Compliance March 25, 2015

NQDC Plans a Target of Tax Reform Recommendations

A report from Democratic staff of the U.S. Senate Committee on Finance says nonqualified deferred compensation (NQDC) plans are a "tax avoidance" strategy and raise a number of issues of fairness.
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The report notes that these plans are generally only provided to highly compensated employees and gives these employees some control over the timing of the inclusion of income for tax filing purposes. Using an example identified for Senator Ron Wyden (D-Oregon), ranking member of the committee, by the nonpartisan staff of the Joint Committee on Taxation (JCT) and outside independent experts, the report states that a high-income earner can choose to avoid paying taxes on compensation for 20 years or even longer. In addition, these employees have the compounding benefit of accruing earnings tax-free during the deferral period.

The report contrasts this with rank and file employees who only have the opportunity to defer compensation within limits, such as under a qualified defined contribution (DC) plan or by contributing to an individual retirement account (IRA).

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Among recommendations included in the report, is a proposal in a tax reform discussion draft put forth by U.S. Representative Dave Camp (R-Michigan) which provides that under a NQDC plan, all compensation deferred under the plan would be included in gross income for the taxable year of vesting. When estimated as a part of Camp’s tax reform plan, this proposal would raise $9.2 billion over ten years, the report said.

The committee’s Democratic staff also recommended adopting a proposed $1 million cap on deferred compensation and closing an Internal Revenue Code Section 162(m) “loophole.” The letter explains that under 162(m), subject to a number of limitations, compensation paid to certain senior executives in excess of $1 million is nondeductible by the employer. However, if an employee’s compensation is deferred until retirement when the employee is no longer a senior executive, the compensation will not be subject to the $1 million cap. This is because 162(m) only applies to compensation paid during a year if the employee is a senior executive on the last day of the year.

The Markets March 25, 2015

Insurance Company Financials Suggest Income Product Gap

Research from Cerulli Associates suggests financial advisers face a lack of new income products and approaches, due mainly to low interest rates and weaker financials among insurers.
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Financial market returns in recent years have been challenging for income-seeking investors, according to the first-quarter issue of “The Cerulli Edge – Retirement Edition.” The report warns that a period of extended and historically low interest rates has called into question the viability of overweighting traditional fixed-income securities as a vehicle for generating retirement income.

Elizabeth Malin, an analyst at Cerulli, notes strong domestic equity markets have accompanied this period of low interest rates, pulling more assets into equity investments and negatively impacting the balance sheets of some insurance companies.

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“In reaction to challenging financial conditions, the insurance and annuity industry is in the early stages of reinventing itself with a more diversified set of product solutions,” she suggests. “If positioned correctly, the evolution of the annuity industry can tie well with the emergence of a more interactive planning process.”

Cerulli’s report finds these secular pressures have a particular impact for financial advisers, in part because the client base of advisers tends to skew older than the working population as a whole. On average, Cerulli says 45% of an adviser’s book of business are clients older than 60, indicating that many advisers may have numerous clients who are retired and drawing income in a challenging environment.  

Cerulli suggests advisers can add value to their practices and services by working closely with insurance companies during this turbulent time. Offering problem-solving insurance products to clients will improve satisfaction, outcome and loyalty, the report notes. 

“Advisers find themselves forced to craft portfolios that, in certain instances, rely on more risky sources of retirement income,” Malin explains. “Notably, the two most prevalent retirement income products for advisers in 2014 were both equity-based, relying on dividends from individual stocks and equity mutual funds, and as a result, taking more risk than they intend.”

Cerulli concludes that retired investors in particular are likely to be more risk averse and less able to withstand market downturns. “Advisers can potentially mitigate these factors through prudent asset allocation and diversification strategies,” Malin explains, but they will also have to rely on continued product innovation among insurers.

Information on obtaining Cerulli reports is available here. 

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