Chapter 26
NONQUALIFIED DEFERRED COMPENSATION
LEARNING OBJECTIVES:
A. Have a basic understanding of nonqualified deferred compensation
B. Identify key methods of arranging and funding nonqualified deferred
compensation
C. Identify key tax-related issues with nonqualified deferred compensation
plans
REVIEW:
This chapter covers nonqualified deferred compensation, focusing somewhat on
retirement aspects. After pointing out why an employer might want to incorporate
such a plan – primarily recruiting, retaining, and rewarding employees –
advantages and disadvantages are discussed. A section on objectives in plan
design follows, which focuses on employer and employee objectives, types of
benefit and contribution formulas, withdrawals during employment, termination of
employment, funded versus unfunded plans and financing approaches. As you
would expect, the tax implications sections goes into some detail. The areas of
constructive receipt, economic benefit, income taxation of benefits and
contributions, FICA, federal estate tax treatment and taxation of the employer are
covered. ERISA requirements are discussed, and several references for learning
more are included. The chapter closes with a question and answer section
highlighting different types of nonqualified deferred compensation arrangements.
CHAPTER OUTLINE:
A.
B.
C.
D.
E.
What Is It?
When Is It Indicated?
Advantages
Disadvantages
Objectives In Plan Design
1
Chapter 26
F.
G.
H.
I.
J.
1. Employer Objectives
2. Employee Objectives
3. Types of Benefit and Contribution Formulas
4. Withdrawals During Employment
5. Termination of Employment
6. Funded versus Unfunded Plans
7. Financing Approaches
Tax Implications
1. Constructive Receipt
2. Economic Benefit
3. Income Taxation of Benefits and Contributions
4. Social Security (FICA) Taxes
5. Federal Estate Tax Treatment
6. Taxation of the Employer
ERISA Requirements
Where Can I Find Out More About It?
Questions And Answers
Chapter Endnotes
FEATURED TOPICS:
Nonqualified deferred compensation
Types of benefits and contribution formulas: salary continuation formula, salary
reduction formula, excess benefit plan, stock appreciations rights and phantom
stock formulas
Financing approaches: reserve account maintained by employer, employer
reserve account with employee investment direction, corporate-owned life
insurance, Rabbi trust, third-party guarantees
Nonqualified deferred compensation taxation issues
FIGURES:
Figure 26.1 Nonqualified deferred compensation Design Worksheet
Figure 26.2 Alternative Reporting and Disclosure Statement For Unfunded
Nonqualified Deferred Compensation Plans For Certain Selected Employees
Figure 26.3 Years Until Break Even For Deferred Compensation Assuming Tax
Rates Will Increase And Current Rate is 28% or 33%
Figure 26.4 IRS Model Rabbi Trust Sample Document
Chapter 26
CFP® CERTIFICATION EXAMINATION TOPIC:
Topic 61: Types of retirement plans
A. Characteristics
2) Non-qualified plans
Topic 33: Non-qualified deferred compensation
.
A. Basic provisions and differences from qualified plans
B. Types of plans and applications
C. Income tax implications
D. Funding methods
E. Strategies
COMPETENCY:
Upon completion of this chapter, the student should be able to:
1. Have a basic understanding of nonqualified deferred compensation
2. Identify key methods of arranging and funding nonqualified deferred
compensation
3. Identify key tax-related issues with nonqualified deferred compensation
plans
KEY WORDS:
nonqualified deferred compensation, key employee, salary continuation formula,
corporate-owned life insurance (COLI), salary reduction formula, excess benefit
plan, stock appreciation right (SAR), phantom stock formula, accelerated
distribution, haircut provisions, funded plan, unfunded plan, reserve account,
rabbi trust, third-party guarantees, constructive receipt, economic benefit, secular
trust
DISCUSSION:
1. Discuss when it would be appropriate to implement a nonqualified
deferred compensation plan, and what benefits would be achieved by
doing so.
2. Discuss similarities and differences between the different approaches
to nonqualified deferred compensation plan funding and benefits.
Chapter 26
QUESTIONS:
1. Which of the following benefits are usually created with nonqualified deferred
compensation plans?
(1) “up front” income tax deduction for employer
(2) tax deferral for employee
(3) “back end” tax deduction for employer
(4) tax deduction for employee
a.
b.
c.
d.
(1) and (2) only
(1) and (3) only
(2) and (3) only
(3) and (4) only
Chapter 26, p. 220
2. Which of the following plan types relates best to this plan description: “At
retirement, disability, or death, the XYZ Corporation will pay you or your
designated beneficiary $50,000 a year for 10 years starting at age 65”?
a.
b.
c.
d.
salary continuation formula
salary reduction formula
excess benefit plan
phantom stock formula
Chapter 26, p. 222
3. Which of the following is a major concern for allowing withdrawals of deferred
compensation amounts during employment?
a.
b.
c.
d.
de minimis cashouts
constructive receipt doctrine
salary reduction
excess benefits
Chapter 26, p. 224
4. Which of the following are situations or reasons for using a rabbi trust?
(1) owner-employee wants to establish a qualified retirement plan
(2) fear that business ownership might change prior to benefits being paid
(3) new management might be hostile to the key employee and fail to honor
its obligation to pay
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(4) litigation to enforce payment is too costly
a.
b.
c.
d.
(1) and (3) only
(2) and (4) only
(1) (2) and (3) only
(2) (3) and (4) only
Chapter 26, pp. 234-35
ANSWERS:
1. c
2. a
3. b
4. d