One of the often-overlooked ways employers can reward key executives is through the creation of a nonqualified deferred compensation plan. "While traditional retirement plans such as 401(k) and pension plans remain extremely attractive ways to benefit senior executives, a growing number of area businesses are adding nonqualified deferred compensation plans to provide supplemental benefits that help them attract and retain their best people," states Leo Thomas, manager of the Los Angeles office of Price, Raffel & Browne, one of the nation's largest firms specializing in pension plans and retirement planning.
For human resources managers, nonqualified deferred compensation plans often are the benefit of choice since they provide the potent combination of flexibility and the ability to tie key employees to the company. Since the introduction of 401(k) plans in the mid-80's, Congress has passed numerous laws to reduce the amount of qualified retirement plan benefits that companies can provide to highly compensated and midlevel executives. "As a result of legislative changes, qualified plans, while still attractive, are only a starting point in successful executive compensation and retirement benefit planning," Thomas notes.
Companies of all sizes are increasingly using nonqualified plans for a variety of reasons, the retirement plans executive notes. "With a nonqualified plan, it is possible to target benefit dollars to a select group of executives," Thomas states. "Additionally, the design of a proper nonqualified plan allows these designated executives to defer the receipt of certain amounts of pay and, as a result, exclude these amounts from current income."
To maximize the effectiveness of a nonqualified plan, employers must consider a number of factors, including issues of participation, taxation, funding of the plan, security and, ultimately, the form of distributions. Under the Employee Retirement Income Security Act of 1974 [ERISA], a typical nonqualified plan may be offered to a "select group of management or highly compensated employees" (often referred to as the top-hat or select group).
"Avoiding taxation at the time of deferral is essential when a company designs a nonqualified plan," the Price, Raffel and Browne executive explains.
The IRS's general position is that income may not be deferred once it has been earned. To satisfy the IRS, an employee's election to defer compensation must be made before the period in which the income will be earned. "So, for example, an agreement for a key executive to defer salary for the year 2000 must be established during the prior year," Thomas states.
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