NQDCs Have Never Been More Popular. Is There Room for Them to Grow?

Art by Anja Susanj

As the labor market remains tight across many sectors, employers have sought ways to attract talent and keep their top people. In recent years, one tool of choice has been nonqualified deferred compensation plans, valued for their flexibility and low cost. But with the pressing need for talent retention now going well beyond top Fortune 500 executives, what’s next for NQDCs?

“The Great Resignation and the decoupling of the physical location from the work has really created a higher demand for retention,” says Tony Greene, senior vice president at NFP Corp., an insurance broker and consultant that offers deferred compensation plans. “There’s a fluidity, and senior people are the most fluid. Highly-compensated people are the ones with the most ability to work flexibly. We spend a lot of money recruiting key talent.”

NQDC plans first emerged as a way for high-paid employees to supplement their retirement savings with earnings held for a later date with tax advantages similar to a retirement plan. With IRS rules capping the amount that can be paid into a 401(k), those workers were unable to put aside enough money to be sure they would keep the same standard of living during retirement. The NQDC option was a way to increase that savings pool.

As the benefit became popular at larger firms, it made its way downstream to smaller ones and to nonprofit organizations. 2022 data from PLANSPONSOR (which, like PLANADVISER, is owned by Institutional Shareholder Services Inc.) show that the assets held in NQDC plans has ballooned to $172 billion in 2022, up from $73 billion in 2013. The number of plan participants has also risen, topping 741,786 last year, compared with 714,242 a decade ago. Industry experts say the push is continuing this year, particularly as workers move between companies.

Pre-Pandemic Push

In the years before the COVID-19 pandemic, the aging of the workforce helped drive some of the take-up for NQDCs, but so did an increasing appreciation of key employees—a consideration that only became more acute as the job market tightened.

Employers are “very thoughtful about the fact that the people they’re doing this for have been important to the company, so they want to do something for them,” says Patti Bell, assistant vice president of advanced solutions at Principal Financial Group.

Greene, of NFP, notes that key people are worth more because they drive measurable value. In a small business, he says, losing one key person can mean losing a year’s worth of work. What’s more, replacing a highly-compensated employee can cost as much as two to four times each $100,000 of that employee’s compensation.

To some extent, the urge is felt more keenly at smaller firms than large ones, and even felt more at nonprofits than for-profits, experts say. While key employees may not fall prey to the same labor market whims as less senior people, the pandemic likely prompted a widespread reckoning.

“Key people aren’t going to go across the street for $10,000 more, but there is a concern that if their needs aren’t met, they might start to look around,” says Mark Ritter, a senior director with RSM US, an audit, tax, and consulting firm.

Ritter and others say the bespoke, customizable nature of NQDC plans is by far one of their bigger draws.

Principal’s Bell offers a few examples of the more creative versions she’s seen: a lump-sum payment offered after a year or two of employment that can pay down student debt for a sought-after attorney or physician; a similar arrangement that allows a second-in-command to buy the company from the owner, or to pay for a partnership stake. But with so much recent take up, could the recent rush into NQDC adoption be nearing a saturation point?

Some experts say it’s possible. Jason Stephens, senior director of the executive benefits practice at CAPTRUST, says interest has waned a bit for the benefit. He sees some of the big macro drivers, including the tightness in the labor market, starting to ease.

“You have to be considerate: When the market shifts, can you put these things back in the bottle?” Stephens says. “If you make a plan overly attractive in the current market, could it be richer than you intended? When we’re talking to plan sponsors, we always tell them to consider all that.”

Ritter echoes that, pointing out that NQDC plans, by definition, cannot be adopted widely, because once a certain threshold of employees is enrolled, it will no longer be considered a nonqualified plan, but instead be subject to ERISA guidelines.

An Evolving Benefit

While some experts are more focused on creative plan designs, Stephens thinks future progress will come from helping employees make better use of the plans they’re receiving.

“The challenge is [in not] designing a plan that might be too flexible for a participant to understand,” he notes. “Plan sponsors want to offer the flexibility, but also the education, to show the employees the value of the benefit.”

That means the next iteration of NQDC enrollments might include something like financial planning advice or access to a consultant who can help the employee manage the benefit, Stephens says. He also notes the broad wave of consolidation sweeping the employee benefits industry, impacting NQDC plan administrators in particular. Now, Stephens says, many administrators may have started as qualified-benefit shops and added a somewhat streamlined nonqualified practice along the way.

“Anecdotally, we’ve heard a lot of feedback about that: Is it a watering-down of the service model? It’s caused a little bit of consternation,” Stephens says. Some service providers are “not as robust as the original nonqualified specialists would have been.”

For his part, Ritter thinks there may start to be more explicit linking of the payout of the deferred benefit with some form of performance metrics, which he calls a “sensible best practice.”

Ultimately, though, he believes deferred compensation for key employees will always be a need: “You want to design these kinds of plans to excite people, not just to get them not to quit. I think they’re going to keep evolving as long as corporate cultures keep evolving.”