Deferred Compensation Protection Trust

Protect your Deferred Comp and Retire with Confidence

Overview

Unlike your 401(k), your non-qualified deferred compensation (NQDC) is an unsecured liability (i.e. “promise to pay”) of your employer. This means it is possible to lose your entire account balance in the event of a bankruptcy of your employer. In the bankruptcy process, your NQDC claim is not a high priority for the court; NQDC participants are “general unsecured creditors.” While no one expects to experience a bankruptcy, it occurs more frequently than commonly thought.

Executives and retirees can now access a low-cost, long-term risk management solution that provides essential protection of their NQDC retirement savings and income. The Deferred Compensation Protection Trust (DCPT) offers substantially greater assurance and security that in a catastrophic event, like the sponsoring-employers’ bankruptcy, participants’ net worth will not be decimated.

Example of How It Works

Twenty (20) participants, each with a certain minimum balance in an NQDC plan sponsored by a different company in a different industry, deposit a small amount of cash (e.g. 1%) for each year of desired protection (minimum 5 years). The pooled cash is invested in U.S. Treasury Securities. At the end of the term of the trust, the assets pooled in the Trust are paid according to the number of bankruptcies.

# of Bankruptcies

Projected
Payouts

Annual Cost

0

Each participant receives their money back

0.00%

1

Beneficiary of the bankrupt plan receives their full protected balance; the other 19 participants share in the remaining cash

0.47%

2

Beneficiaries of the two bankrupt plans receive their full protected balance; the other 18 participants share in any remaining cash

1.00%

3+

Beneficiaries of the three (or more) bankrupt plans receive a partial payout of their protected account balance

1.00%

Key Points

  1. Employer bankruptcy can cause a total loss of non-qualified deferred compensation (NQDC) account balances
  2. Risk pooling enables cost-effective spreading of similar financial risk across participants in a self-funded plan designed to protect against large losses
  3. Lower cost than paying taxes on compensation and much simpler and easier than Credit Default Swaps (CDS)
  4. Other benefit security devices, such as rabbi trusts, do not pay in the event of bankruptcy
  5. Based on the time-tested principles of both Modern Portfolio Theory (MPT) and Risk Pooling, the Deferred Comp Protection Trust (DCPT) was developed from our Stock Protection Trust for concentrated stock positions
  6. By combining the powerful benefits of MPT and Risk Pooling, the DCPT transforms single-account/single-company balance risk by enabling investors to “mutualize” and, therefore, substantially reduce downside risk, while retaining all future appreciation of their NQDC assets and income…all at an affordable cost

Key Benefits

Increased retirement security

Account balances in non-qualified deferred compensation plans are unfunded and unsecured. Bankruptcies often cause NQDC participants to lose their entire account balance. The Deferred Comp Protection Trust helps solve this problem by providing a large payment that can partially or fully offset the loss of retirement savings.

Full refund in the event of no bankruptcies

It is possible none of the protected companies will experience a bankruptcy. In this case, all pooled cash is refunded. The yield on the pooled cash covers all administrative expenses.

Lower cost than paying taxes

By deferring compensation over at least 10 years, executives can realize substantially higher after-tax income, especially if they collect their payments in states that do not charge income tax. The cost of protecting deferred comp is substantially lower than the cost of the state income taxes you would pay by not deferring your compensation.

Fully transparent and easy to understand

Unlike Credit Default Swaps (CDS), the Deferred Comp Protection Trust is fully transparent, easy to understand, and involves no counterparty risk (i.e. the pooled cash is invested exclusively in U.S. Treasury Securities).

Frequently Asked Questions

Unlike your 401(k), your deferred compensation is an unsecured liability of your employer. It is possible to lose your entire account balance if your employer files for bankruptcy.

Should your employer file for bankruptcy, the Deferred Comp Protection Trust can provide a large payment to help offset the loss of your retirement savings. Other benefit security devices, such as rabbi trusts, do not pay in the event of bankruptcy.

To maximize your after-tax compensation, it can make a lot of sense to defer. For example, if you spread payments over 20 years, you could realize nearly twice the amount of compensation versus electing a lump-sum payout. This is especially the case if you plan to retire in a state without income tax. If you do elect to defer, you’ll want to manage the risk of losing your retirement savings due to bankruptcy of your employer.

A diverse group of participants funds a series of the Deferred Compensation Protection Trust, a Delaware master statutory trust. Each participant’s deferral plan is sponsored by a different company in a different industry. At the end of the Protection Period (5 or 10 years), the cash in the trust is used to offset losses caused by any bankruptcies. In the event of no bankruptcies, trust assets are fully refunded less administrative expenses.

Approximately 95% of the cash will be invested in U.S. Treasury Securities (e.g. 10-year U.S. Treasury Bonds for 10-year Protection Trusts). The remaining 5% is invested in a money market fund that invests only in U.S. Treasury Securities.

Each trust protects the deferral plans of similar-risk "peer group" companies. For example, a trust could be comprised of companies with a certain minimum credit rating.

Yes. If for any reason you are not comfortable with any of the companies, you may withdraw without penalty.

Payouts are made at the end of each trust's Protection Period, and the payouts are based on the total number of bankruptcies occurring during the Protection Period.

According to IRS Private Letter Ruling 9344038, "The sponsoring company may increase the participant's compensation in the amount of the premium payment, and the participant will include that increase in gross income." However, the Protection Trust is not connected to your company-sponsored deferral plan. It is a separate and independent vehicle for your wealth management and protection.

Resources

Additional Information
  • Introduction to Protecting Deferred Compensation September 2018 Download PDF
  • IRS Private Letter Ruling April 2018 Download PDF

Find out more

For more information on the valuable protection provided by the Deferred Compensation Protection Trust, please contact us.