Nonqualified retirement plans at an ‘all-time high,’ as employers compete for talent

According to a new report from WTW, many employers are making changes to nonqualified retirement plan offerings, in an effort to attract and retain top employees such as executives and other high-income earners. The analysis found that there is a renewed focus on nonqualified retirement plans, which are plans that are not subject to Employee Retirement Income Security Act (ERISA) rules and can include deferred-compensation plans, executive bonus plans, and split-dollar life insurance plans. The nonqualified plans do not generally use pre-tax dollars, in contrast to plans such as 401(k)s.

“Employer interest in nonqualified retirement plans is at an all-time high. In fact, we have helped clients implement more new plans and redesign existing plans in the past two years than in prior years,” said Chris West, senior director, head of Dallas Retirement, and leader of WTW’s Nonqualified Plans Specialty Group. “While employers have been investing time and effort into their nonqualified plans, many recognize they aren’t getting or providing the value intended. As a result, employers are looking to improve the employee experience through more focused communication and education as part of their redesign strategy.”

A growing interest in nonqualified plans

The WTW report surveyed 396 U.S for-profit and nonprofit organizations that offer nonqualified retirement plans, representing 7.5 million employees. More than half of survey respondents (56%) said they offer only a nonqualified DC retirement plan, while 35% sponsor both a nonqualified DC and DB plan. In addition, more than half of respondents (55%) either made changes to their nonqualified defined benefit (DB) retirement plans in the past two years or said they plan to make changes in the next two years. In addition, 75% said they changed their nonqualified defined contribution (DC) retirement plans in the past two years or plan to do so in the next two years.

The survey found that employers are focused on becoming more competitive in this area by improving participant experience. For example, the data showed that sponsors of DC plans were looking at improved communication (52%), education (47%), and financial counseling (28%) as their key strategies for improvement in the next two years. The WTW report also noted that 60% of sponsors provide financial counseling benefits to executives either directly via an employer vendor or through a stipend for financial advice.”

The use of rabbi trusts

The report noted that 60% of DC respondents and nearly half (47%) of DB respondents said they informally fund their nonqualified plans by use of a “rabbi trust”—a term that covers trusts that have traditionally been used to support nonqualified benefit arrangements. This kind of trust was first created by a rabbi and his congregation, and the IRS approved the arrangement, leading to the commonly-used term.

“A rabbi trust creates security for employees because the assets within the trust are outside the control of employers; they are typically set up to be irrevocable,” said Investopedia. “In other words, once the employer makes contributions to a rabbi trust, they cannot retrieve them.”

A battle for talent

The report underscores the fierce battle for talent that is taking place in corporate America: it says the top reasons for the renewed interest in nonqualified retirement plans is either attraction/retention of talent (ranked as a top-three reason by 84% of respondents) or creating a competitive benefit package (also 84%). The other highly-ranked reason is to provide an avenue for accumulating wealth in addition to qualified plans (74%).

Employers are also putting their money into nonqualified plans: four out of five companies provide some sort of employer contributions for such plans. The survey found that 53% of employers said they made matching contributions for these plans, 34% said their plans featured employer contributions only, 32% featured discretionary employer contributions, 16% used profit sharing/incentive contributions, and 21% featured employee contributions only.

Related: Nonqualified deferred compensation plans: Key to drawing top talent

Most of the plan sponsors (66%) use account-based distribution—these are accounts where contributions are spread across the year; class year distributions, which allows different distribution payouts for each year’s contributions, were used by 34% of employers—even though the report said that this type of distribution provides more financial flexibility.

The report raised several issues around nonqualified accounts. It noted that only 23% of nonqualified DB sponsors have either completed or plan to complete some de-risking action and asked, “Will this trend increase as sponsors continue to de-risk qualified DB plans?”

The report also found that 50% of sponsors do not regularly review their plans for compliance with applicable regulatory and operational requirements. The WTW report suggested this might be another way that companies can provide better implementation of these arrangements. “An independent assessment of any existing funding or potential new funding should be performed to reduce frictional fees and to manage financial risk from these programs,” said Beth Ashmore, managing director, Retirement at WTW.