Qualified Retirement Plan
9-1
•
Up front deduction for employer
•
Automatic tax-deferred built-up
•
Segregated, protected trust funding
•
Tax deferral for employee until benefits paid
•
Mandated broad employee participation requirements
•
Stringent vesting requirements to prohibit forfeitures
•
Mandated contribution and benefit limitations
•
Highly-regulated by Department of Labor (ERISA)
and IRS
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
Non-Qualified Deferred Compensation
9-2
•
No up front deduction for employer
•
No automatic tax-deferred built-up
•
No segregated, protected trust funding
•
Yes tax deferral until benefits paid (If done right)
•
No mandated broad employee participation requirements
(Exact opposite – limited only to highly-compensated)
•
No stringent vesting requirements to prohibit forfeitures
•
No mandated contribution and benefit limitations
•
Not highly regulated by Department of Labor and IRS.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-3
Non-Qualified Deferred Comp Plan Lingo
.•
“Elective Deferral Plan” or “Salary or Bonus Deferral
Plan”: Executive makes election to defer income to later period.
Pre-tax savings program.
•
“Supplemental Executive Retirement Plan” (SERP):
Company funds a special retirement benefit for key employee(s).
•
“Excess Benefit Plan”: Provide benefits in excess of 415
qualified plan limitations to key employees.
•
“Short-Term Plan”: Executive elected deferral to accumulate for
specific purpose – college, home balloon mortgage, etc.
•
“Death Benefit Only”: Benefit paid only on death of employee.
Equivalent of life insurance. Can be structured to avoid estate tax
inclusion. Escapes 2039 inclusion.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
The Old Tax Traps
.•
9-4
Constructive Receipt Trap of 451. Key is to make deferral
election before compensation earned and avoid pay-out elections after
point of accrual.
•
Economic Benefit Trap. Employee taxed on economic benefit
received. Key is to confer no economic benefit – keep promise
unfunded, no power to assign rights. Keep as unfunded promise with
rights no greater than general creditor of corporation.
•
Section 83 Trap. Property transferred as compensation taxable
now if not subject to substantial risk of forfeiture. Good news:
unfunded, unsecured promise to pay deferred compensation not
“property” under 83.
•
“Reasonable Compensation” Trap. Risk factor when employee
is also shareholder. Company deduction at stake.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
The New Tax Trap – 409A
9-5
• . Fixed Distribution Events. Disability, separation from service,
death, specific schedule, change of control, or unforeseen emergency.
•
No Distribution Accelerations. Very limited exceptions – domestic
relations orders, forced divestiture, to pay FICA taxes on deferred
amounts.
•
Deferral Election Before Year Earned. Exceptions for first year
(election within 30 days of eligibility) and performance-based bonuses
(election at least 6 months before year end)
•
Tough to Extend Deferral. At least 12 months in advance before
effective date and first payment begins and for at least 5 yrs more.
•
No Assets Outside U.S. Foreign assets used to pay benefits deemed
property under section 83.
•
No Employer Financial Health Triggers. Any related assets
deemed property under section 83.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
The Pain of 409A
.
•
Immediate Taxation of All Deferred
•
Interest Calculated at One Percent Above Normal
Underpayment Rate
•
Extra 20% Penalty on Deferred Amount
A Trap With Real Teeth!
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-6
9-7
Key Structural Issues
.
•
Mandatory or elective?
•
Who funds? Part of regular pay or something extra.
•
Any golden handcuffs – forfeiture provisions?
•
How does deferral grow – at what rate or based on
what index?
•
Payout options – retirement, death, disability, defined
date in future.
•
Hardship withdrawal rights.
•
General creditor risk – what can be done to hedge this?
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
Deferred Comp – Collateral Issues
9-8
• . Financial statement impact – a real liability for the company
• Qualified plan benefits – may reduce if elective deferral out of executive’s pay.
•
Accrual on benefit not interest to company – just additional deferred
compensation. Albertson Case.
•
ERISA compliance can be handled with letter – employer info, plan for tophat group, number in plan.
•
Staying Top Hat – smaller the better, promote exclusivity, for only the very
privileged.
•
Shareholders (even big ones) can be included, but keep reasonable.
•
Tax implications at executive’s death – unpaid benefits included in estate;
may qualify for marital deduction; subject to income tax as IRD under 691.
•
Social security - If no substantial risk of forfeiture, taxable in year earned, not
paid. This good because executive probably already over cap in year earned.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-9
Key Deferred Comp Strategies
.
•
Indispensable Executive - SERP with golden
handcuffs
•
Owner Deferred Comp – Reflect real value against
company’s limited capacity to pay
•
Booster to Do-It-Yourself Retirement - Something
special for the privileged few
•
The financially irresponsible executive
•
The alternative to real equity
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-11
Naked Deferred Comp Option
Company
Pay Benefits
Per Agreement
Executive
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
• Nothing funded
• Executive General
Creditor
• Executive taxed on
receipt of benefits
• Company gets
deduction when
executive taxed
Mitigating the Non-Payment Risk
9-12
• . Third Party Guarantee – parent company, majority
shareholder. Guarantor can not be in the business.
•
Surety Bond – only if obtained and funded by executive. If
company does it, will be considered funded plan.
•
Rabbi trust
•
Secular trust with Crummey type executive withdrawal
powers.
•
Company owned life insurance program.
•
Split dollar insurance funded program
•
Bonus insurance program
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-13
Rabbi Trust Option
Company
Agreement to
pay benefits
Company funds
Executive
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
Insolvency Reversion
Rabbi
Trust
Benefits paid on
behalf of company
9-14
Rabbi Trust – Why?
•
Company’s will to pay fades – Rabbi helps
•
Company doesn’t plan for payment burden –
Rabbi helps
•
Company’s management doesn’t appreciate
costs of plan – Rabbi helps
•
Company goes under – Rabbi doesn’t help
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-15
Requirements of Rabbi Trust
•
Sole purpose to provide plan benefits, except revert on
company bankruptcy or insolvency.
•
Duty to notify trustee of bankruptcy or insolvency.
•
Trustee must stop all payments when notified.
•
State law can not grant executive any priority rights in
trust over other creditors.
•
Trust can’t be funded with securities of employer.
•
No insolvency trigger or other provision that could
frustrate rights of general creditors of company.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-16
Life Insurance Tax Benefits
•
Tax deferred inside build-up in policy – no income tax
on growth of amount in policy.
•
Tax-free borrowing privileges against cash surrender
value. Company can use to cover after-tax cost of
payments during retirement.
•
Tax-free death benefit – company can use to fund
after-tax cost of remaining benefit at employees death
or to recoup amounts already paid out under plan.
•
Mitigate financial statement impact – policy shows as
growing asset.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-17
Life Insurance Structuring Options
•
Straight Corporate Ownership
•
Rabbi Trust Ownership
•
Split Dollar – Executive has death benefit that can
be estate tax- protected through ILIT
•
Executive Bonus Insurance with Gross-Up
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-18
Company Owned Insurance Option
Policy Death Benefit
Company
Pay benefits
per agreement
Executive
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
Policy loans
Premiums
Insurance
Policy
9-19
Rabbi Owned Insurance Option
Excess Policy Proceeds
Company
Agreement to
pay benefits
Insolvency reversion
Company funds
Rabbi
Trust
Death
Benefit
Pays benefits
Premiums
Executive
Policy
loans
Insurance
Policy
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
9-20
Split Dollar Insurance Option
Company
Policy Loans
Premiums
Pay benefits
during life to
executive
Imputed income
Gross-up?
Death benefit
over cash value
Executive
Imputed giftCrummey
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
Insurance
Policy
Executive
ILIT
9-21
Bonus Insurance – Poor Person Trust
Company
Contingent
repayment
obligation
Restrictive endorsement –
pre-retirement
Comp for premiums
Plus gross-up
Executive
Insurance
Policy
Premiums
Loan withdrawals
Death benefit
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com