An IPO is a milestone event for a company and its executives. Public company management teams and their boards need to always explore ways to better attract and retain executive talent. A nonqualified deferred compensation plan (DCP) is a common executive benefit offered by more than 70% of public companies.
Establishing a DCP for your executives and senior management provides significant benefits to the company and plan participants with no P&L impact to the company. A DCP allows executives to defer income above qualified plan limitations inherent in 401(k) plans, as well as to defer restricted stock units (RSU) and performance stock units (PSU). The ability to defer RSUs/PSUs, which may have significantly increased in value post-IPO, provides a material financial benefit to executives. From the company’s perspective, these compensation deferrals are viewed as a future promise to pay and are typically structured with an offsetting asset to ensure minimal or no P&L impact to the company sponsor. These assets are often held in trust for the benefit of the executives.
Advantage of Deferral vs. Taxable Investment 37% Tax Rate $828,566 or 114%
45% Tax Rate $814,561 or 150%
Blended Tax Rate $664,844 or 116%
Note*
Assumes executive age of 45, 7 annual deferrals of $50K, a net rate of return of 8%, and 20 annual payouts beginning at age 65 (note: payouts in the DCP are taxable when taken).
Blended tax rate assumes 37% in years 1-5, 45% in years 6-10 and 50% in years 11+.
Cumulative after-tax payouts assume 3.8% tax on investment income associated with the healthcare reform legislation.
Mezrah Consulting provides a full complement of services to design, implement and fund new DCPs while also providing the ongoing administration for plans through our software-as-a-service (SaaS) platform, mapbenefits®.
The Cumulative After-Tax Payouts comparison graphic illustrated to the right, demonstrates the power of pre-tax compounding of deferrals invested on a tax deferred basis. The bars on the left, indicate the future value of compensation assuming no deferral (taxes paid on compensation including earnings). The bars on the right, illustrate the future value of deferred compensation invested on a tax deferred basis.
Benefits to the Executive
Pre-tax wealth accumulation opportunity for executives
Allows pre-tax deferrals of salary, bonus, severance, RSUs and PSUs
Restores benefits lost due to 401(k) limits
Allows the executive to maintain the full number of RSUs/PSUs upon vesting as there is no forced sale to pay taxes
Provides participants with flexible payout options (e.g. retirement, separation, specified date, etc.)
Allows executives to select from a variety of investment funds including a fixed rate of return
Benefits are secure as deferred dollars are held in trust by an independent third party given a change in control, change in heart or the company’s inability to pay
Plan balance is beyond the reach of creditors or judgments of the executives
Benefits to the Company
A highly visible benefit
Provides deferral opportunity with minimal or no impact to corporate earnings
Cost recovery for the corporation
Funding dollars can accumulate on a tax-favored basis
Remain competitive within the industry
Improves executive retention and attraction
Maximizes 162(m) deduction
Corporate Cost Summary
Financial Assumptions
Average Age of Census: 45
Retirement Age: 65
Annual Deferral: $1,000,000
Years to Defer: 7
Benefit Payout Duration: 20 Years
Net Rate of Return: 8%
Corporate Tax Rate: 26.5%
Benefit Payout Source: Corporate Cash
Securities offered through Lion Street Financial, LLC. (LSF), member FINRA & SIPC. Investment Advisory Services offered through Lion Street Advisors, LLC (LSA). LSF is not affiliated with Mezrah Consulting. LSF, LSA and Mezrah Consulting do not offer legal or tax advice. Please consult with the appropriate professional regarding your individual circumstances.
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