Solving Business Issues with Deferred C ompensation P lans Lisa Jones, Esq., CPC, QPA John Carnevale, JD, AIF, President & CEO
What We Will C over What is a non-qualified Plan How a non-qualified plan can help your business How does a nonqualified plan differ from a qualified Plan Design consideration 457(b) and 457(f) plans Getting a Plan up and running Questions
What is a Non-Qualified Deferred C ompensation P lan? Generally, it allows contributions and benefits above the qualified plan limits. It is compensation that is payable in the future. It can be employer provided or employee elected salary deferral. It can have names like 409A plan, 457(b) plan, 457(f) plan, supplemental executive retirement plan (SERP), Excess plans, stock appreciation right (SAR), restricted stock grants and rabbi trust agreements.
How Can a Non-Qualified P lan Help Your Business? Attracting and retaining top talent is a critical function for every successful business. While a qualified retirement plan can provide attractive tax benefits and savings opportunities, too often, the benefits are simply not enough. A non-qualified plan allows you to provide contributions and benefits above the qualified plan levels and you aren t subject to the qualified plan rules. It allows you to hand pick who will be in the plan. It can be used as an incentive - employer contributions will only be made for an employee if the employee and or the organization meets certain goals. It can be contingent on the employee staying with your organization for a specific number of years and allows longer vesting schedules than a qualified plan, ( golden hand cuffs ). It allows executives to defer income above the qualified plan level and avoid current taxation.
Qualified P lan vs. Nonqualified P lan The qualified plan presents the following advantages: The costs of the plan can be deducted immediately by the employer Earnings on trust assets are not subject to current taxation. For the employee, the benefits are protected from creditors should the company have financial difficulty. Executives know that their benefits are being funded in advance and will be available upon their retirement. When the executive retires the lump sum value of their benefit can be rolled into an IRA and remain tax deferred, subject to RMDs. To obtain all of these advantages a qualified plan must satisfy the many nondiscrimination requirements imposed by the Internal Revenue Code and ERISA. Qualified plan employee deferrals and employer contributions should generally be maximized before putting money into a nonqualified plan.
Qualified P lan vs. Nonqualified P lan (cont.) Advantages of a nonqualified plan include the following: It can provide larger retirement benefits than those that can be earned in a qualified plan. Discrimination is permitted. Programs may be established for a single employee, or multiple selected employees, subject to some limitations. Benefits, vesting and other provisions do not need to conform to qualified plan standards and can be different for each participant. Maximum flexibility. The employer can tailor the benefit amounts and payment terms and conditions to the needs of the employer and the employee. The cost to operate a nonqualified plan is generally lower than to operate a qualified plan.
Qualified P lan vs. Nonqualified P lan (cont.) However: In a nonqualified plan employer deductions are only available when funds are made available to employees. Funds set aside by the employer remain on the employers books and may be subject to taxation on investment earnings. Unlike a qualified plan, the plan assets are subject to the claims of creditors. Rollovers are not permitted in a nonqualified plan. All distributions are subject to immediate taxation. (Exception for governmental 457(b) and transfers in tax-exempt 457(b) plans). Employees can be subject to tax prior to their actual receipt of funds. Proper design will minimize this risk. A nonqualified deferred compensation plan is a contractual agreement in which the employee agrees to be paid in a future year for services rendered currently. The employee is an unsecured creditor.
Design is Key for a Nonqualified Deferred C ompensation P lan An effective NQDC plan can help the company s efficiency and effectiveness while offering rewards to talented executives. Identify the company s objectives. What are you trying to accomplish? To attract employees and provide a competitive compensation package? To encourage the employee to stay with the organization for a stated period? To Incentivize? Contributions will be made if the employee/organization meets certain preestablished goals. Who should be included in the plan? When will distributions be allowed? Plan benefits and all conditions on receipt of those benefits should be clearly described in a written plan adopted by the employer.
Design is Key for a NQDC P lan Contribution formulas are highly flexible. Salary reduction the executive makes a written irrevocable deferral election prior to the beginning of the year to reduce the compensation to be paid to them. This allows the executive to defer amounts that can t be deferred to a 401(k) plan due to ADP test constraints or 402(g) limits, ($18,000 in 2015 plus a $6,000 catch up for participants age 50 or older). New participants have 30 days after they become eligible to make their election. There are different rules for deferring performance based pay. Changes can t be made to deferral elections during the plan year. The deferral election can be written to be evergreen. In a 457(b) deferral elections can be changed before the beginning of each month
Design (continued) Employer Contributions - the benefits many executives receive from qualified plans will represent a considerably smaller percentage of their final pay than that received by rank and file employees. This is due to IRS limits on the compensation that can be considered in a qualified plan, ($265,000 in 2015), and the annual addition limits, ($53,000 in 2015). The same is true of the social security benefits these employees will receive, (the Social Security wage base is $118,500 in 2015). The employer can make up for this in the NQDC plan. In addition, or instead of, the Employer contribution can be conditioned on the employee or the company meeting certain objectives. The Employer contribution can also be in the form of a match. We need to choose a vesting schedule and decide when accounts will become nonforfeitable. Delayed vesting is often attractive to employers as golden handcuffs to encourage employees to stay with an employer. Class year vesting is also often used. We need to decide when distributions will be allowed, (separation of service, retirement, death, disability specified date, upon a change in control, unforeseeable emergency), and the form of payment.
Design (cont.) Change of payment form or timing are allowed subject to strict rules Election of the form of payment must be made before the year in which the compensation is earned. No payment accelerations,( haircut ). If a participant wants to change the timing or form of a payment they must make an election in writing one year in advance of the scheduled payment and generally the payment must also be pushed back at least 5 years. Choose a financing strategy pay-as-you-go, mutual funds, Rabbi trust, corporate owner life insurance (COLI)?
457(b) and 457(f ) Deferred compensation plans for state and local government as well as taxexempts. Governmental 457(b)s may include any employee. A tax-exempt 457(b) must be limited to a top hat group. 457(b) plans allow participants to make an additional deferral equal to the current 402(g) limit, ($18,000 in 2015). The $18,000 may be all deferrals, all employer contributions or a combination. Governmental 457(b) plans allow an age 50 catch up similar to 401(k) and 403(b) plans. Tax-exempt 457(b) plans do not allow age 50 catch-ups but do allow a catchup when a participant is within 3 year of the plan s Normal Retirement Age. Governmental 457(b) plans allow rollovers similar to qualified plans and 403(b) plans. Tax-exempt 457(b) plans can only allow a transfer to another tax-exempt 457(b) plan. Distributions can t be rolled over. 457(f) plans are not subject to contribution limits. A tax-exempt 457(f) plan must limit participation to a top hat or select group of management.
Getting a NQDC P lan up and running Decide upon the plan features. Select the initial participants. Decide upon plan assets, if applicable. Execute a plan document. Make sure you have the needed participant forms. Do a one time top hat filing with the DOL. Work with your payroll company to add the needed payroll codes and to make sure FICA and FUTA are deducted properly, distributions are paid and taxed properly and that W-2s have the correct coding. Educate your participants.
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