Self-directed brokerage accounts in non-qualified plans?

[Guest annieo]

Does anyone have experience with self-directed brokerage accounts in non-qualified plans? Can they even have them?

[Guest EAKarno]

Nonqualified plan participants cannot have any dominion and control over any "plan assets" used to hedge deferred compensation liabilities. The participants may choose their investment benchmark which determines their rate of return on deferred amounts, however, the employer is never obligated to actually purchase such an investment. Thus, to use the phrase "self-directed brokerage accounts" in the context of a nonqualified plan would be incorrect. Plan participants must be aware that they are only selecting hypothetical investment benchmarks, that they have no ownership rights or interests in any investment fund, and that their actual payment will come solely from the general assets of the employer.

That being said, I will tell you that the vast majority of the nonqualified plans that our firm designs and administers allow for daily self directed hypothetical investments from an array of funds. Theoretically, participants could be allowed to choose any investment vehicle thay wanted, but the administrative complexities of trying to hedge against the risk of being liable for such investments would be more than any reasonable employer would be willing to bear.

[Guest annieo]

Thank you for the response. It was helpful.

Does anyone have concerns as to whether a participant in such an arrangement would be viewed as having more rights than an "unfunded, unsecured promise to be paid"? Could this type of arrangement cause a Rabbi Trust to be treated as funded for ERISA purposes?

[Guest LRichey]

Self-directed accounts in nonqualified plan designs do raise some serious ERISA funding questions (and in a neat "Catch 22"; therefore possible constructive receipt issues). Those plans with self-directed accounts that use "401k bookkeeping" (the plan is the fund is the plan) are the most at risk.

I recently co-authored an article that was published electronically on exactly your topic. Email me if you would like a copy of the article.

[Guest wmacdonald]

Originally posted by annieo

Does anyone have experience with self-directed brokerage accounts in non-qualified plans?  Can they even have them?

Yes, as stated in previous messages, these types of plans are becoming more common today (see survey on http://www.crgworld.com for prevalence data). The administration of the plans is very important. We designed a plan recently, that gave the executive 55 funds to choose from, and also gave them a opportunity to "write in" any additional funds. Our systems can track, with daily values, over 5,000 funds. I hope this was helpful.

[Dave Baker]

See also

http://www.benefitslink.com/boards/index.php?showthread=7039

[Guest]

Why do employers adopt these programs? Sure, its great for employees but it is a very costly benefit. Allowing employees to defer compensation essentially means that the employer is borrowing from its employees instead of from a third party. These borrowings will now carry potentially exhorbitant interest rates (e.g., S&P 500 index) instead of a reasonable fixed or floating rate from a third party. Moreover, borrowing from employees is inherently more expensive than borrowing from a bank since the "interest" on the employee loan accrues on a pre-tax basis (no deduction until paid to employee as compensation) instead of on an after-tax basis on a borrowing from a bank (interest deductible as it accrues). Throw these wild "interest" rates on top of this and you really have a uncontrollable liability. Sure, the employer can hedge the liability by actually investing in the underlying funds but what a waste of shareholder capital that should be more productively used in the employer's underlying business. Presumably the employer can earn more with this money in its underlying business; if not, it ought to close its doors and become an investment company.

[Guest wmacdonald]

Harry O, you bring up a valid point, however with variable type plans (interest tied to mutual fund rates), financial analysis will prove them to be "cost neutral" to shareholders. I can provide you with a economic analysis to prove that point. However, that being said, one needs to step back and ask, "why put such a plan in"? With the 401 (k) limits, and the need to attract and retain executives in this tight labor market, companies look for low cost ways to provide benefits to there management group. By properly funding the plan, you can offset the liability exposure the company would have. Prevelence studies will show, many companies are taking advantage of this low cost benefit. See our study at http://www.crgworld.com. Other studies that show the same data, KPMG, Hewett etc.

[Guest EAKarno]

Actually, if properly designed, operated, and funded, a 401(k) style nonqualified deferral plan will turn out to be earnings and cash flow positive over its lifetime. This is a result of the tax arbitrage offered by funding with an insurance wrapped vehicle that defers or eliminates tax on earnings to the corporation.