The Power of Deferred Compensation Plans

The Power of Deferred Compensation Plans
A deferred compensation plan (DCP) is a contractual agreement between a corporation or other employer and one or more of its key executives under which the corporation promises to pay benefits in the event of death disability or retirement, provided that the executive is employed by the corporation at the time the benefit becomes payable.

The typical DCP is drawn up in a written agreement between the two parties and should contain the benefits to be provided by the employer and what the executive must achieve before he can receive these benefits. While there are two types of plans, qualified and non-qualified, I’ll be focusing on non- qualified plans. Unlike qualified retirement plans, non-qualified DCPs can discriminate and only choose highly paid executives. Also, there are no governmental reporting requirements.

Non-qualified plans are mere unsecured promises by the employer to the employee and aren’t protected against a financial failure of the company. When the policy is owned by the employer, the employee is a mere creditor of the corporation.

If your client is an employer, she may want to use a deferred compensation plan (DCP) in a few different situations:

To reward an employee for his loyal service after a certain number of years
To provide a financial incentive for an employee to stay with her company for a number of years. In this situation, the DCP acts as a “Golden Handcuff” because it’s only available if the employee meets certain pre-set conditions related to the completion of certain employment requirements.
To reward an employee by supplementing his current retirement plan at some point in the future.
Designing Objectives

Just as the objective in a closely held business is to always attempt to use corporate assets to gain personal benefit, a similar objective in designing a DCP should always be to use the lowest available tax bracket, corporate or personal. A strategically designed DCP often creates such alternate beneficial options when it comes to choosing between the employer’s corporate lower tax bracket and the employee’s higher personal tax bracket.

Using Life Insurance to Fund the Plan

Although there are two funding methods for a DCP Investments in stocks and bonds, or a life Insurance policy. Continue Reading