To attract and retain top executive talent, many employers supplement their benefit packages with non-qualified executive benefit plans.
A non-qualified plan may not be bound by many of the restrictions imposed on qualified plans, such as the requirements to include all eligible employees. Non-qualified plans are not subject to most of the requirements of the Employee Retirement Income Security Act of 1974 (“ERISA”). To avoid falling within the requirements of ERISA, some non-qualified plans must meet the definition of a “top-hat” plan, which provides deferred compensation for a select group of management or highly compensated employees. Although the types of plans described in this article generally meet this test, be sure to consult your tax specialist, a tax attorney or employee benefit specialist before selecting the plan that works best for your company.
Some of the most common non-qualified executive benefit plans include:
- Executive Bonus Plans
- Split-dollar Plans
- Non-qualified Deferred Compensation - which consists of:
- 401(k) Mirror Plans
- Salary Reduction/Deferral Plans
- Supplemental Employee Retirement Plans (SERPs)
Executive Bonus Plans
Executive Bonus Plans are among the simplest plans to implement and administer. Here’s how an Executive Bonus Plan works: The Company pays the executive a bonus that will be considered as taxable income to the executive. If the bonus is considered to be reasonable compensation, then the Company may take an income tax deduction for the bonus paid to the executive. The bonus may be used to pay premiums on a permanent life insurance policy with cash value. The executive owns the life insurance policy, and therefore owns the policy’s cash value. He or she is free to use the cash value of the policy, unless the Company adds a restrictive endorsement to the Plan.
These Plans can help to ensure the executive’s loyalty to the Company, since many employees consider the provision that the employer pay the premiums to be a valuable benefit. If the employee leaves the Company, he or she can always pay the premiums out of pocket. Some employers, however, add a “golden handcuff” to this type of Plan in the form of a “restrictive endorsement,” which requires that the employee obtain employer permission to access the cash value.
One drawback of Executive Bonus Plans is their relatively high cost to the employer, which is equal to the cost of a cash bonus plus any additional bonus that may be paid to the employee to cover income taxes due. A Split-dollar Plan can create similar advantages, at a lower cost to the employer. With Split-dollar Plans, the Company and executive agree to split the benefits of the employee’s life insurance policy. Because the Company may recover its cash outlays later (when the executive dies or retires) from the policy’s cash value, the Company’s cost is generally limited to the “time value of money” on premiums advanced.
There are two basic types of Split-dollar Plans: Economic Benefit Regime and the Loan Regime. In the first type, the employee owns the policy, and assigns the cash value and a portion of the death benefit to the employer as collateral. In the second type, the Company owns the policy and, through an endorsement, gives the executive the right to designate a beneficiary for a portion of the death benefit.
Non-Qualified Deferred Compensation (NQDC)
There are three basic types of NQDC plans: 1) 401(k) Mirror Plans; 2) Salary Reduction/Deferral Plans; and 3) Supplemental Executive Retirement Plans (SERPs). Generally speaking, these types of Plans represent an unsecured promise by an employer to pay a benefit in the future.
401(k) Mirror Plans
In a “401(k) Mirror Plan,” the executive may voluntarily defer a portion of their salary in an amount greater than allowed under regular 401(k) rules, and the Company may contribute to the Plan as well.
Salary Reduction/Deferral Plans
With a Salary Reduction/Deferral Plan, the executive defers their own salary to fund the Plan. The salary amounts deferred are not currently taxable to the executive, but will become taxable at retirement to the executive – and, at the same time, deductible by the business.
Supplemental Executive Retirement Plans (SERPs)
A SERP is a type of NQDC Plan in which the Company makes an unsecured promise to pay a future benefit, based on agreement and executive performance. While the employee is working for the Company, he/she may not take a distribution from the SERP; it is only after retirement or some designated event under the Plan that the employee may start to take distributions.
In most cases, for all three variations of NQDC, any informal funding by the employer is tied to the Company’s general assets – which are not shielded from creditors. In some cases, these assets are placed in a “rabbi trust,” a type of trust that defers the taxability of the Plan’s benefits. A rabbi trust provides Plan participants with some security because assets can’t be touched by the Company or a future acquirer, although they can be tapped by creditors in the event of the Company’s insolvency or other creditor action.
In summary, executive benefit plans demonstrate the owner’s commitment to the future and evidence of the Company’s desire to have its most valuable people be part of it. Rewarding key people can also be a preliminary step in identifying a successor owner – which can potentially help the Company survive the unexpected loss of the current owner, while creating the liquidity needed for successors to ultimately buy out the owner’s interest, thus ensuring the continuity of the firm for years to come.
Prepared by The Guardian Life Insurance Company of America. This Material is Intended For General Public Use. By providing this material, we are not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact [agent name] for guidance and information specific to your individual situation. Guardian, its subsidiaries, agents or employees do not give tax or legal advice.
Registered Representative and Financial Advisor of Park Avenue Securities, LLS (PAS), 355 Lexington Ave., 9th Fl., New York, NY 10017, 212-541-8800. Securities products/services and advisory services are offered through PAS, a registered broker dealer and investment advisor. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is an indirect wholly owned subsidiary of Guardian. Wealth Advisory Group LLC is not an affiliate or subsidiary of PAS or Guardian. PAS is a member FINRA, SIPC.
2019-80376 (Exp. 06/20)