Executive Compensation - Nonqualified Deferred Compensation Plans
A nonqualified deferred compensation plan is a contractual agreement whereby the employee or independent contractor agrees to be paid for services in a tax year subsequent to the tax year in which the services are rendered. Such arrangements generally are designed to pay the deferred compensation to the individual until such time as he or she may be in a lower tax bracket (such as following retirement). Payments generally may be made only upon retirement, death, disability, a fixed schedule set at the time of deferral, change in control or unforeseeable emergency.
Nonqualified deferred compensation plans must satisfy the requirements of Code Section 409A. The plan and the deferral election must be in place at or before the time of the performance of services for which compensation is deferred. The deferral election must include an election as to the time and manner in which benefits ultimately will be paid, and any acceleration of payment generally is prohibited. Failure to comply with Code Section 409A could subject the compensation to accelerated taxation, interest, and a twenty percent penalty tax.
Nonqualified deferred compensation plans are covered by some provisions of ERISA and are subject to certain reporting and disclosure obligations unless they satisfy the requirements for either the “top hat plan” exemption or the “excess benefit plan” exemption.
- The “top hat plan” exemption is available for any nonqualified deferred compensation plan that is unfunded and maintained by the employer primarily for a select group of management or highly compensated employees. A top hat plan is subject to certain reporting and disclosure requirements under Title I of ERISA, but can avoid the annual filing of Form 5500 by making a one-time filing with the Department of Labor.
- The “excess benefit plan” exemption covers plans that provide benefits to certain employees whose annual accruals under qualified plans are limited by Code Section 415.
Benefits accrued under a nonqualified deferred compensation plan must remain unfunded in order to avoid constructive receipt of the underlying income until payment. However, assets may be placed in a “rabbi trust,” which is reachable by the employer’s creditors, and the plan will still be treated as unfunded.
For a discussion regarding 2010 year-end compliance issues for employee benefit plans, see "2010 Year-End Compliance Checklist for Employee Benefit Plans".