Deferred Compensation, Diversified WealthBy: Andrew Rosen, CFP®, CEP®

In working with a lot of upper level executives some interesting things start to happen as one moves up the corporate ladder.  Once such thing happens, an executive hits a certain income threshold.  By IRS limits, they actually become reversely discriminated against.  I know that sounds like a crazy assertion, but the issue is real. In order to keep top talent, companies use some creative tactics to make sure all levels of the corporate ladder are treated fairly.

The Background

There is a mandated restriction put in place by the government on annual compensation limits to most qualified retirement plans.  In 2018, the limit used to determine contribution limits to the majority of corporate sponsored retirement plans is $275,000 per year.  This means for any regular income (base + bonus usually) above this threshold you may not receive qualified benefits (i.e. employer match).

Where and why is this an issue?  I’ll describe two examples to illustrate the “reverse” discrimination.

Example 1:  An employee earns $150,000 total income. Their company matches 6%, as long as the employee contributes 6%.  This person puts in their pre-tax limit in 2018 of $18,500 + $6,000 (50 or over catch-up) for a total of $24,500.  Since this individual put in the required 6% (or $9,000), they’ll receive another 6% (or $9,000) in employer matching contributions.

Example 2:  An upper level executive (also 50+ years old) earns $400,000 in total income working for this same company.  This executive also contributes the 2018 maximum allowable to their 401(k) — $24,500. However, this individual is only entitled to 6% of their first $275,000 of income.  In 2018, that means their employer match amount is $16,500, not the $24,000 that would represent 6% of their salary.

The Problem

The issue here isn’t that the higher compensated employee received more matching dollars (as they simply have more salary to be matched).  The executive employee in the above example has $125,000 of additionally earned income for which they are not allowed to receive employer benefits.

$400,000 – $275,000= $125,000

Therefore, the higher level executive is only receiving matching dollars on a little over 4% of their income.  The other employee however receives the full 6% matching contribution on all their salary.

Thus if a large corporations want to keep these upper level executives, they must come up with a creative solutions to entice top talent.

The Creative Solution

So what do these companies do?  Smart companies when faced with this conundrum get creative!  They offer the adversely impacted executives some form of a non-qualified plan, usually in the form of deferred compensation.  Since these plans aren’t governed by ERISA, they adhere to an entirely different set of rules.

A deferred compensation plan allows the employer to offer these executives a savings vehicle where they can contribute and receive match dollars on income over and above the 2018 threshold of $275,000.  This way, these employees are receiving similar employee benefits as their less compensated counter parts.

The Outcome

Although many nuances exist in these plans (such as they are unsecured assets until a separating or vesting even), they are generally put into place with very good intentions.  Employers keep and treat top talent equally.  Employees have more deferral possibilities and can save in line with their retirement lifestyle needs.

I suggest working with someone to help guide you through the ins and outs of these alternative retirement plans.  At Diversified, we deal with these plans every day. We are well equipped and happy to help!

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Andrew Rosen

In his role as Financial Planner, Andrew forges lifelong relationships with clients.  He coaches them through all stages of life and guides them to better achieve their life goals.  For more information about Andrew or the other firm partners, Kyle Hill and David Levy, click the link below.

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