1. society
2. work
3. retirement

M May 22, 2012
“Why Deferred Compensation is “Wh
D f
d C
ti i Making a Comeback”
Today’s Presenter:
Tom Miller
President
(949) 265‐5700
[email protected]
7700 Irvine Center Drive  Suite 930  Irvine, CA 92618  949-852-2288  www.VLadvisors.com
2
We’re happy to provide a copy of today’s slides. Information will be provided at the close of the presentation.
For questions during today’s presentation:
Use the question panel
to the right of your screen
7700 Irvine Center Drive  Suite 930  Irvine, CA 92618  949-852-2288  www.VLadvisors.com
3
What is a Deferred Comp Plan?
p
A Deferred Compensation Plan (DCP)
is a retirement plan that is intended to
provide long-term security for a select group
of key employees above and beyond that
provided under the company’s qualified
f
retirement plans.
4
Features

Nonqualified

S
l ti
Selective

Unsecured

Unfunded

Flexible
5
Total Compensation Allocation
Nonqualified
Retirement
Plans
Salary
Qualified
Retirement
Plans
Performance
Incentives
Executive
Benefit Plans
Sales
Incentives
Core
Growth
Health &
Welfare Plans Incentives
6
Total Compensation Allocation
Nonqualified
Retirement
Plans
Qualified
Retirement
Plans
Executive
Benefit Plans
Core
Health &
Welfare Plans
Salary
Performance
Incentives
Sales
Incentives
Growth
Incentives
7
The 4 Basic Components of a D f
Deferred Compensation Plan (DCP)
d C
ti Pl (DCP)
Account
Vesting
8
The Account A liability on the books of the sponsoring company
Employee Deferrals
Company Contributions
Account
9
The Appreciation The gains (or losses) credited to the Account
Market Appreciation
Increase in value of sponsoring company
Interest
Account
10
Vesting
The percentage of the Account payable upon p
g f
p y
p
termination (or other selected events)
Forfeitable
Vested
Account
11
Distributions
The manner in which the Account is distributed
Lump Sum, 5 year, 10 year, etc.
12
Plan Type: E
Executive Deferral Plan
ti D f
l Pl

Executives given option to voluntarily remit pre‐tax deferrals

May include company contribution (matching, ad hoc, profit sharing, incentive)

Investment options provided similar to company 401(k) plan
k l

Participants are fully vested in their own deferrals, partially vested in company’s
13
Executive Deferral Plan

Deferral election made at beginning of plan f
f
year (always calendar year after first year of eligibility)
l bl

May defer different percentages from salary, bonus or any other cash compensation component
14
Executive Deferral Plan

I
Investment choices may be offered
t
t h i b ff d

May change investment choices at any time
y
g
y

Investments are “hypothetical” 
Participants must not control investments (constructive receipt)
15
Key Advantages
y
g

Selective participation

Creative contribution options (virtually unlimited)

Inventive distribution arrangements
d
b

Attractive appreciation possibilities
16
Corporate Purposes
p
p
1.
Offer a helpful and attractive (pre‐tax) way ff
f
for higher‐paid employees to save for retirement (attraction and retention)
d
2.
Tie wealth of the employees to the p y
achievement of key corporate goals
17
In recent years, the use of deferral plans has dropped noticeably. Why?
18
Why?
y

New compliance rules (409A)

Risk issues (economic uncertainty)
(
y)

Perception that the plans do not create “alignment”
alignment
19
But the original problems still exist:
g
p

High tax rates (and possibly getting higher)

Limits on 401(k) deferrals (with no other pre‐
4 ( )
(
p
tax options remaining)
20
Suppose…
pp

…could turn 409A into a positive?

…could deal with the risk issue reasonably?
y

…could use these plans to create greater internal alignment and focus?
21
Challenge #1: 409A
g
4 9

New IRC Code Section added in 2005

“The ERISA of Nonqualified Plans”
q

Purpose was to establish rules relating to the timing of deferrals and distributions

Also restricts the “acceleration” of benefits

Imposed tax penalties (20% excise tax) for non‐compliance
22
4 9
409A

For the first several years…
f
 …uncertainty about how the law would be interpreted
 …confusion about the meaning of specific terms  …debate about how to interpret areas not mentioned or not clear
 …efforts by the IRS to clarify and opportunities to repair problems
23
Now that the rules have settled

Numerous gray areas clarified
f

Uniform definitions of terms

Three key questions resolved:
 How do we avoid constructive receipt?
 When can we accelerate benefits?
 Under what conditions can we postpone distributions?
24
The result
Consultants and attorneys are now able to provide bright line guidance. able to provide bright‐line guidance. DCPs can be established and administered with greater ad
ste ed t g eate
confidence and clarity. 25
Challenge #2: Risk
g

Reality—employees must consider employer insolvency risk

However, if this is an over‐riding risk, they will have to assume other risks in order to prepare for retirement
26
Deferral Plan Risk
Assume:
Employee defers $25,000 for 10 years
E
Earns 8% total return
8% t t l t
40% tax bracket
V l i Value in 10 years: Pre‐tax $391,137
After tax $234,682
Bankruptcy risk : $234,682 after taxes
p y
27
Alternative Risk
Assume:
Employee takes the $25,000 as income
Invests $15 000 for 10 years
Invests $15,000 for 10 years
Earns 8% total return (taxable)
40% tax bracket
Value in 10 years
After tax $195,888
What’s the risk?
h
h i k?
28
Comparing Risks
p
g
AT Value in Deferral Plan
AT Value outside Plan
Difference
Total Return needed to Equalize
$234,682
$195,888
$38,794
13.3%
What additional investment risk must the employee assume to achieve the same result?
How does this risk compare with the employer insolvency risk?
29
Challenge #3: Alignment
g 3
g

How does a deferral plan support corporate f
financial goals?
 A typical plan doesn’t drive productivity
 It may support attraction and retention goals, but not alignment goals

Is there a better way?
30
Strategic Implications
g
p
How might a deferred compensation plan
be employed to drive company results?
31
Plan Objectives
j

Help management employees build a long‐
term retirement account

Finance the plan based on the achievement of specific production targets

Message: “The more successful the company is, the bigger your retirement account will h b
ll
be.”
32
Option #1: Sample Target Matrix
p
p
g
Revenue Growth %
>25
12%
15%
20%
22%
25%
>20
9%
12%
17%
20%
22%
>18
6%
10%
15%
17%
20%
>15
4%
%
7%
%
10%
%
13%
%
17%
%
10 to 15
0%
4%
6%
8%
10%
8
<8
8‐9.5
8
9.5
9.5‐10.5
9.5
10.5
10.5‐12
10.5
12
>12
12
PT Income %
Assume: Revenue Growth of 22% and PTI of 11%
33
Contribution Award
Assume: Revenue Growth of 22% and PTI of 11%
Contribution = 20% of TCC
Name
TCC
Contribution
John
325,000 65,000 Sam
235,000 35,
47,
47,000 Mary
210,000 42,000 Pete
200,000 40,000 Sue
185,000 37,000 1,155,000 231,000 34
Company Contribution
p y

Identify one or two key drivers of company Id
tif t k d i
f performance (e.g., revenue and/or income goal)

Establish factors that calculate contributions to employees accounts as targets are met
to employees’ accounts as targets are met

Factors and targets can be company based, or vary by department or employee
35
Option #2: Phantom Stock I
Investment Account
t
t A
t

Establish company “phantom share price”

Credit earnings to the deferral plan tied to g
p
change in the share price

Employee account may remain self‐
Employee “account” may remain “self‐
directed”

Company “account” would reflect changes in C
“
” ld fl h
i value of the sponsoring company
36
The Account Two sources of funds
Employee Deferrals
Company Contributions
Account
37
Employee Account
p y
Market Appreciation
Interest
Employee
Account
38
Company Account
p y
Increase in value of sponsoring company
Company
Account
39
Combine both incentives

Tie company contribution to performance
f

Tie appreciation to phantom stock price
pp
p
p
40
Results/Objectives
/ j

Cl if Clarify targets

g
Meaningful awards

Win‐result for shareholders (self‐financing plan)

“Ownership” commitment (funds at risk)

Retention enhancement (vesting schedule)
41
“Bottom line”
If you’re not offering a deferred compensation plan you may be foregoing a competitive advantage needed to attract and retain key talent as well as an effective way to focus your people on your most important goals.
42
Attracting Premier Talent
g

They will find non‐traditional pay structures alluring h
ll f d
d
l
ll
and differentiating

The pay structure will respect their entrepreneurial mindset and appeal to their interest in wealth accumulation opportunities

They will accept the responsibilities and acco ntabilit associated ith tr e al e creation accountability associated with true value creation (i.e., they won’t “expect” higher pay without creating results)
43
Last point—shareholder equity creation
ti

A DCP may be subject to a unique tax‐
leverage opportunity that results in long‐
term value for the sponsoring business
l f h
b

The value results from the effect of the timing differences for the company tax deduction between the date of deferral and the date of payment
44
Assumptions:
p




$10,000 of annual deferrals
f
f
8% average annual growth
Level deferrals for 7 years
ld f
l f
Lump sum payment in year 8
45
Future Value of Employee’s Account
Deferrals
Gain
$89,228
70,000
19,228
46
Let’s follow the tax deduction related to the gain.
f ll
h
d d
l d
h
At the time the money is paid:
$19,228
X 40%
$7,691 tax benefit
47
Let’s follow the tax impact of the matching investment
f ll
h
f h
h
$19,228
$19
228
X 40%
$7,691
$7,
9 tax cost
$7,691
Tax benefit
$7,691
Tax Cost
$
$0
W
Wrong
Ri ht?
Right?
48
What if the gain on the Company’s investment f
was not subject to taxes?
$19,228 Investment gain
( ) Taxes on gain
($0)
T
i
($19,228) Payment to employee
$7,961 Tax benefit
$7,691 Net Impact (permanent benefit to shareholders)
49
DCP’s use carefully structured insurance arrangements that can help create this opportunity for long‐term benefit.
50
Today’s Take‐Aways
y
y

DCPs are back

Consulting professionals can guide you gp
g
y
through the 409A zone

The tax benefits are real for both employees and employers

Take your plan to the next level by including T
k l h l l b i l di strong performance incentives
51
Questions?
52
Complimentary Offer
p
y
DCP Feasibility Study
 Project likely deferrals
 Quantify impact on financial statements
 Identify possible shareholder gains
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Next Online Seminar:
“Creating an Ownership Mentality g
p
y
without Giving Away Equity”
To be held on:
b h ld
Tuesday, June 26th, 2012
7700 Irvine Center Drive  Suite 930  Irvine, CA 92618  949-852-2288  www.VLadvisors.com
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55
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Thank you for attending
y
g
Please complete our brief survey immediately
following our presentation.
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You may request a copy of our slides,
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Breakthrough and more information about the
DCP Feasibility Study
Study..
60
Thank you!
Tom Miller
President
949
5 57
(949) 265‐5700
[email protected]
61