Northwestern Mutual: Deferred Compensation Plans

In today’s competitive market, businesses are looking for ways to incentivize and compensate key employees without giving them ownership in the company. Although many of these businesses already have competitive group benefits, there are additional options, including Nonqualified Deferred Compensation (NQDC), that you can offer to select groups of key employees.

A major advantage of utilizing a NQDC plan is your ability to use it as a way to recruit and retain top talent. In addition, employees under this plan will not be taxed on income earned until a set future date.

The most common NQDC plan is a Supplemental Executive Retirement Plan (SERP). This arrangement involves the employer agreeing to pay additional amounts, on top of current compensation, to an employee at a later date. This plan is usually funded through the employer’s life insurance contract for a few reasons:

  • Assets in qualified retirement plans grow tax-deferred, but this is not true for assets owned by an employer as part of a nonqualified plan. When the employer owns life insurance, however, the assets will grows tax-deferred.
  • Life insurance is likely the only vehicle that can assure that the funding will be complete at the death of the employee.
  • Employers can be the beneficiary of the policy, thereby recovering tax-free the costs to implement the NQDC plan.

Here’s how to set up a SERP:

  1. The employer and employee enter into a written agreement under which the employer agrees to pay the employee or designated beneficiary deferred compensation benefits upon a certain date or event, such as the employee’s death, disability, or retirement.
  2. The employer applies for, and is the owner and beneficiary of, a life insurance policy that insures the life of the employee.
  3. Upon the payment date or triggering event, the employer pays the employee the promised deferred compensation benefits. Payment can take several forms – lump sum or stream of payments. The employer can also transfer the policy ownership to the employee.
  4. If the employer keeps ownership of the policy, they can:
    • Withdraw from the policy in a tax-favored manner to have the funds to pay the benefits.
    • Recover the cost of implementing the plan from the life insurance policy, either through its cash value or ultimate death benefit.

For additional information on NQDCs and SERPs, contact Northwestern Mutual’s team of experts to speak with a qualified financial advisor.

A special thank you to Northwestern Mutual’s Financial Advisor, Matt Robb, M.A., CLU®, WMCP®, RICP®, for the content of the blog post.