Distinctive executive benefit programs can attract and retain top employees by helping them meet their financial goals.

Authors: Brian Deane Nathan Trotman

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Highly compensated employees (HCEs) continue to be an elevated flight risk, making effective incentives for top talent a high priority. Employers compete on two levels — internal retention and external attraction. And both challenges require them to offer alternatives for individualized options that support near-term and long-term retirement goals.

Compensation trends, inflation concerns and a variety of other factors have increased the importance of offering distinctive executive benefit programs, regardless of employer size. Because top talent is a significant investment in the current direction and future prospects of any organization, it's critical to know and address HCEs' pain points. Strengthening the commitment of these HCEs to stay in place — and to grow where they are — minimizes potential loss, including the loss of the institutional knowledge they continue to accumulate.

Often there are tipping points in careers that prompt critical influencers to look for a new opportunity elsewhere. At these junctures, reinforcing the value they see in their rewards can help diminish or neutralize this inclination.

Incentives may have different success rates for HCEs depending on their career stage and life situation. Reward structures targeted to 65 year olds are less likely to capture the interest of younger generations whose retirement needs are less immediate. But interest in shorter-term incentives could provide a solution. Some employers are combining shorter-term incentives with longer-term incentives, such as bonus plan structures and in-service distributions, to help sustain engagement and loyalty. This approach also supports mid-career goals like saving for a vacation home or sending children to college.

How nondiscrimination testing requirements affect HCE contributions

Traditional qualified plans such as a 401(k) are set up to work for the masses. Financial advisors often suggest that individuals directly defer 10% of their income into retirement savings, but contribution limits can make it impossible for HCEs to meet that threshold because of their salary level. To help ensure that a 401(k) or any other qualified plan is beneficial for all participants, not just the highly compensated, employers are required to meet nondiscrimination testing standards. Ratios for HCE and non-HCE contribution levels typically must fall within a margin of 2%. If they don't, HCE contributions are reduced accordingly.

When non-HCEs decide not to contribute to the 401(k) plan, their 0% rate brings down the average contribution. And this factor may limit the contribution percentages permitted for HCEs. Consequently, employees who earn $150,000 or more in 2023 may not be able to reach their retirement target. This can happen even if the plan passes nondiscrimination testing and the HCE is allowed to defer the statutory maximum of $22,500 plus a $7,500 catch-up.1 While saving $30,000 per year may seem like a lot, it may leave some HCEs short of their goals.

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Highly compensated employees for plan year 2024 are employees who own more than 5% of the interest in a business or earn a minimum salary of $150,000 in 20231

Broadening the use of nonqualified deferred compensation (NQDC) plans for incentive purposes

Executive compensation usually takes the form of a nonqualified deferred compensation (NQDC) plan, most often funded by voluntary participant deferrals or employer contributions. This plan benefits the organization overall from the standpoints of succession planning, brand perception and general wellbeing. For participants, it can help fill the gap between a qualified plan's contribution limits and the amount of replacement income an HCE expects in retirement. If a participant is falling short of retirement readiness goals, an NQDC or cash balance plan may boost their assets without requiring an employer contribution.

Nonqualified plans allow organizations to differentiate rewards without the restrictions of nondiscrimination testing. And they can be customized based on individual potential, performance and preference.

Core considerations of an NQDC plan include eligibility, contributions, growth, vesting and distribution. A key advantage for HCEs is the ability to save for retirement, while also mitigating taxes on their assets once that milestone is reached.

Compensation deferred to an NQDC plan is allowed in excess of qualified plan maximums. Participants are taxed on the deferrals plus any earnings at the time they actually receive the money. These plans are also exempt from the Employee Retirement Income Security Act of 1974 (ERISA), which means that no fiduciary responsibilities, nondiscrimination testing or 5500 filings apply.

Rules that govern NQDC plans tend to be complex, including the most common type, which is a 409A deferred compensation plan (56%).2 So it's often helpful for sponsors to thoroughly review and compare available options. Preparation can position sponsors to better to verify that any changes they implement align with organizational goals and comply with applicable Section 409A regulations.

New plan implementation typically takes from 60 to 90 days from start to finish and often includes a feasibility study, an informal contribution and cost analysis, plan design, a vendor search and document drafting. A legal review by ERISA Counsel is also required. And employee communication and enrollment, as well as a funding analysis, complete these necessary steps. However, organizations with an established deferred compensation plan have a few other boxes to check. Benchmarking the plan's design and utilization, and evaluating its funding status, asset/liability balance and effect on the company's financials, are also essential.

Core considerations for NQDC plans are eligibility, contributions, growth, vesting and distribution

Evolving retirement solutions and increasing their potential for synchronizing investments

By considering all available options such as 401(k) plan limits and traditional IRA conversions, HCEs can maximize their retirement contributions. They may benefit by investing in a Roth 401(k), or a nondeductible traditional IRA that is later converted to a Roth account. Other considerations include a backdoor Roth contribution or opening a health savings account (HSA) in conjunction with enrollment in a consumer-directed high-deductible health plan.

An HSA is a versatile and powerful financial instrument for covering short-term expenses and meeting long-term needs. Portability, tax advantages and the potential to generate long-term savings for funding medical care in retirement are benefits that will likely appeal to many HCEs. Maximum total contributions in 2023 are $3,850 for an individual plan and $7,750 for a family plan.1

More unique plan structures are emerging, along with financing options such as entity ownerships or premium financing that use life insurance products in a nonqualified plan. Financing removes significant hurdles, including the need for the plan sponsor and participants to commit to a massive capital outlay. Another opportunity is setting up a deferred bonus nonqualified plan, which greatly increases the incentive for HCEs to take a long-term investment over an immediate commission.

It's also possible to fix gaps in retirement and tax savings that occur with NQDC, and to carve out plans for individual life insurance and disability insurance. The upside of these solutions can be expansive  — they help sustain businesses over the long term through retention and timely retirement of key employees. Contributing factors are easier navigation of ERISA limits, standardized group limits and more favorable tax regulations and estate tax rules.

The increasing relevance of how HCEs are compensated

Organizations may delay implementation of a nonqualified plan because the process can be intimidating for the uninitiated, especially if no other plan exists. But sooner is better. Promised benefits that appear on balance sheets but remain unfunded can potentially become a growing obligation. Once the plan is in place, management becomes easier over time.

Considering differentiated and individualized incentives supports the goals of both HCEs and the organization. By offering more uniform access points and investment allocation choices  — and ensuring that employees understand how to use their plan features  — employers can enhance income planning. When that happens, the outcomes of efforts to attract and retain key employees are likely to improve.

Author Information

Sources

1Miller, Stephen. "2023 Benefit Plan Limits and Thresholds Chart," SHRM, 28 Oct 2022.

2"2022 Workforce Trends Report Series: Financial Wellbeing," Gallagher, Jan 2023.

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