Retirement planning for owner-employees, executives, and other highly-compensated employees can often fail because of one well-kept secret:
These people will rarely, if ever, be able to meet their retirement income needs by simply using qualified retirement plan techniques.
Surprised?
The fact is that qualified plans are seldom sufficient for business owners or top executives if they want to maintain their lifestyle in retirement, and the reason becomes clear when the total costs (and burdens) of qualified plans are compared with their limited benefits. These top-earners are often severely limited in the amount of contributions they can make and nondiscrimination testing frequently caps at much less than the maximum, which is often less than 3% of compensation.
While it’s not unusual to find that an average wage earner in a company is able to achieve a retirement income of about 60-80% of final compensation, a highly-compensated owner, executive, or employee can often expect to achieve a retirement income of about 10-30% of final compensation. They’ll even likely face taxes on their Social Security, too.
That’s a huge gap.
This may be the reason many successful companies have adopted non-qualified plan techniques, either in addition to, or sometimes a substitute for, a qualified plan.
If the employer is willing to give up the current deduction of a qualified plan, or is already maximizing its current plan, s/he can gain flexibility to design and fund a nonqualified plan with no limits on either contributions or benefits except reasonable compensation limits.
In effect, it’s like having a “unlimited” 401(k)-like deferral option; and, the employer can choose the plan participants, as well as the employer matching and contribution guidelines. There’s more: The employer can avoid the burdens of non-discrimination, disclosure, and reporting requirements by fitting the plan into an ERISA safe harbor exemption, even though there are some additional requirements that must be met; but, now an employer can use a nonqualified plan to design deferred compensation in favor of select executives, highly compensated employees, and even independent contractors!
Why would an owner or senior executive want to do this?
Besides the obvious benefit of addressing the retirement income gap for him or herself, there’s a sound business reason: Keeping top talent, not only for the foreseeable future but for future business value in case of a sale! When it’s time to make your exit, how can a potential buyer be assured that top key talent will stay on?
Proper planning will allow you to show your potential buyer that your key talent has “skin in the game” and an interest to protect – they’re unlikely to go anywhere; and, let’s face it, the biggest asset any company has is its employees, especially the key personnel that make it all work.
If you have a successful business, are concerned about your meeting your retirement income needs, and look to business value as a key component to building your net worth, you may want to talk with your financial advisor about the feasibility of adopting a non-qualified plan.
Retirement isn’t a destination; it’s a roadmap.
