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By John Wolf and Tom Cullen CPA
Non-qualified Deferred
Compensation
A substantial percentage of highly compensated individuals either enter into or actively consider deferred compensation arrangements with their employer. The basic thrust of such arrangements is to postpone the receipt of currently earned income until a later taxable year.
409A Non-qualified Deferred Compensation Plans
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Postponement of Income
Instead of paying additional compensation now, the employer pays it to the executive at some future time. These payments are referred to as “deferred” compensation plans because they represent compensation currently being earned but which will not be paid until a future date.
Non-qualified Deferred Compensation Plans, 2020-2021
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Note: If the income has already been earned (i.e., the employee has an undisputed right to it) deferral is impossible. When using the term “non-qualified” refers to the fact that the plan does not attempt to meet the stringent coverage and contribution. Requirements were necessary to obtain government approval for retirement plan treatment.
Advantages
The biggest advantage of non-qualified deferred compensation is that the employer is not restricted by the red tape and all the rules and regulations accompanying qualified plans. Some of those restrictions include the following:
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IRS Scrutiny & Approval
Every qualified plan must receive specific approval from the IRS, in the form of a determination letter, to be considered “legal.” Non-qualified plans are not subjected to these procedures.
Nondiscrimination
The employer may provide non-qualified deferred compensation as a fringe benefit based on merit rather than age and seniority. Qualified plans should not “discriminate” in favor of only highly compensated personnel.
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ERISA
The Employee Retirement Income Security Act exempts an unfunded arrangement maintained primarily to provide deferred compensation for a select group of management or highly compensated employees (ERISA §201(2)).
Funding
ERISA prescribes specific funding requirements, under which the employer must write a check on behalf of the plan every year. Non-qualified plans may be “funded” from working capital, from funds set aside by the employer, or from a combination of both, depending on the needs of the plan and the employer.
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No Immediate Cash Outlay
The deferral allows the employer to offer a benefit that does not require an immediate cash outlay to the employee. It also allows the company to replace benefits lost by the new employee due to relocating from one company to another. Annual Report
The Internal Revenue Service must receive an annual report for every qualified plan. Also, many plans must provide summary plan descriptions, annual summaries, and other materials to participants. A non-qualified deferred compensation plan can avoid these costs.
Notice Requirement
However, Department of Labor regulations requires that an employer providing a non-qualified deferred compensation plan send a brief notice (such as a short letter) to the Department (ERISA §110, §104(a)(3) and DOL Regs. §2520.104-23). The notice must state that a plan has been established, and it must describe the overall nature of the plan.
Purposes & Benefits
Non-qualified plans have been used for many purposes including the following:
(1) Recruitment,
(2) Retirement benefits for ineligible older employees,
(3) Replacement of lost benefits,
Making equal the retirement benefits among all employees,
(5) Rewards and incentives, and
(6) Reduction of employer’s costs.
Non-qualified deferred compensation
Benefit Formula
A non-qualified retirement benefit can be based on any number of factors, such
as:
(1) Company stock performance,
(2) Return on an investment portfolio,
(3) Employee’s final five-years average pay,
(4) Cost-of-living index, or
(5) Any other logical method.
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Incentive
Deferred compensation plans that are tied to company profits are usually referred to as “incentive” plans. Under these plans, employees may earn deferred bonuses only in years of company profits. Alternatively, the portfolio of “investments” of the plan may consist of the employer’s stock. Under such plans, company earnings are used to calculate the growth of the phantom portfolio.
Deferred Bonuses
Bonuses, based on productivity or profits, are helpful to a company as an incentive for top executives. An added “sweetener” to these bonuses is the opportunity to allow the executive to defer some or the entire bonus to a future date. The deferral maybe for a few years or may last until the executive retires. 8-4
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Disclaimer: John Wolf and paystubmakr.com are making a total effort to offer accurate, competent, ethical HR management, employer, and workplace advice. We do not use the words of an attorney, and the content on the site is not given as legal advice. The website has readers from all US states, which all have different laws on these topics. The reader should look for legal advice before taking any action. The information presented on this website is offered as a general guide only.