Defined Contribution Plan Consulting

Non-qualified Plan Consulting

Non-qualified deferred compensation (NQDC) plans are often used for executives to accumulate additional retirement benefits due to limits under traditional tax-qualified retirement plans.

Cowden Advisers, Inc. consult with clients of all sizes with non-qualified deferred compensation designs, including make whole plans that replace benefits not received due to tax-qualified plan limits, elective plans and supplemental executive retirement plans. Our approach focuses on the optimal solutions to create flexible non-qualified deferred compensation programs while still complying with constructive receipt rules and expanded coverage for employees.

Our practice is also sensitive to the special needs of tax-exempt entities. It is very difficult to compensate executives at tax-exempt organizations due to the Section 457 limits under federal tax rules. We work with clients to develop and evaluate benefit programs in light of these limits and the special reporting requirements for tax-exempt organizations.

A non-qualified deferred compensation plan is any elective or non-elective plan, agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee compensation sometime in the future. NQDC plans do not afford employers and employees with the tax benefits associated with qualified plans because, unlike qualified plans, NQDC plans do not satisfy all of the requirements of § 401(a).

Despite their many names, NQDC plans typically fall into four categories. Salary Reduction Arrangements simply defer the receipt of otherwise currently includible compensation by allowing the participant to defer receipt of a portion of his or her salary. Bonus Deferral Plans resemble salary reduction arrangements, except they enable participants to defer receipt of bonuses. Top-Hat Plans (aka Supplemental Executive Retirement Plans or SERPs) are NQDC plans maintained primarily for a select group of management or highly compensated employees. Finally, Excess Benefit Plans are NQDC plans that provide benefits solely to employees whose benefits under the employer's qualified plan are limited by § 415. Despite their name, phantom stock plans are NQDC arrangements, not stock arrangements.

NQDC plans are either 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. The employer may simply keep track of the benefit in a bookkeeping account, or it may voluntarily choose to invest in annuities, securities, or insurance arrangements to help fulfill its promise to pay the employee. Similarly, the employer may transfer amounts to a trust that remains a part of the employer's general assets, subject to the claims of the employer's creditors if the employer becomes insolvent, in order to help it keep its promise to the employee. To obtain the benefit of income tax deferral, it is important that the amounts are not set aside from the employer's creditors for the exclusive benefit of the employee. If amounts are set aside from the employer's creditors for the exclusive benefit of the employee, the employee may have currently includible compensation.

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. A qualified retirement plan is the classic funded plan. A plan will generally be considered funded if assets are segregated or set aside so that they are identified as a source to which participants can look for the payment of their benefits. For NQDC purposes, it is not relevant whether the assets have been identified as belonging to the employee. What is relevant is whether the employee has a beneficial interest in the assets. If the arrangement is funded, the benefit is likely taxable under §§ 83 and 402(b).

NQDC plans may be formal or informal, and they need not be in writing. While many plans are set forth in extensive detail, some are referenced by nothing more than a few provisions contained in an employment contract. In either event, the form of a NQDC arrangement is just as important as the way the plan is operated. That is, while the parties may have a valid NQDC arrangement on paper, they may not operate the plan according to the plan's provisions. In such a circumstance, the efficacy of the arrangement is not dependant upon its form.

Arrangements of this type results in various payroll tax impacts and we can assist clients in understanding the tax obligations and develop a comprehensive plan to obtain the best solutions.