Nonqualified Deferred Compensation Plans Increasingly Include Noncompete Clauses

Non-qualified deferred compensation plans are increasingly being used by employers as retention tools by including noncompete or “bad actor” forfeiture clauses, according to research released Wednesday by the Plan Sponsor Council of America.

Of 135 companies offering NQDC plans to employees, 30% said they had noncompete clauses in the 2022 report, up from just 11.5% in 2021, according to data provided to PLANADVISER. In addition, 40% of employers said they have a “bad actor” forfeiture provision in 2022’s report, up from 23.7% in 2021.

The upward trend of NQDC plans is often used as a carrot for highly compensated employees to have a tax-deferred investment option beyond their company 401(k). The use of this benefit, along with the increase in the retention clauses, shows an attempt by employers to keep high-level employees in a tight labor market, according to the researchers.

“In an increasingly competitive market, employers are looking for new and creative ways to differentiate themselves, and their benefit programs are an integral part of that positioning,” Nevin Adams, head of research and chief content officer for the American Retirement Association, said in a press release. “Nonqualified deferred compensation programs provide both the flexibility in design and funding to attract key talent—and to help ensure that those individuals are committed to their employer.”

The interest in NQDC as a benefit has risen since the Great Resignation had employers scrambling to draw and retain talent, says Emily Langdon, a partner at Husch Blackwell LLP who advises employers in implementing NQDC plans.

“The Great Resignation created a much greater awareness of certain employee benefits (or the lack thereof) that are desirable for many employees,” Langdon says. “It is clear that employers are feeling pressure at all levels of employment, especially in their efforts to retain executive leadership and to attract new executives.”

In today’s economic environment, most employers are looking for ways to retain employees through benefit programs and incentive plans that are tied to performance goals, objectives, and other subjective standards, Langdon says. At the same time, she notes, employers also “want to ensure that performance awards are only awarded for positive performance and are forfeited in the event that a key executive is terminated for cause or engages in other activity (e.g. competition) that is detrimental to the employer.”

Meeting Goals

The PSCA findings of an uptick in noncompete clauses for NQDCs come just as the Federal Trade Commission has proposed a ban on noncompete clauses nationally. The regulator is following a mandate from President Joe Biden’s administration to stop the use of noncompete contracts for workers, which the FTC estimates would boost wages for American workers by a combined $300 billion per year and expand career opportunities for 30 million Americans. Critics of the mandate, such as the U.S. Chamber of Commerce, say noncompete agreements are important tools for preserving competitive data and information, and furthermore may not be within the mandate of the FTC.

Langdon says even if the broad ban goes through, NQDC plans have enough flexibility to keep some kind of retention measures should an employee breach company policy or leave early.

“An NQDC plan can typically be structured to meet an employer’s goals while still complying with other applicable laws,” she says. 

Tony Greene, senior vice president of business development benefits for NFP, says the firm does not recommend noncompete clauses in NQDCs as it is a “contentious issue and expensive to try and enforce.”

NFP, which is an independent provider of NQDC compensation and consulting services, more often sees forfeiture provisions in supplemental executive retirement plans – sometimes called “golden handcuffs” – as related to future payments promised by the employer. These plans, however, more commonly use vesting schedules as a retention strategy, he says. Overall, Greene sees a ban on noncompete clauses as a good development for employee benefits.

“For the deferred compensation world it’s actually going to be a boon because it’s going to remove one of the sticks, and employers will need to focus on carrots,” he says. “There is a lot you can do in vesting schedules, and a lot you can do with discretionary bonus programs. This would put a bigger premium on design of the programs, which is probably a good thing for all parties involved.”

The Washington D.C.-based PSCA said NQDC interest is primarily driven by the desire to offer competitive benefit packages, with 87.9% of respondents naming it as a top motivation. Another 83.6% of respondents marked retaining eligible employees as a driver to offer NQDCs.

Thirty percent of companies surveyed that offer a NQDC plan use it to help eligible employees raise their income replacement ratio, and 30% offer it to allow highly compensated employees to defer the same portion of income as other workers, the PSCA found.

The survey also found that more than three-quarters (77.3%) of employers make contributions to their employees’ NQDC plans. Almost one in five employers (19.7%) note that participation in their NQDC plan by employees has increased compared to a year ago.

On average, 5.6% of employees are eligible to participate in an NQDC plan among those companies surveyed. More than two-thirds of employers use job position/title as the main criteria for NQDC plan eligibility.