Bryant - Course 5. Retirement Planning & Employee Benefits. 3. Non-Qualified Plans Flashcards
Joe Bradley, at 42, is a successful executive at Trinity Corporation. His wife Beth is a public school teacher. They lead a comfortable life in their home in New York. Though their income is $120,000 a year, Beth is worried about whether they have planned adequately for their life after retirement-it has been just a couple of years since they started their retirement planning. She feels that with their kind of spending pattern, they will need additional benefit planning. She wants to discuss with Joe the possibility of using nonqualified plans like stock options in addition to the qualified plans that they have already invested in.
One’s postretirement life may bring with it certain unforeseen expenses. The retirement benefits received through qualified plans may not be able to entirely support these expenses. Nonqualified plans go hand in hand with qualified plans to provide employees with additional retirement benefits.
The Nonqualified Plans module, which should take approximately six hours to complete, will explain nonqualified plans and describe the various types of nonqualified plans.
Upon completion of this module, you should be able to:
* Explain nonqualified plans, and
* Describe the various types of nonqualified plans and their tax implications.
Module Overview
After years of hard work and hectic schedules, retirement for most people means a peaceful and restful life. However, it also has many people worrying about their financial security. They are hounded by questions such as, “Will I be able to fulfill all my financial liabilities?” “Will our post-retirement financial position support our lifestyle?” “Can the retirement plan we have opted for support all our medical expenses?” And the list goes on.
Besides the traditional tax advantage and qualified retirement benefits that employers provide, people may feel the need for additional benefits to ensure enhanced financial security. In such cases, they can opt for non-qualified deferred compensation plans. Unlike qualified plans, these plans do not meet ERISA requirements and are discriminatory. They provide tax deferral for the employee. They also meet the financial planning objectives of both the employer and the employee. There are various types of non-qualified plans, as listed below:
- Supplemental executive retirement plans provide benefits to selected employees only. They are not qualified under the IRC or ERISA. Therefore, the employer has the freedom to decide whom to include and exclude from the plan.
- In Split Dollar Life Insurance, an employer and an employee share the costs and benefits of the life insurance policy. These plans can be used between a parent corporation and a subsidiary, or a parent and a child.
- A Stock Option, too, is a non-qualified plan. Employers often use stock options to compensate executives. The plan specifies the price of the stock and also the period within which it can be purchased. For this type of plan, taxation is deferred to the time of purchase of stock or later. The two main types of stock option plans for compensating executives are incentive stock option plans and non-statutory stock options.
- Employee stock purchase plans are similar to stock option plans. The purchase of these is brought about by salary deductions during the offering period. They are offered at a price lower than the market price. The plans are usually tax qualified under Section 423.
- Phantom stock, also a type of non-qualified plan, involves units similar to company shares. The value generally equals the full value of the underlying stock.
- Loans to executives are usually restricted to loans for specified purposes. Typically, such loans are interest-free or made at a favorable interest rate.
To ensure that you have a solid understanding of non-qualified plans, the following lessons will be covered in this module:
* Non-qualified Plans
* Non-qualified Deferred Compensation Plans
* Supplemental Executive Retirement Plans
* Split Dollar Life Insurance
* Stock Options
* Employee Stock Purchase Plans
* Phantom Stock
* Loans to Executives
Section 1 - Nonqualified Plans
Nonqualified plans provide employees additional retirement benefits. These plans do not meet the requirements under ERISA. Nonqualified plans offer the employer a great deal of flexibility when designing the plan. The employer can decide who is to be included in the plan. He may want to include only the highly compensated employees or members of management.
In the case of nonqualified plans, earnings are taxed currently to the employer (not tax deductible). The employer receives a tax deduction only once the employee has received the benefits of the plan or the benefits have been made available. Earnings are taxable to the employee when the funds are distributed to the employee or made available.
To ensure that you have a solid understanding of nonqualified plans, the following topics will be covered in this lesson:
* When Is It Used?
* Timing of Corporate Tax Deduction
* Coverage of Nonqualified Plans
* Forfeiting Benefits
* Tax Treatment of Earnings
* Coverage of Independent Contractors and Directors
Upon completion of this lesson, you should be able to:
* Describe the usage of nonqualified plans,
* Explain the tax deductions for nonqualified plans,
* Identify the groups eligible for nonqualified plans,
* Explain when the plan benefits are forfeitable,
* Describe the tax implications for plan earnings, and
* Detail coverage of independent contractors and directors.
When are Nonqualified plans Used?
Nonqualified plans can be used to fill many different needs. Some ways in which nonqualified plans may be used are:
* Nonqualified plans can be designed for key employees without the sometimes prohibitive cost of covering a broad group of employees.
* Nonqualified plans can provide benefits to executives beyond the limits allowed in qualified plans.
* Nonqualified plans can provide “customized” retirement or savings benefits for selected executives.
When Do Corporations Receive a Tax Deduction?
The corporation receives a deduction when the employees receive benefits, or otherwise when the funds are made available.
Amy is employed at Abacale Corporation and is a key employee. Abacale has a non-qualified plan for Amy and set aside money into it for her in 2018, 2019 and 2020. In 2021, Amy is allowed to take a withdrawal and does so. In what year may Abacale take a deduction?
* 2018
* 2019
* 2020
* 2021
2021
* Abacale Corporation may take a deduction in the year that Amy takes a distribution, or when the funds are made available, which is 2019.
Who Must be Covered in Non-Qualified Plans?
The corporation is free to discriminate as it sees fit. The plan may cover only independent contractors or members of management or highly compensated employees.
- Qualified plans must cover all employees who meet minimum age and length of service requirement. For example, Age 21 and One Year of Service.
- Nonqualified plans do not have to meet any requirements and can discriminate as they see fit. The plan can cover only independent contractors, or members of management, or highly compensated employees.
When are Benefits in Nonqualified plans Forfeitable?
The qualified plan vesting rules apply only if the plan covers rank-and-file employees.
* If the plan covers only independent contractors or a select group of management or highly compensated employees, benefits must be forfeitable in full at all times or subject to current taxation to the employee.
Practitioner Advice:
* For that reason, these plans are often referred to as “Top Hat” plans.
What is the Tax Treatment of Earnings
and Coverage of Independent Contractors and Directors in Nonqualified plans?
The earnings of plan assets set aside to informally fund a nonqualified deferred compensation plan are taxed currently to the employer unless the use of assets that provide a deferral of taxation is used.
* Also, there is no tax deduction to the employer currently.
- Independent contractors and directors may be covered in the same manner as an employee.
Section 1 - Nonqualified Plans Summary
Nonqualified plans provide employees additional retirement benefits. These plans do not meet the requirements under ERISA and offer the employer a great deal of flexibility when designing a plan.
In this lesson, we have covered the following:
* When is it Used: Nonqualified plans can be used to fill many different needs. One way nonqualified plans may be used is to** provide additional benefits for key employees or executives**
* Timing of Corporate Tax Deduction: In case of a nonqualified plan, the corporation receives a deduction once the employees have received the benefits or when the benefit is made available.
* Coverage: Nonqualified plans are discriminatory. The corporation has the freedom to decide as it sees fit whom the plan covers. It could cover only independent contractors or members of management or highly compensated employees.
- Forfeiting Benefits: Vesting rules for qualified plans apply only if the plan covers rank-and-file employees. In a case where the plan covers only independent contractors or a select group of management or highly compensated employees, the benefits could be forfeitable in full at all times.
- Tax Treatment of Earnings: The earnings of assets set aside to informally fund nonqualified plans are currently taxed to the employer unless assets that defer taxation are used. Also, the employer does not get a tax deduction currently. The earnings are taxable to the employee when distributed as benefits. However, the employer is entitled to an income tax deduction at that time.
- Coverage of Independent Contractors and Directors could be the same as that for an employee.
Which of the following are features of nonqualified plans? (Select all that apply)
* These plans provide additional retirement benefits to employees.
* They qualify under ERISA.
* The employer has a great deal of flexibility while planning the program.
* These plans can discriminate.
These plans provide additional retirement benefits to employees.
The employer has a great deal of flexibility while planning the program.
These plans can discriminate.
* Nonqualified plans provide employees additional retirement benefits. The plans are not qualified under ERISA requirements. As a result, the employer has freedom while planning the program. The employer can decide who is to be included in the plan. He may want to include only highly compensated employees or members of management. Plan benefits for these groups are forfeitable in full at all times.
Which of the following options regarding nonqualified plan vesting rules are true? (Select all that apply)
* The qualified vesting plan rules apply if the plan covers rank-and-file employees.
* They must always meet certain vesting schedules.
* The qualified vesting rules do not apply if the plan covers a select group of management or highly compensated employees.
* For nonqualified deferred compensation benefits to remain tax deferred to the employee, the benefits are forfeitable in full at all times.
The qualified vesting plan rules apply if the plan covers rank-and-file employees.
The qualified vesting rules do not apply if the plan covers a select group of management or highly compensated employees.
For nonqualified deferred compensation benefits to remain tax deferred to the employee, the benefits are forfeitable in full at all times.
* The qualified plan vesting rules apply in the case of rank-and-file employees. If the plan covers only independent contractors or a select group of management or highly compensated employees, benefits may be forfeitable in full at all times.
Section 2 - Nonqualified Deferred Compensation Plan
A nonqualified deferred compensation plan is any employer retirement, savings, or deferred compensation plan for employees that does not meet the tax and labor law (ERISA) requirements applicable to qualified pension and profit sharing plans.
Nonqualified plans usually provide retirement benefits to a select group of executives, or provide such a select group with supplemental benefits beyond those provided in the employer’s qualified retirement plans.
Nonqualified plans do not provide the same type of tax benefit as qualified plans, because in the nonqualified plan, the employer’s income tax deduction generally cannot be taken up front. The employer has to wait until the year in which the employee reports income from the deferred compensation plan to take its deduction.
However, a nonqualified plan can provide tax deferral for the employee, as well as meet employer and employee compensation and financial planning objectives.
Informal financing of the plan through life insurance or some other type of employer-held asset reserve can increase the security of the plan to the employee almost to the level of a qualified plan.
To ensure that you have a solid understanding of nonqualified plans, the following topics will be covered in this lesson:
* When Is It Used?
* Advantages of Deferred Plans
* Disadvantages of Deferred Plans
* Employer Objectives
* Employee Objectives
* Types of Benefit and Contribution Formulas
* Withdrawals during Employment
* Termination of Employment
* Funded Versus Unfunded Plans
* Financing Approaches
* Tax Implications
* ERISA Requirements
Upon completion of this lesson, you should be able to:
* List the uses of deferred plans,
* Describe the advantages,
* Describe the disadvantages,
* Explain employer objectives,
* Identify employee objectives,
* Distinguish between the various types of benefit formulas,
* Explain the withdrawal provisions for employees during employment,
* Describe termination provisions for employees,
* Compare funded and unfunded plans,
* Compare the various financing approaches,
* Identify the tax implications for nonqualified deferred compensation plans, and
* Describe the two types of nonqualified deferred plans.
When Is a Nonqualified Deferred Compensation Plan Used?
Apart from the qualified retirement plans of the employer, a nonqualified plan can provide supplemental retirement benefits to a select group of executives. Nonqualified plans are not subject to all the ERISA rules applicable to qualified plans.
This gives the employer much flexibility in plan design. A nonqualified plan can be used in the following situations:
* When an employer wants to provide a deferred compensation benefit to an executive or group of executives, but the cost of a qualified plan would be prohibitive. This would be as a result of the large number of nonexecutive employees who would have to be covered. A nonqualified plan is ideal for many companies that do not have or cannot afford qualified plans but want to provide key employees with retirement income.
* When an employer wants to provide additional deferred compensation benefits to an executive already receiving the maximum benefits or contributions under the employer’s qualified retirement plan.
* When the business wants to provide certain key employees with tax-deferred compensation under terms or conditions different from those applicable to other employees.
* When an executive or key employee wants to use the employer to create a forced, automatic, and relatively painless investment program that uses the employer’s tax savings to leverage future benefits.
* Since amounts paid by the employer in the future would be tax-deductible, the after-tax cost of the deferred compensation would be favorable.
* For example, if the employer is in a combined federal and state tax bracket of 40%, it can pay $50,000 to a retired executive at a net after-tax cost of only $30,000 because its tax deduction saves it $20,000, that is 40% of $50,000.
* When an employer needs to solve the Four R’s (recruit, retain, reward, and retire). These plans are a fundamental tool in designing executive compensation to meet these issues.
* When a closely held corporation wants to attract and hold nonshareholder employees. For such employees, an attractive deferred compensation package can be a substitute for the equity-based compensation packages of company stock and stock options. The employees would expect to receive these if they were employed by a public company.
What are the Advantages of nonqualified plans?
The design of nonqualified plans is much more flexible than that of qualified plans. A nonqualified plan:
* Allows coverage of any group of employees, or even a single employee, without any nondiscrimination requirements,
* Can provide an unlimited benefit to any one employee subject to the reasonable compensation requirement for deductibility, and
* Allows the employer to provide different benefit amounts for different employees, on different terms and conditions.
* It involves minimal IRS, ERISA, and other governmental regulatory requirements, such as reporting and disclosure, fiduciary, and funding requirements.
* It provides deferral of taxes to employees, but the employer’s deduction is also deferred. The advantage of deferral is debated when income tax rates are relatively low, and there is some expectation of higher rates in the future. However, if dollars otherwise paid currently in taxes can be put to work over the period of deferral, planners can show advantages in nonqualified plans, even if future tax rates are higher.
* The tradeoff in current federal corporate and individual rates for the highest income levels no longer favors deferred compensation, as the two rates are now similar.
* An employer can use a nonqualified plan as a form of golden handcuffs that help to bind the employee to the company. Since the qualified plan vesting rules do not apply if the plan is properly designed, the plan can provide forfeiture of benefits according to almost any vesting schedule the employer desires. The forfeiture is applicable for almost any contingency, such as terminating employment before retirement, misconduct, or going to work for a competitor.
* Although the plan generally involves only the employer’s unsecured promise to pay benefits, the plan can provide security to the executive through informal financing arrangements such as corporate-owned life insurance (COLI) and/or a rabbi trust.
* Assets set aside in some types of informal financing arrangements are available to use for corporate purposes at all times.
Which of the following are considered advantages of a nonqualified plan? Click all that apply.
* The design is flexible
* Can provide deferral of taxes to employees
* The tax deduction is deferred
* Minimal governmental regulatory requirements
The design is flexible
Can provide deferral of taxes to employees
Minimal governmental regulatory requirements
* Nonqualified plans have many advantages, such as a flexible design, minimal government regulatory requirements, deferral of employee taxes, use by the employer as “golden handcuffs” that help bind the employee to the company, and some assets set aside in some informal arrangements are available to use for corporate purposes.
What are the Disadvantages
of a nonqualified plan?
Though a nonqualified plan provides several benefits, there are also certain drawbacks in this plan. The disadvantages of a nonqualified plan are:
* The employer’s tax deduction is generally not available for the year in which compensation is earned. It must be deferred until the year in which income is taxable to the employee. This can be a substantial period of time: 10, 20, or even 30 or more years in the future.
* From the executive’s point of view, the principal problem is lack of security as a result of depending only on the employer’s unsecured promise to pay. In addition, most of the protections of federal tax and labor law (ERISA) that apply to qualified plans, for example the vesting, fiduciary and funding requirements, are not applicable to the typical nonqualified plan.
* While accounting treatment is not entirely clear, some disclosure of executive nonqualified plans on financial statements may be required. This would reduce the confidentiality of the arrangement, which could be considered undesirable by both employer and employee.
* Not all employers are equally suited to take advantage of nonqualified plans.
* As a result of their pass-through tax structure, S corporations and partnerships cannot take full advantage of nonqualified plans.
* The employer must be one likely to last long enough to make the payments promised under the plan. Although funds can be set aside to provide payments even if the employer disappears, the full tax benefits of the plan cannot be provided unless the employer exists at the time of payment, so it can take its tax deduction. Many closely- held businesses, family businesses and professional corporations do not meet this criterion.
* Special problems exist when tax-exempt or governmental organizations enter into nonqualified plans.
What are Employer Objectives
in nonqualified deferred compensation plans?
Employers usually adopt nonqualified deferred compensation plans to provide an incentive to hire key employees, to keep key employees and to provide performance incentives. In other words, to provide the typical employer compensation policy objectives that apply to other forms of compensation planning.
Plans reflecting employer objectives typically consider the following types of design:
* Eligibility is confined to key executives or technical employees that the employer wants to recruit and keep.
* Plan eligibility can be part of a predetermined company policy or the plan can simply be adopted for specific individuals as the need arises.
* Performance incentive features are included. The features may include benefits or contributions based on salary, increases if specific profits or sales goals are achieved, or benefits related to the value of the employer’s stock.
* Termination of employment would typically cause loss or forfeiture of benefits, particularly for terminations followed by undesirable conduct, such as competing with the employer.
* The plan often would not provide immediate vesting of benefits. Vesting will occur over a period of time in order to retain employees.
What are Employee Objectives
in nonqualified deferred compensation plans?
An employee’s personal financial planning objective is primarily to obtain additional forms of compensation for which income tax is deferred as long as possible, preferably until the money is actually received. Usually it is only highly compensated employees who wish to or can afford to defer compensation to a substantial extent, since only they have enough discretionary income to support substantial saving.
From the employee’s point of view, the tax deferral, and therefore the compounding of dollars that otherwise would be paid currently in taxes, is a major benefit of the plan. In addition, it is possible that plan benefits may be paid when the employee is in a lower marginal tax bracket. However, due to frequent changes in the tax laws, this factor is difficult to predict.
An employee who has enough bargaining power to influence the design of a nonqualified deferred compensation plan would favor the following types of provisions:
* Benefit certainty, which is usually more important than incentive provisions. Employees rarely seek contingent features unless the company is definitely growing and the employee wants a benefit based on company growth.
* Employees would want a benefit that is immediately 100% vested without forfeiture provisions, for cause or otherwise.
* Employees would like to have funds available for various purposes during employment, to the extent possible under the tax law.
* Concern for benefit security is significant, and employees will want to explore some of the financing or informal funding arrangements, such as corporate-owned life insurance (COLI), rabbi trusts or surety bonds.
What are the Types of Benefit and Contribution Formulas in a nonqualified deferred compensation plan
The benefit formula is the basic starting point in designing or explaining a nonqualified deferred compensation plan.
Executives covered under the plan first want to know what benefits the plan provides, rather than methods of financing those benefits, such as corporate-owned life insurance (COLI) arrangements. Benefit formula design is almost wide open for nonqualified deferred compensation plans as great flexibility is possible, and formulas can be designed for the specific needs of specific employees.
Some common benefit formula approaches include:
* Salary continuation formula,
* Salary reduction formula,
* Excess benefit plan, and
* Stock appreciation rights.
Describe the Salary Continuation Formula
Salary continuation generally refers to a type of non-elective nonqualified deferred compensation plan that provides a specified deferred amount payable in the future. A salary continuation plan provides benefits in addition to other benefits provided under other plans and requires no reduction in the covered employee’s salary.
For example, the contract might provide that at retirement, disability, or death, the XYZ Corporation will pay you or your designated beneficiary $50,000 a year for 10 years starting at age 65.
A salary continuation formula generally uses a defined benefit type of formula to calculate the benefit amount. The formula is not subject to the limitations applicable to qualified defined benefit plans, such as the limitation on benefits, or the amount of salary used in the formula.
A nonqualified salary continuation plan for a selected group of executives with similar formulas for the entire group is sometimes referred to as a SERP, for supplemental executive retirement plans.
Describe the Salary Reduction Formula
A salary reduction formula involves an elective deferral of a specified amount of the compensation that the employee would have otherwise received. The employer contribution under this type of plan could be in the form of a bonus, without actual reduction of salary. The plan is somewhat similar to a defined contribution type of qualified plan, although the qualified plan restrictions do not apply.
The amount deferred each year under a salary reduction formula is generally credited to the employee’s account under the plan. When benefits are due, the amount accumulated in this account determines the amount of payments. Payment is generally in the form of a lump sum, but the account balance can also be paid in an equivalent stream of periodic payments.
The salary reduction formula generally provides a method by which earnings on the account are credited. These earnings credits may be based upon a specified interest rate, or an external standard, such as Moody’s Bond Index, the federal rate or other indexed rate, or the rate of earnings on specified assets.
In a salary reduction arrangement, the employer has no obligation to actually set assets aside. The participant’s account can be purely an accounting concept existing only on paper. In that case, when payment becomes due, the employer pays it from its current assets. This points out the fact that all nonqualified deferred compensation plans are essentially based only on the employer’s contractual obligation to pay benefits.
Practitioner Advice:
* Since the financial stability of corporations is not bullet proof, a financial planner needs to explore all alternatives to a nonqualified deferred compensation plan, as well as the company’s financial strength, before recommending that his or her client defer current income into a non-qualified salary reduction agreement.
Describe the Excess Benefit Plan
Under ERISA Section 4(b)(5), an excess benefit plan is a plan that is unfunded and is not subject to Title I of ERISA, which contains the reporting and disclosure, participation, vesting, funding, and fiduciary responsibility provisions.
Excess benefit plans are designed to provide benefits only for executives whose annual projected qualified plan benefits are limited under the dollar limits of Code Section 415. An excess benefit plan makes up the difference between the qualified plan benefits top executives are allowed under Section 415 compared to the benefits provided to rank-and-file employees. In other words, highly compensated employees receive the difference between the amounts payable under their qualified plan and the amount they would have received if there were no benefit limitations under Code Section 415.
For some time, it was believed that an excess benefit plan could not restore benefits lost under the Code Section 401(a)(17) limitation on compensation of $330,000(2023) (as indexed), which would limit the usefulness of this type of plan.
Even if the excess benefit formula is not specifically based upon the Section 401(a)(17) compensation limitation, many nonqualified plan benefit formulas are related to qualified plan formulas and are designed to make the executive whole, that is, to provide an amount that makes up the difference between the benefit that the executive would have received under the employer’s qualified plans without the limitations of either Section 415 or Section 401(a)(17) and the amount actually received.
Exam Tip:
* The maximum annual benefit a company can provide in a qualified defined benefit plan is the lesser of $265,000 (2023) or 100% of the participant’s compensation averaged over his three highest-earning consecutive years.
* For an employee who makes significantly more than this limit, an excess benefit plan can provide a greater percentage of pre-retirement income during retirement.
An excess benefit plan makes up the difference between the percentage pay that top executives are allowed under Section 415 and that which rank, and file employees are allowed. State True or False.
* False
* True
True
* Highly compensated employees receive the difference between the amounts payable under their qualified plan and the amount they would have received if there were no benefit limitations under Code Section 415.
Describe Stock Appreciation Rights/Phantom Stock Formulas
The benefit formula in the plan can be determined on the basis of the value of a specified number of shares of employer stock, or contributions to a salary-reduction formula can be stated in terms of shares of employer stock rather than cash.
Generally, no actual shares are set aside, nor are shares of stock necessarily actually distributed. The value of employer stock simply is the measure by which the benefits are valued. Obviously, this type of formula provides a substantial incentive for the executive, and, from the employer viewpoint, matches the size of benefits with company success.
There is no firm distinction between these two types of benefit formulas.
* A stock appreciation right (SAR) formula provides that the employee’s future benefits are to be determined by a formula based on the appreciation value of the company’s stock over the period between adoption of the plan and the date of payment.
The American Jobs Creation Act signed into law changes to the tax treatment of nonqualified deferred compensation plans under Section 409A.
* To be exempt from Section 409A, the stock appreciation right (SAR) must not be less than the fair market value of the stock subject to the option at the time the option is granted.
* In addition, a stock appreciation right will not be subject to 409A under the following exceptions:
* The stock appreciation right’s exercise price is not less than the fair market value of the underlying stock on the date the stock appreciation right is granted and cannot become less than such amount;
* The stock of the service recipient subject to the stock appreciation right is traded on an established securities market;
* Only such traded stock of the service recipient may be delivered in settlement of the stock appreciation right upon exercise; and
* The stock appreciation right does not include any feature for the deferral of compensation other than the deferral of recognition of income until the exercise of the stock appreciation right.
Describe Forms of Benefits in Nonqualified deferred compensation plans
Nonqualified deferred compensation plans usually provide payments at retirement in a lump sum or a series of annual payments.
* Life annuities or joint and survivor annuities for the participant and spouse can also be provided.
* Since the elaborate restrictions on qualified plan payouts do not apply, considerable design flexibility is available.
Describe Taxation Considerations of a Funded or an Unfunded Plan in a nonqualified deferred compensation
The questions that must be asked in a nonqualified deferred compensation plan is, “When are the deferred amounts included in the employee’s income and when is it deductible by the employer?”
The nonqualified deferred compensation plan may either be funded or unfunded, though most are intended to be unfunded because of the tax advantages unfunded plans afford participants.
An unfunded arrangement is one where the employee has only the employer’s “mere promise to pay” the deferred compensation benefits in the future, and the promise is not secured in any way.
A funded arrangement generally exists if assets are set aside from the claims of the employer’s creditors, for example in a trust or escrow account.
In the unfunded plan, the tax consequence will be determined on the Doctrine of Constructive Receipt. The rules for Constructive Receipt are found in Section 451.
Cash basis taxpayers must include gains, profits, and income in gross income for the taxable year in which they are actually or constructively received. Under the constructive receipt doctrine, a cash-basis taxpayer will report income in the year in which it is actually or constructively received. Constructive receipt means that the income is made available to the taxpayer so that he may draw upon it at any time. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.
Establishing constructive receipt requires a facts and circumstances determination regarding the taxpayer’s control of the receipt of the deferred amounts.
* If there are no substantial limitations or restrictions, the amount is not deferred and is currently taxable.
* Therefore it is necessary to scrutinize all plan provisions relating to each type of distribution or access option to determine if the employee has unfettered control of the receipt of the deferred amounts.
In an unfunded plan, amounts set-aside in trust for the employee are available to satisfy the general creditors of the corporation in the event of a bankruptcy. In the funded plan, the tax analysis is the understanding of Economic Benefit Doctrine found under Section 83. Under the economic benefit doctrine, if an individual receives any economic or financial benefit or property as compensation for services, the value of the benefit or property is currently includible in the individual’s gross income.
When property is transferred to a person as compensation for services, the service provider will be taxed at the time of receipt of the property if the property is either transferable or not subject to a substantial risk of forfeiture. If the property is not transferable and is subject to a substantial risk of forfeiture, no income tax is incurred until it is not subject to a substantial risk of forfeiture or the property becomes transferable. The analysis under Section 83 is to determine the definition of “property.”
“Property” includes real and personal property other than money or an unfunded and unsecured promise to pay money in the future. In addition, it includes a beneficial interest in assets, including money, that are transferred or set aside from claims of the creditors of the transferor, for example, in a trust or escrow account.
Therefore, the cash equivalency doctrine must also be considered when analyzing a nonqualified deferred compensation arrangement.
* Under the cash equivalency doctrine, if a promise to pay of a solvent obligor is unconditional and assignable, not subject to set-offs, and if the right to receive a payment in the future is reduced to writing and is transferable, such as in the case of a note or a bond, the right is considered to be the equivalent of cash and the value of the right is includible in gross income.
The amounts are deductible by the employer when the amount is includible in the employee’s income. Interest or earnings credited to amounts deferred under nonqualified deferred compensation are added to the additional deferred compensation and are deductible when the employee is taxed on the distribution.
Describe Withdrawals During Employment in a nonqualified deferred compensation
Employees recognize that any kind of deferred compensation plan holds money that they could have usually received earlier in cash. Thus, certainty of receipt is a very important consideration. Similarly, employees like plan provisions that permit them to use deferred funds when they need them.
However, if a deferred compensation plan simply allowed the participant to withdraw from the plan at any time without restriction, the plan would fail to defer income taxes under the doctrine of constructive receipt. Withdrawals must be subject to a restriction or limitation that prevents them from being currently available within the constructive receipt doctrine.
Some commonly used withdrawal provisions include:
* Penalty or haircut provisions are no longer permitted: Provisions under Section 409A allow withdrawal for a wide range of reasons stated in the plan, or even upon the mere request of the participant, due to termination of employment, death, disability or retirement. Penalties that are based on a percentage of the withdrawal, known as haircut provisions, are not permitted. For example, if the participant requests $10,000, he receives $10,000, less a stated percentage penalty, such as 6%.
* Suspension of participation provision: This is a typical withdrawal provision that suspends the employee’s participation in the plan for a period such as six months after withdrawing money from the plan.
* Hardship withdrawal provision: Another way to avoid constructive receipt is to condition withdrawals upon events that are not within the employee’s control. In effect, death and disability provisions are examples of this approach. Withdrawals may also be conditioned on other specific hardships, such as financial emergencies, health matters, purchase of a house, educational costs for family members, and the like. The specific hardship withdrawal rules for Section 401(k) plans need not be followed in a nonqualified plan.
* The withdrawal provision can be quite broad, as long as it provides a significant limitation or restriction on the employee’s ability to gain access to the plan funds. It is very helpful if the plan gives the final decision concerning the withdrawal to a person or committee that is not controlled by the employee.
Describe Termination of Employment in a nonqualified deferred compensation
If the plan emphasizes employer objectives, termination provisions are designed to maximize incentive features and noncompetition and similar provisions. At the extreme, an employer-instituted plan may even provide a complete forfeiture of nonqualified benefits if the employee terminates employment before retirement. Most employer-instituted plans will at least have a vesting schedule under which benefits do not become vested until a specified number of years of service have been attained. Graduated vesting can also be used. If the plan is unfunded, the ERISA vesting provisions generally do not apply and any type of vesting schedule generally can be used.
If an executive’s termination of employment results from disability, special benefits may be provided, particularly if the employee has some bargaining power in designing the plan.
* An employee will generally want benefits paid immediately upon disability.
* For this purpose, the employee will also want to use a definition of disability that is somewhat less restrictive than the total and permanent disability required for Social Security disability benefits.
A typical disability provision based on employee objectives would provide for disability payments if the employee is no longer able to continue working in his specific profession or executive position. Disability determinations can be shifted to a third party such as an insurer, or a physician chosen by the employer and employee, in order to minimize possible disputes.
Compare Funded versus Unfunded Plans
In the employee benefit area, the term funded plan has a very specialized meaning.
* In the tax sense, a plan is formally funded if the employer has set aside money or property to pay plan benefits through some means that restricts access to the fund by the employer’s creditors.
* For example, setting assets aside in an irrevocable trust for the exclusive benefit of employees covered under the plan.
* For ERISA purposes, the Department of Labor (DOL) has not specifically endorsed this clear-cut definition of funding, but for plans that benefit a select group of management or highly compensated employees, if the plan is unfunded for tax purposes, it probably will be regarded as unfunded for ERISA purposes.
Assets used to informally fund or finance the employer’s obligation under a nonqualified plan can, and almost always should, be set aside, but if this fund is accessible by the employer’s creditors, providing no explicit security to the employee ahead of other employer creditors, the plan is deemed to be unfunded for tax purposes. As indicated above, although the issue is not completely clear, such an arrangement is probably also an unfunded one for ERISA purposes. Most nonqualified deferred compensation plans are unfunded because of significant tax and ERISA considerations:
* In a funded plan, amounts in the fund are taxable to the employee at the time the employee’s rights to the fund become substantially vested. Under the rules of Code Section 83, substantial vesting can occur before funds are actually received by the employee.
* Funded plans are generally subject to the ERISA vesting and fiduciary requirements, which create design inflexibility. Under the ERISA vesting rules, the plan must have a vesting schedule at least as fast as either the three-year schedule, that is, no vesting up to three years of service, 100% vesting after three years, or the two-year to six-year schedule:
YEARS OF SERVICE VESTED PERCENTAGE
2 20%
3 40%
4 60%
5 80%
6 100%
The vesting and fiduciary rules for funded nonqualified and qualified plans are the same.
What are some Financing Approaches
for nonqualified deferred compensation plans?
Because almost all nonqualified deferred compensation plans are unfunded in the formal sense, employees initiating deferred compensation arrangements are likely to seek ways to increase benefit security.
The following approaches are commonly used:
* Reserve account maintained by employer
* Employer reserve account with employee investment direction
* Corporate-owned life insurance
* Rabbi trust
* Third-party guarantees
What is a Reserve Account Maintained by Employer Approach to funding?
The employer maintains an actual account, invested in securities of various types.
* There is no trust in this case.
* Funds are fully accessible to the employer and its creditors.
* The plan is considered unfunded for tax and ERISA purposes.
What is the Employer Account with Employee Direction Approach to funding?
With this variation, the employee obtains greater security by having the right to direct or select investments in the account.
* He or she must limit this right to a choice of broad types of investment such as equity, bonds and a family of mutual funds.
* The ability to choose specific investments may lead to constructive receipt by the employee.
* Also, the investment direction by the participant must be advisory only and not binding.
What is the Corporate-owned Life Insurance Approach to funding?
Life insurance policies on the employee’s life, owned by and payable to the employer corporation, can provide financing for the employer’s obligation under nonqualified deferred compensation plans.
* With life insurance financing, the plan can provide a substantial death benefit, even in the early years of the plan.
* This is of significant value to younger employees.
Exam Tip:
* Informally funding a nonqualified deferred compensation plan with life insurance is common because the cash value buildup is tax-deferred.
What is the Rabbi Trust Approach to funding?
A rabbi trust is a trust set up to hold property used for financing a deferred compensation plan, where the funds set aside are subject to the employer’s creditors.
* These trusts are referred to as rabbi trusts because an early IRS letter ruling involved an arrangement between a rabbi and the employing congregation.
* The IRS has ruled that trusts designed this way do not constitute formal funding in the tax sense.
* The DOL has a working premise that rabbi trusts meeting with the approval of the IRS will not cause excess benefit plans or top-hat plans to be funded for ERISA purposes.
* Establishing a Rabbi trust to hold funds does not provide the employer with a current tax deduction, however.
What is the Third-party Guarantees Approach to funding?
In these arrangements, there is a guarantee from a third party to pay the employee if the employer defaults.
* The guarantor could be an insurance company or some other entity.
* On occasion, third-party guarantees have received favorable tax treatment.
* But the law in this area is not entirely clear.
* Employer involvement raises the possibility that the guarantee may cause the plan to be deemed formally funded for tax purposes.
* However, it appears that if the employee, independently of the employer, obtains a third-party guarantee, the IRS would not necessarily view the plan as formally funded.
What are the Tax Implications
of Nonqualified deferred compensation plan?
Nonqualified deferred compensation plans are subject to certain tax implications.
* These include constructive receipt, economic benefit, taxation of benefits and contributions, Social Security taxes and federal estate taxes.
* In the case of constructive receipt, an amount is considered for taxation if it is put aside or credited to the employee’s account unless the employees control of the receipt is subject to a substantial limitation or restriction.
* According to the economic benefit doctrine, a compensation agreement that provides a current economic benefit to an employee is taxed as soon as the employee is vested in contributions made to the fund, even when the employee does not have a right to withdraw cash at that time.
What is Constructive Receipt?
Under the constructive receipt doctrine, code Section 451, an amount is treated as received for income tax purposes, even if it is not actually received, if it is credited to the employee’s account, set aside, or otherwise made available.
Constructive receipt does not occur if the employee’s control over the receipt is subject to a substantial limitation or restriction.
A requirement of a passage of time until the employee can receive money is usually considered a substantial limitation or restriction.
In a typical deferred compensation plan, for example, if the plan provides that an amount is not payable for five years or not payable until the employee terminates employment or retires, it will not be constructively received before that time.
The view of the IRS is that an agreement to defer compensation generally must be made before the compensation is earned.
* In order to defer compensation after services have already been performed, the IRS is of the opinion that the plan must have a substantial risk of forfeiture of the benefits.
Plan distribution provisions must be designed to avoid constructive receipt.
* For example, assume that the plan provides for distribution in 10 equal annual installments. If the employee can elect, at any time, to accelerate payments, then, under the constructive receipt doctrine, the employee would have to include in income each year the amount that the employee could have elected to receive.
Or, for instance, consider that the plan provides for a payout in 10 annual installments with an election at any time to spread payments out further. The constructive receipt doctrine may require taxation under the original 10-payment schedule, regardless of any election to further defer payments, unless the plan imposes a substantial risk of forfeiture.
A typical forfeiture provision found in nonqualified plan distribution provisions of this type is a requirement that the employee be available for consulting and refrain from competing with the employer.
Which of the following is considered constructive receipt for income tax purposes?
* Amount is payable upon termination
* Credited to an employee’s account
* Set aside
* Amount is payable in five years
Credited to an employee’s account
Set aside
* An amount is treated as received for income tax purposes, even if it is not actually received, if it is credited to the employee’s account, set aside, or otherwise made available. Constructive receipt does not occur if the employee’s control over the receipt is subject to a substantial limitation or restriction.
Describe the economic benefit doctrine
A compensation arrangement that provides a current economic benefit to an employee can result in current taxation, even though the employee has no current right to receive cash or property.
* For example, suppose an employee is covered under a funded nonqualified deferred compensation plan that has an irrevocable trust for the benefit of the employee.
* Under the economic benefit doctrine, the employee will be taxed as soon as the employee is vested in contributions made to the fund, even though the employee does not, at that time, have a right to withdraw cash.
* This factor makes funded plans extremely unattractive.
The economic benefit doctrine does not generally affect unfunded plans, and almost all nonqualified deferred compensation plans are unfunded.
* It is possible that some incidental benefits in the plan could create an economic benefit.
* This issue has sometimes been raised in the case of a plan that includes an insured death benefit.
* Currently, however, the IRS does not claim that there is an economic benefit resulting from the insured death benefit in a properly designed nonqualified plan.
Describe Income Taxation of Benefits and Contributions in nonqualified deferred compensation plans
Employees must pay ordinary income tax on benefits from unfunded nonqualified deferred compensation plans in the first year in which the benefit is actually or constructively received.
Death benefits from nonqualified plans that are payable to a beneficiary are taxable as income in respect as a decedent to a recipient.
Describe Social Security (FICA) Taxes
in nonqualified deferred compensation plans
Amounts deferred under nonqualified deferred compensation plans are not subject to Social Security taxes until the year in which the employee no longer has any substantial risk of forfeiting the amount, provided the amounts are reasonably ascertainable.
* In other words, as soon as the covered executive cannot lose his interest in the plan, he will be subject to Social Security taxes.
* Conceivably, this could be earlier than the year of actual receipt.
For example, assume that the plan provides that benefits are payable at retirement, but the benefits become vested five years after they are earned.
* Then the amounts deferred will enter into the Social Security tax base five years after they are earned.
* Note that this is neither the year in which they are earned nor the year they are paid, a circumstance that complicates tax compliance in this situation.
Although part of the Social Security taxable wage base, the Old-Age, Survivors, and Disability Insurance (OASDI) part has an annual upper limit ($160,200 for 2023), the Medicare hospital insurance portion is unlimited.
* The Medicare tax rate is 1.45% for the employer and for the employee.
* A surtax of 3.8% is applied to Net Investment Income or the excess of modified adjusted gross income above $200,000 filing single and $250,000 married filing joint.
* Also, an additional 0.9% on all earned income above the wage thresholds.
* For higher-paid executives, the inclusion of deferred compensation in the wage base during a year of active employment will not result in additional OASDI taxes if the executive’s current, that is, non-deferred compensation, is more than the OASDI wage base, but additional Medicare taxes will be payable.
* This factor must be considered while designing nonqualified deferred compensation plans.
Describe Federal Estate Tax Treatment
of a nonqualified deferred compensation plan
The amount of any death benefit payable to a beneficiary under a nonqualified deferred compensation plan is generally included in the deceased employee’s estate for federal estate tax purposes, at its then present value.
* In other words, the commuted value of payments made to the employee’s beneficiary are included in the employee’s gross estate.
* But such payments are considered income in respect to a decedent, Code Section 691 income, and an income tax deduction is allocated to the recipient of that income for the additional estate tax the inclusion generated.
* To the extent that payments are made to the employee’s spouse in a qualifying manner, the unlimited marital deduction eliminates any federal estate tax.
You can design a plan so that the decedent does not have a right to receive the benefit prior to death.
* A plan designed to provide only death benefits is referred to as a death benefit only (DBO) plan.
* For employees potentially liable for substantial federal estate taxes, the DBO plan may be an appropriate design.
Describe Taxation of Employer for a nonqualified deferred compensation plan
For a nonqualified deferred compensation plan, the employer does not receive a tax deduction until its tax year, which includes the year in which the compensation is includable in the employee’s taxable income.
* If the plan is unfunded, the year of inclusion is the year in which the compensation is actually or constructively received.
* For a formally funded plan, compensation is included in income in the year in which it becomes substantially vested.
Like other forms of compensation, payments under a deferred compensation plan are not deductible unless the amounts meet the reasonableness test. The same issues can arise with respect to deferred compensation as with regular cash compensation or bonus arrangements.
The IRS raises the reasonableness issue in the year in which an employer attempts to take a deduction.
* For nonqualified deferred compensation, this is generally the year in which the employee includes the amount in income-that is, a year that is later than the year in which the services were rendered.
* Compensation can be deemed reasonable on the basis of prior service. However, it is possible that a combination of deferred compensation and current compensation received in a given year can raise reasonableness issues, particularly if the deferred amount is very large.
Publicly held corporations generally cannot deduct compensation in excess of $1 million per tax year to certain top-level executives.
* If assets are set aside in a reserve used to informally finance the employer’s obligation under the plan, income on these assets is currently taxable to the employer.
* Consequently, the use of assets that provide a deferral of taxation can be advantageous.
* Life insurance policies are often used because their cash value build-up from year to year is not currently taxed.
* Death proceeds from the policy are also free of tax, except for a possible alternative minimum tax (AMT) liability.
If assets used to finance the plan are held in a rabbi trust, the employer’s tax consequences are much the same as if assets are held directly by the employer.
* For tax purposes, the rabbi trust is a grantor trust.
* A grantor trust’s income, deductions, and tax credits are attributed to the grantor, in this case the employer, for tax purposes.
What are the 2 types of nonqualified deferred compensation plans that are eligible for at least partial exemptions from the ERISA requirements?
Two types of nonqualified deferred compensation plans are eligible for at least partial exemptions from the ERISA requirements.
1. Unfunded excess benefit plan: This type of nonqualified deferred compensation plan, designed solely to supplement the qualified retirement benefits limited in amount by Code Section 415, is not subject to any ERISA requirements.
2. Top-hat plan: The top-hat plan involves the most important ERISA exemption. Under ERISA, if a nonqualified plan is unfunded and maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees, the plan is exempt from all provisions of ERISA except for the reporting and disclosure requirements, and ERISA’s administrative and enforcement provisions. Top-hat plans can satisfy the reporting and disclosure requirements by providing plan documents, upon request, to the Department of Labor, and by filing a simple, one-time statement about the arrangement with the Department of Labor.
The Department of Labor is responsible for interpreting this provision of ERISA, and it has not yet issued clear guidelines. The DOL’s current position seems to be that the select group of management or highly compensated employees is limited to those employees who, by virtue of their position or compensation level, have the ability to affect or substantially influence the design and operation of their deferred compensation plan. However, a plan that covers only a few highly paid executives will probably meet this ERISA exemption.
If a plan does not meet one of these ERISA exemptions, it must generally comply with most of the ERISA provisions applicable to qualified pension plans, including the vesting, fiduciary, minimum funding, and reporting and disclosure provisions.
As a result of these ERISA aspects, almost all nonqualified deferred compensation plans are limited to management or highly compensated employees and are formally unfunded, even though they may utilize some informal financing methods as discussed earlier.
Finally, the courts have sometimes held that a nonqualified deferred compensation plan was not subject to ERISA because it was not a plan within the meaning of ERISA. This ERISA exemption has been generally held to apply to plans covering one or only a few employees, where there was no ongoing administrative scheme to maintain the plan. Unless the situation is nearly identical to reported court cases, this exemption is not very practical to rely upon, because it is based on particular facts found by courts in each case, and the result of future court proceedings cannot be easily predicted.
Section 2 Nonqualified deferred compensation plan Summary
A nonqualified deferred compensation plan does not meet the tax and labor law (ERISA) requirements applicable to qualified pension and profit sharing plans.
In this lesson, we have covered the following:
* When Is It Used?: As the cost of qualified plans proves to be prohibitive, an employer uses nonqualified plans when he wants to provide executives with a deferred compensation benefit. A nonqualified plan is ideal for companies that want to provide key employees with retirement income. Another instance of use would be when an employer wants to provide additional deferred compensation benefits to an executive already receiving the maximum benefits or contributions under the qualified retirement plan.
* Advantages: There are several advantages to a nonqualified plan. It is more flexible than a qualified plan. It allows coverage of any group of employees or a single employee without nondiscrimination requirements. It can provide an unlimited benefit to any one employee, but is subject to the reasonable compensation requirement for deductibility. It also enables the employer to provide different benefit amounts for different employees, on different terms and conditions. It involves minimal IRS, ERISA, and other governmental regulatory requirements. Additionally, it provides deferral of employee taxes and employer deductions.
* Disadvantages: A nonqualified plan has several disadvantages. An employer’s tax deduction is generally unavailable for the year in which compensation is earned. It must be deferred until the year in which income is taxable to the employee and can take even 30 years or more. Not all employers may be equally suited to take advantage of nonqualified plans. One major drawback of these plans is that as a result of their pass-through tax structure, S corporations and partnerships cannot take full advantage of them. The employer must be one likely to last long enough to make the payments promised under the plan. The full tax benefits of the plan cannot be provided unless the employer exists at the time of payment, so it can take its tax deduction. Special problems exist when tax-exempt or governmental organizations enter into nonqualified plans.
* Employer objectives: Employers usually adopt nonqualified deferred compensation plans to provide an incentive to hire or retain key employees, and to provide performance incentives. For these plans, eligibility is confined to key executives or technical employees that the employer wants to recruit and keep. It depends on company policy or could be adopted for specific individuals as the need arises.
* Employee objectives: are primarily used to obtain additional forms of compensation for which income tax is deferred until the money is actually received. For the employee, the tax deferral, and therefore the compounding of dollars that would be paid currently in taxes, is a major benefit of the plan. In addition, it is possible that plan benefits will be paid when the employee is in a lower marginal tax bracket.
- Types of benefit and contribution formulas: The benefit formula helps design or explain a nonqualified deferred compensation plan. Benefit formula design is almost wide open for nonqualified deferred compensation plans as great flexibility is possible and formulas can be designed for the specific needs of specific employees. Some common benefit formula approaches include: salary contribution formula, salary reduction formula, excess benefit plan, and stock appreciation rights.
- Withdrawals during employment: Employees like plan provisions that permit them to use deferred funds when they need them. Withdrawals must be subject to a restriction or limitation that prevents them from being currently available within the constructive receipt doctrine. Some commonly used withdrawal provisions include: Penalty or haircut provisions, the suspension of participation provision, and the hardship withdrawal provision.
- Termination of employment: Termination provisions can be used to maximize incentive features and noncompetition. An employer-instituted plan may even provide a complete forfeiture of nonqualified benefits if the employee terminates employment before retirement. If an executive’s termination of employment results from disability, special benefits may be provided, particularly if the employee has some bargaining power in designing the plan.
- Funded versus unfunded plans: From the tax point of view, a plan is formally funded if the employer has set aside money or property to pay plan benefits through some means that restricts access to the fund by the employer’s creditors.
- Financing approaches: Since almost all nonqualified deferred compensation plans are unfunded in the formal sense, employees initiating deferred compensation arrangements might seek ways to increase benefit security. The approaches commonly used include reserve account maintained by employer, employer reserve account with employee investment direction, corporate-owned life insurance, rabbi trust, and third-party guarantees.
- Tax implications: The tax implications for nonqualified deferred compensation plans include constructive receipt, economic benefit, taxation of benefits and contributions, Social Security taxes and federal estate taxes.
- ERISA requirements: Two types of nonqualified deferred compensation plans are eligible for at least partial exemptions from the ERISA requirements, unfunded excess benefit plans and top-hat plans.
Jennifer is the owner of a software corporation. As an employer she would like to enhance the retirement benefits received by Rob, a senior executive in the company. She consults her financial consultant, Randolph, and inquires about nonqualified plans. He tells her that it is indeed a good idea to opt for a nonqualified plan. He also gives her the various other instances where she can use the plan. Which situations would Jennifer be able to use the plan to benefit both Rob and her? (Select all that apply)
* Jennifer would like to provide Rob with the benefits and at the same time not overshoot the allocated budget.
* Jennifer would like to provide Rob a deferred compensation under conditions that are different from those applicable to the junior employees.
* Rob would be able to create an investment program that will utilize Jennifer’s tax savings to influence his future benefits.
* Jennifer would be able to convey to Rob that his work in the company is appreciated. She would also be able to put to rest a fear that has troubled her regarding Rob not being content.
* Jennifer would like to receive tax deduction the same year in which Rob defers his compensation.
Jennifer would like to provide Rob with the benefits and at the same time not overshoot the allocated budget.
Jennifer would like to provide Rob a deferred compensation under conditions that are different from those applicable to the junior employees.
Jennifer would be able to convey to Rob that his work in the company is appreciated. She would also be able to put to rest a fear that has troubled her regarding Rob not being content.
* As an employer, Jennifer can use the deferred plan to her advantage, as she can provide additional benefits to Rob within the company’s budget. She need not use the same benefit program for all other employees, that is, the plan gives her the flexibility to decide whom to include for the benefit plan. Also, by using the deferred plan she can make sure that Rob is happy with the working conditions in the company. However, Jennifer will not receive a tax deduction in the year that Rob receives the compensation. The deduction will be deferred until the year that the income is taxable to Rob, and this could take up to 30 years or more.
A type of nonelective nonqualified deferred compensation plan that provides a specified deferred amount payable in the future.
Salary continuation formula
A plan that involves an elective deferral of a specified amount of the compensation that the employee would have otherwise received.
Salary reduction formula
A plan that provides benefits only for executives whose annual projected qualified plan benefits are limited under the dollar limits of Code Section 415.
Excess benefit plan
A plan that gives an employee a stake in a company’s growth (as reflected in its stock price) without actually investing in the company’s stock.
Stock appreciation rights
This provision has multiple withdrawal reasons stated, including the request of the participant, but there are penalties for early withdrawal.
Penalty or haircut provision
