Creating Your Own Entitlement

February 16, 2015

by Michael G. Goldstein, EVP Corporate Strategies

You need to now focus on creating your own entitlement. A voluntary deferral of your current earnings into a non-qualified deferred compensation plan is once again gaining traction in the corporate world.

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The generation that has given us the iPhone, laptop computers, Windows, Star Wars and ET is now giving us a reason to revisit Social Security. The generation’s mantra that 60 is the new 40, 40 is the new 20 and 20 is the new embryo does not stop the inexorable advance of time. We are now facing the onslaught of a large generation facing Social Security. Will there be enough for subsequent generations and should they plan now?

There is an old Chinese curse “May you live in interesting times”. Well we certainly do. A large national debt, politicians offering tax cuts and then tax increases depending on which way the wind blows and a need to control our national debt weighed against entitlement programs including Social Security. Although Social Security should have sufficient funds to meet successive generations’ needs it may not have enough to meet promised benefits.

One certainty that will emerge from all this is that either taxes will rise or entitlements will fall or both. What will that mean to the individual facing retirement? In a new trend in the wealth management arena many people from ages thirty to the mid-sixties are being counseled by wealth managers to reduce from 25% to 50% the amount they expect to receive from Social Security. Some are going as far as instructing clients under the age of fifty to not count on any social security benefits.

There is a savings crisis in the United States although it has improved since the panic of 2008. The ever present 401(k) plan may stop the erosion of retirement benefits but will not be enough to fund current life styles. More companies are reducing or canceling their defined benefit pension plans. In other words you will have to rely on your own efforts to generate your retirement benefits.

You need to now focus on creating your own entitlement. A voluntary deferral of your current earnings into a non-qualified deferred compensation plan is once again gaining traction in the corporate world. A corporation will sponsor a non-qualified plan but the individual in most circumstances will be doing the funding with pre-taxed dollars. These plans can discriminate concerning participation and in fact cannot be made available to those who are not highly compensated or part of a select group of management. You can contribute up to 100% of your compensation to such a plan These plans have certain limitations in that the sponsoring company can’t deduct the deferrals until they are physically paid out and the deferrals are not protected against the insolvency of the sponsoring company. If a participant is comfortable with the fiscal soundness of the sponsoring company then participating in such a plan also allows for more flexibility than encountered in a 401(k) plan including distributions prior to age 59 &1/2, without penalty or periodic distributions for specified needs such as college tuition.

A sponsoring corporation that is concerned about retaining its key personnel could match with unvested contributions in one of these plans with the vesting occurring at retirement so that there is an incentive to stay with the company. This retains the company’s best talent. Also these plans may also be used to protect a company in the event there is a need to claw back compensation pursuant to the Dodd-Frank provisions.

The tax benefit under this plan is that you are able to invest pretax dollars as opposed to after tax so that growth will be significant because it will be on a gross amount not the net. So if tax rates rise at the time of deferral and subsequently go down (as has happened in the past) at time of retirement when you receive distributions then you have managed to achieve a beneficial arbitrage. Depending on what assets are made available for investing it is possible to defer tax on the growth just like in a 401(k) plan. The way this is achieved is through the use of Corporate Owned Life Insurance a key investment strategy in non-qualified plans.

What the individual has accomplished in participating in a non-qualified plan is to create his or her own entitlement and ensure that one’s retirement will not need to rely on the Social Security safety net. So perhaps we can now change the curse to “May you live in a comfortable retirement” and after all how bad can that be?

Published on LinkedIn February 16, 2015