through 1976. Dr. Laffer’s book, The End of Prosperity, is available for purchase at www.amazon.com.
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The Value of Pragmatism [ Continued from Page 7 ] natively, with an NQDC plan, those assets are technically unfunded, and are subject to the claims of the company’s creditors. Even though companies “informally fund” these arrangements in a Rabbi Trust, these assets nonetheless belong to the sponsoring employer, which slightly complicates plan administration. A revealing statistic underscores the complexity of plan administration: Only 15 percent of respondents in the Clark Survey manage their NQDC plans in-house.
Identifying Major Providers Nonetheless, it will be difficult to resist the urge to locate and delegate a firm to handle all the exigencies of plan administration. Understand that no single firm specializes in pure plan administration; it is simply not a stand-alone business model. These services are provided for the sole purpose of gathering assets under management whether that is mutual funds or corporate-owned Life Insurance (COLI). By example, Fidelity Investments is not in the 401(k) recordkeeping business; however, the company must offer that tool to capture and support the assets. To learn which NQDC plan administrators suit your situation, first examine direct revenue sources. You can actually segment the entire field into two groups: those that sell mutual funds (401(k) providers); and, those that sell COLI. Many COLI-motivated firms may sell a combination of mutual funds and COLI, and there are just a handful that use both. The 401(k) providers are somewhat at a disadvantage because their systems have been designed to manage plans in a systematic box, with corresponding restrictions and limitations on plan design. We urge you to avoid the mistake of oversimplifying the selection of a provider because you desire a simpler plan. In our experience, plan participants will be dissatisfied, and your firm will be at a competitive disadvantage. If you have taken the time to evaluate the www.retirementcapital.com
need for a nonqualified plan, do not take short cuts on design, security, funding and, especially, plan administration.
How to Evaluate Best-in-Class We recommend that you apply the following five criteria to make a best-in-class decision on the appropriate plan provider, one that can consistently meet the majority of your objectives: 1. Expertise/Experience Ever-changing tax codes are reason enough to accept nothing less than an expert in nonqualified plans. Interpretation of these codes demands a level of critical thinking, knowledge and experience typically not found in generalist firms. Look for seasoned teams with a consultative approach to help you benefit from a plan built and serviced on best practices. 2. Technology Best practices plans require state-of-the-art technology solutions that lead to robust website functionality and convenience for both plan sponsor and plan participants. A meticulous record keeping system is needed to accommodate custom plan designs, track pre- and post-§409A and §409A plans, handle due diligence on investment options, and produce a steady stream of customized corporate reports. Technology is not the major differentiator it once was. Most of the major firms in fact use the same platform, provided by the same firm. 3. Stability By asking these two direct questions, you can uncover real stability in a provider: 1) does the firm offer an audited administration system and has it passed the SAS 70 II Audit?; 2) is turnover of plan administrators low and the management foundation solid? 4. Communication and Education In a society filled with constant communication, why do we urge you to educate and communicate even more? It is not enough anymore to merely give employees a way to save. They need and want a deeper understanding of how to better Vol. 6 No. 4 • 13
The Value of Pragmatism manage their own investments. Even smaller firms nowadays turn to outside financial consultants to deliver a higher quality stream of communication. Frankly, with the devolution of once-sacred Wall Street brands, more savers are finding solace in the objectivity and impartiality of independent advisory firms. Ensure that your prospective or present provider offers an effective system to educate and communicate with your Board, management and employees. Then, test the waters. Does the advisor possess clear and consistent communication skills? Is he empathetic in a crisis? Will he or his team be accessible and reliable during transitions or otherwise?
a simple yet revealing four-point scoring system that measures key indexes important to clients: (4 indicates “most capable” ; 1 indicates “not as capable”; please see the grid below).
Technology Platform When you evaluate the technology platform of a given provider, you need only to investigate two major areas: 1) Participant access and experience; which is to say, how easy and convenient is it for participants to retrieve up-to-date, accurate information on their accounts 24/7? ; 2) Plan sponsor access and reporting capabilities; that is, can sponsors learn quickly what is needed to operate the system with little training; does
5. Cost Every business decision merits a cost/benefit or risk/reward analysis. It is no different with your choice in providers. Evaluate both hard and soft costs in your decision to work with a nonqualified plan provider. Here are a few cost factors to consider: • funding and security solutions • underlying fee arrangements • tax implications of deferrals and payouts As part of ongoing due diligence evaluation for our clients, Retirement Capital Group (RCG) periodically evaluates and ranks providers, investment strategies, administration systems and more. This work requires the maintenance of very detailed reports of each provider/firm’s capabilities, along with the advantages and disadvantages as applied to each client situation.
RCG Scorecard With downsizing and cutbacks, many companies do not have the time or HR staff to conduct full evaluations on benefit plan providers. By bringing in a thirdparty consultant to do the analysis, clients typically save money, time and learn what they need to know to make a right decision for all concerned. As a specialist in retirement planning, RCG developed
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the platform produce detailed and readable reports on demand? ; is the platform robust and reliable? To illustrate, we use our measurement system in Chart III (on page 15) to evaluate four actual third-party administrators on an anonymous basis: What determines a score of 4 versus 3 in the above grid is functionality of the administration system. For example, we investigate: • How user-friendly are web tools for asset allocation modeling and online enrollment? • Can the system accommodate custom corporate reporting requirements of custom plan designs? • Does the system accommodate daily asset/liability matching to minimize the mismatch? • Can the plan sponsor print “on-demand” corporate reports from the plan website? • Does the system provide functions to help reduce hours spent in plan sponsor administration? www.retirementcapital.com
The Value of Pragmatism
(A) (B) (C)
The system does not support online modifications. Participant must complete a modification form or call the call center Limited to providerâ€™s product Limited to select insurance carriers
Chart III Accuracy of data is paramount. Fortunately, we have found this is a minor issue for most providers. However, we have found a fairly consistent lack of system capabilities by 401(k) providers when administering assets other than mutual funds. With the power of technology to do more in less time, and the urge to go green, companies do not want to get buried in paperwork. Secure and streamlined online enrollment and monitoring technology is must. But do not trust that just because a provider claims it offers a robust technology platform, that it is so. Get online and experience firsthand what the provider claims for your participants.
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The Value of Pragmatism
The Human Factor Unlike a 401(k) plan, a nonqualified plan is a complex mechanism with many moving parts. At first glance, you see a pile of puzzle pieces strewn across a card table, only halfway fitted. Then, as you draw closer, and you begin see the trees, mountains and the pastoral scene. NQDCs are similar, and they deliver best results when handled by a client service team adept in four disciplines: 1) information technology; 2) tax and law; 3) asset management, and; 4) communication and education. You can produce the best designed nonqualified plan, but it will be quickly undone if the system cannot accommodate customization, implementation and communication. Executives won’t participate, and the experience is lost to negative perceptions. A savvy client service team can keep plans on track and in compliance with the new tax laws and regulations. It can effectively manage assets and liabilities to minimize the potential for mismatch. It can manage the re-enrollment and convey the value of the plan to increase participation and utilization of the financial planning tools. When you select a truly experienced third-party administrator firm, your client service standards will rise exponentially. Chart IV evaluates some basic elements of client service. CHART IV
What determines a score of 4 versus 3 is measurable experience of the client service team. For example: • How many years has the client service manager worked at his firm and in nonqualified business? • How many “high profile” plans does he or she manage? • Does the client service team include an investment consultant to monitor the plan investment options and asset allocation models? • Does the client service team offer a CPA to manage corporate accounting/financial reporting? • Since no two plans are alike, does the firm provide custom communication strategies including custom enrollment guides, webinars, and the incorporation of the plan sponsor’s brand on the communication materials?
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The Value of Pragmatism
Cost Priorities and Variables Can you put a price on the cost of hiring the best talent in the business for your company? Can you put a price on their contribution, their value, their loyalty? Then, that is the cost on your nonqualified plan because it is a catalyst to those outcomes. This statement is not meant to be glib. It is a statement of fact. Why else do the majority of Fortune 1000 corporations and a rapidly growing number of smaller firms offer NQDCs to their senior managers. One can make the argument that in this unprecedented period of corporate restructuring, companies cannot afford to shortchange the very people who can lead through the uncertainty ahead. What’s more, cost is not the deal breaker it once was—most thirdparty administrators charge comparable fees. Transparency of hard dollar fees and soft dollar costs of the funding strategy is the linchpin of cost analysis. After receiving a plan administration fee quote from the provider, determine the soft costs of the funding solutions. The option to offset the hard costs with the commissions and basis points the provider earns from the assets under management can help to manage and, possibly, reduce the overall cost of the plan. The following chart (Chart V) gives us a good example. In examining the four plan providers, only provider A and D offers to offset hard dollar fees with commissions earned from the assets under management. Let’s as-
A. Fees reduced by 100% if the plan is financed with COLI. If service agreement terminates within the first 4 years, the client is retroactively charged for administration fees from service inception. B. Fees reduced by 100% if the plan is financed with COLI. If service agreement terminates within the first 3 years, the client is retroactively charged 50% of administration fees from service inception.
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sume for a moment that the annual deferrals were $3 million and the company decided to fund with COLI. The commission could range from $300,000 to $900,000 in year one. Shouldn’t there be some offset? However, be careful here, as each plan provider’s funding solution has generated different soft dollar costs and commissions from the assets under management. The plan provider offering to offset hard dollar fees with commissions may not always be offering the most cost effective long-term solution.
Don’t Pay Twice It is a common practice for a major brokerage firm to bring in a third-party firm to handle plan administration. Be careful with this arrangement: Many times you pay twice. The major Wall Street brokerage firm hires its thirdparty partner to do the technical work, and then splits the commission and fee revenues. To the third-party partner, your company is now less profitable and, one could predict, you may not receive the level of service you deserve. Sad but true, the major brokerage firms on average take one-half of all revenues (not profits) on your account. Make sure there is some value added being provided by both parties.
Small and Effective It is human nature to think that bigger is better. We urge you to suspend this belief. Many firms in the nonqualified space have numerous plans on their books and, yes, they continue to grow. In our experience, the larger the firm, the greater the chance exists for critical details to fall through the cracks. Technology may be the ultimate leveler of this condition; however, the human factor complicates it. Larger, impersonal firms with too many clients and too little time will find it quite challenging to handhold the CEO of a small business or the newly minted human resource manager in a large firm. Ignore the impressive presentations and groups of well-spoken presenters. Large firms have “show and tell” teams they roll out to win the business. But you may never see that team again. You want to do business with the people who have a true stake in your success. Ultimately, smaller is better because smaller independent firms now possess all the technology tools, techniques and systems employed by the behemoths, but with one serious difference—they are fully dependent your goodwill, your financial success and your complete satisfaction. After all, no one is going to bail them out.
Pragmatists Rule We began this article by speaking to the value of pragmatism when choosing plan providers. We then outlined a range of criteria to guide your decision-making process—from experience, stability and technology to communication, education and cost. Then, we went against conventional wisdom. We posed the argument that smaller is better in the nonqualified space for reasons of specialization, client satisfaction of commitment to success. Whether from the client side or the vendor side, pragmatists seek each other out, sometimes unwittingly. Before you make your final decision on a provider, do a common sense litmus test. Look for a culture of pragmatism. Look for people who are down-to-earth, driven by values, cost and quality-conscious. Authentic. And, do you sense a shared vision of what’s possible for now and in the future? Then, and only then, let them earn your business. n
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Bo Lee serves as Vice President, Consultant in RCG’s Western Region. He works closely with large public and private companies to design and implement executive compensation and benefits programs used to attract, reward, and retain key executives. His extensive consulting expertise includes nonqualified benefit plan design, benefit security, informal funding, and administration. Prior to his current position, Mr. Lee was Vice President of Client Services. His responsibilities included strategic planning in the areas of client relationship management, plan administration outsourcing, and trust services outsourcing. He managed client relationship managers and oversaw all activities relating to plan implementation and ongoing client service activities. This included overseeing the selection of the third party administrator and trustee, development of the plan communication materials, integration of takeover plans and conducting enrollment meetings. He was instrumental in building a key differentiator in the RCG consulting model of delivering plan administration solutions through an open architecture solution approach. Mr. Lee is the architect of RCG’s Plan Administration Solutions (PAS) database, which includes the best-of-class plan administration firms in the industry. He has conducted a due-diligence evaluation on firms which include mutual fund companies, trust companies, life insurance companies, retirement plan administrators, and a software company. Prior to joining RCG, Mr. Lee was associated with Compensation Resource Group (CRG), which is now Clark Consulting’s Executive Benefits Practice. He is a graduate from the University of California, Los Angeles with a Bachelors of Arts degree in Economics and is licensed through the National Association of Securities Dealers (NASD).
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