PLANADVISER - September/October 2022 - 31

owned life insurance. COLI insures the lives of the plan
participants; yet, the policies are owned by the plan sponsor,
which pays the premiums and is the beneficiary. An advantage
of COLI is that it can be used as a tax-efficient way to
offset some of the costs of nonqualified executive benefits.
" Life insurance shields the employer from having to
pay corporate taxes on that money each year, " says Matt
Compton, managing director retirement solutions at Brio
Benefit Consulting in New York City. " But [the employer]
is responsible for paying the insurance premiums that are
associated with the corporate-owned policies. "
Compton says when he has cross-compared the expenses
involved in funding an NQDC plan via insurance vs. via
mutual funds, life insurance wins. " Normally, the cost of
the insurance is not nearly as significant as what the taxes
would be in a mutual fund investment vehicle. " Ideally, he
adds, companies should model out the two strategies, to
gain a clearer picture of which would be the better approach.
For NQDC plans that use COLI, one of the main reasons
is flexibility with investments, says Mike Shannon, senior
vice president, nonqualified consulting at Newport Group in
Lake Mary, Florida. The sponsor and its advisers have fewer
constraints than with mutual funds or exchange-traded
funds when recommending and making plan investment
menu changes.
" Consequences can sometimes hamstring a potential
menu change when the funding is mutual funds, " Shannon
says. There, a change in fund managers will trigger realized
gains, and the sponsor will get taxed on the income. " COLI
obviously doesn't have that same consideration, since fund
reallocations don't trigger taxable income, " he says.
On the con side, Mitchell says, there are generally higher
fund manager fees associated with an insurance-based
investment lineup than with an investment approach
containing mutual funds. He has seen a shift among plan
sponsors in recent years away from the insurance-based
approach for this reason, he says.
Still, it is not necessarily an either-or situation, and many
providers find they are best-suited in funding an NQDC with
a combination of COLI and mutual funds, Compton says.
" If an adviser or recordkeeper is doing the proper
modeling, that will show you what the better route is, "
he says. " And,
in split-funded situations,
it can show you
what percentage should be going to the mutual-fund-based
investments vs. what percentage should be going to COLIbased
investments. "
Qualifications and Stipulations
Top hat plans typically benefit executives whose annual
salary exceeds the annual limit for compensation that may
be taken into account under a qualified plan for purposes
of computing the employee's contributions and benefits.
According to the IRS, the maximum annual compensation
this year is $305,000.
" An investment menu designed for a nonqualified plan
has the benefit and flexibility of focusing specifically on the
different demographics, time horizons and financial objecMirroring
a 401(k) plan
has become the most
prevalent investment menu
approach among NQDC
plan sponsors.
tives of the senior management NQDC participants, " says
Shannon. " In addition, there's a great chance to create diversification
and alternative investment opportunities in these
plans that is not typically available in a qualified plan. "
There are possible negatives for the potential sponsor
to consider, though, and advisers can help clients sort
through them.
One minor drawback can be the additional oversight the
plan's investment menu demands, Shannon says. But " that
is easily handled by the plan adviser as an add-on to his or
her qualified plan responsibilities. "
Additionally, Compton notes certain sometimes vague
stipulations. The plan's participants must be highly compensated
and represent no more than 10% of the company's
workforce. ERISA, however, provides no clear definition of
what else constitutes a top hat group.
According to a report from executive benefits consulting
firm Fulcrum Partners, recent case law also speaks to the
lack of clear guidance when it comes to identifying a company's
top-hat vs. rank-and-file employees, who sometimes,
mistakenly, get enrolled in the plan. The firm recommends
plan sponsors " work with experienced executive benefits
consultants who have traditionally used conservative definitions
of top hat plan guidelines " to avoid significant litigation
risk or ERISA fines.
Tried and True
Another common investment approach for sponsors of NQDC
plans is to simply mirror the investments in the company's
qualified 401(k) plan. In fact, Mitchell says, in recent years
mirroring the 401(k)'s lineup has become " by far " the most
prevalent investment strategy used by NQDC plan sponsors.
Earlier in his career, Mitchell says, NQDC sponsors typically
believed that executives needed and wanted a different
investment lineup, with more exotic or sophisticated options.
" But that has not proved to be the case. " Many sponsors have
shifted to mirroring their defined contribution plan because
those provide " simplicity, convenience and lower fees, " while
still allowing for participants' diversification needs, he says.
Shannon disagrees. " There is a huge, missed opportunity
for participants to have additional diversification through
the use of other fund families and more esoteric asset
classes, " he says. He cites " fixed-rate options and REITs [real
estate investment trusts] or alternative investment styles
such as international fixed income that might not typically
be utilized in a broader DC plan. " -Michael Katz
planadviser.com September-October 2022 | 31
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PLANADVISER - September/October 2022

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