Trends in Deferred Compensation A Case Study

Medium | Large Case Trends Larger, complex plans are getting unbundled from their 401k record keeper. Overall weak sponsor and participant education and activism for larger, complex plans. Reduced minimum premium for private placement.

Highland | Nolan Financial Case Study Background: The firm engaged an executive benefits company to review and discover ways to optimize their deferred compensation plan. This firm engaged Highland Capital and Nolan Financial. Initial Basic Plan Details: Implemented in early 2000s Plan is record kept by their 401k record keeper Participants can defer up to 25% of base salary and up to 100% of bonus Maximum investment reallocations per year: 4 Plan is informally funded with mutual funds and company stock

More Plan Details after Initial Meeting Over the past 15 years, the plan has grown to over $30m. Projected annual contributions over $1m per year. Over $1m of realized capital gains and dividends in 2015, which are taxable to the company. Plan document contained a provision that the company reserves the right to acquire life insurance to satisfy its obligations. Distribution option: can elect up to ten annual installments. Overall education, regarding deferred compensation options was weak.

Three Areas of Improvement Plan Design: good not great Participants can defer up to 25% of base salary and up to 100% of bonus Best practices: 50% – 75% of base salary Maximum investment reallocations per year: 4 Best practices: unlimited Minimum deferral period for fixed date accounts is five years from the deferral year. Best practice for an unfunded or mutual funded plan would be less, 2-3.

Three Areas of Improvement 2. Administrative costs: high Over $1m in realized gains and dividends are taxable to the company in addition to record keeping fees Best practice: alternative split funding options including, employer-owned life insurance to mitigate taxes on large deferred compensation portfolio. According to a survey of large companies with $1 billion-plus of annual revenues, approximately 73% of those companies that fund their NQDC plans do so with COLI. Source: www.lifehealthpro.com; “Life Insurance: A Top Funding Vehicle in Executive Comp Plans; August 18, 2014: by Warren S. Hersch in reference to Executive Benefits – A Survey of Current Trends; 2014-15

Three Areas of Improvement 3. Weak Education Distribution option: can elect up to ten annual installments NEOs were unaware that they could benefit from avoiding tax on distributions, if they retired to a state with no state income tax and elect to receive ten annual distributions. 2012 Current % Change Ordinary Income1 35% 39.6% 13% Medical Payroll Tax2 1.45% 2.35% 62% Federal Earned Income Rate 36.45% 41.95% 15% Long-term capital gains rate & qualified dividends rate 20% 33% Medicare tax on net investment income3 0% 3.8% New tax Total long-term capital gains rate & qualified dividends rate (includes 3.8% Medicare tax on net investment income) 23.8% 59% Maximum estate tax rate 40% 14%

Summary and Recommendations Unbundle deferred comp from 401k provider Improve Plan Design Increase base contribution Uncapped reinvestment allocations Reduce minimum deferral period Minimize fiduciary risk: Tussey v ABB Improved sponsor and participant education Tax benefit for ten annual installments Reduce cost via COLI split funding approach Source: www.lifehealthpro.com; “Life Insurance: A Top Funding Vehicle in Executive Comp Plans; August 18, 2014: by Warren S. Hersch in reference to Executive Benefits – A Survey of Current Trends; 2014-15

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Sample Private Placement COLI vs. Mutual Funds