Methods for Sheltering Nonqualified Plan Accounts in the Event of Employer Bankruptcy

From iconic retail brands like Neiman Marcus to popular entertainment venues like Chuck E. Cheese, business bankruptcies have escalated in 2020 due to the COVID-19 pandemic. Company executives invested in Non-Qualified (NQ) plans risk losing a substantial amount in retirement savings due to guidelines set under Section 409A. These guidelines protect NQ plan assets from a change in corporate control but not from a bankruptcy filing, since NQ plan participants are treated as unsecured creditors.

Following are some methods for sheltering NQ plan accounts in the event of employer bankruptcy:

Risk Pooling

StockShield, a specialist in financial risk pooling, offers a solution called Deferred Compensation Protection Trust (DCPT) that helps NQ plan participants diversify their risk of loss by pooling retirement assets across several industries and companies with similar credit ratings. Each participant contributes an annual amount (similar to an insurance premium) for a period of 5 or 10 years. These contributions are invested in Treasury instruments to eliminate any default risk. If no bankruptcies have occurred among the participants at the end of the term, the pooled cash is refunded back to participants, minus any applicable costs and fees. Pooling several company accounts helps spread the risk but once pools are set, the terms are locked in and no changes can be made if one or more companies goes bankrupt. 

Rabbi Trust

Typically used to provide senior executives with additional benefits to an existing compensation package, a rabbi trust is a nonqualified employee trust that benefits both employees and the employer. A rabbi trust is typically set up as an irrevocable trust where assets in the trust are outside the control of employers. If a company is taken over, the new company has no power over the trust or its terms. However, a rabbi trust does not protect participant assets from unsecured creditors in the event of a bankruptcy filing.

Laddering Strategy

Executives whose NQ plans allow for flexibility in making new payment elections during annual enrollment may opt to minimize bankruptcy risk by keeping retirement assets in the NQ plan for a relatively short time period. If an employer’s bankruptcy risk remains low, a plan participant may be able to re-defer assets prior to receiving a taxable payment. Re-deferrals are typically allowed as long as the election is made at least 12 months prior to the original payment date and the new payment date is delayed by at least five years. NQ plan participants may continue to re-defer for as long as they are comfortable with their employer’s financial health. If the company’s financial picture changes for the worse, a participant can then allow the scheduled payments to take place, thus drawing down the NQ plan balance that may be at risk due to an employer bankruptcy filing.

Limiting Exposure

In choosing investments for NQ plans that limit exposure to bankruptcy risk, some financial advisors recommend that no more than 10 percent of an entire portfolio should be held inside NQ plans. Some plan sponsors may limit participation in the plan for those whose accounts exceed $1 million. 

Investment Allocation

In times of economic uncertainty, NQ plan participants may want to consider keeping their more aggressive investments inside their NQ plan and leave more conservative holdings in other accounts that would not be adversely affected by an employer bankruptcy.

NQ Plan Review

Some NQ plans allow for specified payment events such as an unforeseeable emergency, and they may even allow for accelerated payments under certain conditions, including death, disability, separation from service prior to retirement, plan termination, or change in control. NQ plan participants should undertake a thorough review of their plan with a qualified benefits attorney to determine strategies for proactively protecting retirement assets in the event of employer bankruptcy.

HBL helps clients stay on top of the legislative and regulatory changes that apply to their businesses, and we ensure that benefit plans and processes are updated to stay in compliance. To learn more, call our team today at 678-439-6236.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.