CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Retirement Planning & Employee Benefits
Session 14
Fundamentals of Deferred
Compensation
©2014, College for Financial Planning, all rights reserved.
Session Details
Module
8
Chapter(s) 1, 2
LOs
8-1
8-3
Identify characteristics of a nonqualified
deferred compensation plan.
Identify characteristics of a given form of
informal funding for a private, unfunded
nonqualified deferred compensation plan.
14-2
Definition of Nonqualified Deferred Compensation
“A nonqualified deferred compensation plan means
any plan that provides for the deferral of
compensation.”
 American Jobs Creation Act of 2004 – IRC
Section 409A
14-3
Nonqualified Deferred Compensation Overview
409A—Increased restrictions on deferred
compensation
• Nonqualified plans are ideal for business owners
and key employees who want to provide
benefits for themselves in excess of qualified
plan limitations
• The historically low personal income tax
brackets make nonqualified deferred
compensation less attractive than previously
• The prospect of rising taxes in the future also
makes nonqualified deferred compensation less
attractive
14-4
Nonqualified vs. Qualified Plans
Characteristic
Qualified Plan
Nonqualified Plan
Internal Revenue Code Requirements
Discrimination
Plan may not discriminate
Plan may discriminate
ERISA Requirements
All plans must satisfy ERISA and
IRC requirements
Certain plans are partially exempt
from ERISA
Employer deduction
Available in year of plan
contribution
Available in year of employee
taxation
Employee deferral
Tax-deferred until plan
distribution; rollovers allowed
Tax-deferred only if unfunded or
funds are at risk; no rollovers
Fund earnings
Earnings accrue tax-deferred
until distribution
Earnings usually are currently
taxable to employer
Distributions
Taxed at ordinary rates;
averaging may be available on
lump sums
Taxed at ordinary rates; averaging
not available on lump sums
Tax Treatment
14-5
Types of Nonqualified Deferred Compensation
• Pure deferred compensation (employee funded)
• Supplemental plans (employer funded)
o Excess benefit plan
o Supplemental Executive Retirement Plan
(SERP)
o Death Benefit Only plan (DBO)—
provides a survivor benefit
14-6
Excess Benefit Plans
• An excess benefit plan is linked indirectly to the
•
•
qualified plan or plans in place and provides for
benefits in excess of the amount to which the
employee would otherwise be entitled under
the qualified plan
The payment is typically made when the
employee retires and is usually paid out the
same way that benefits are paid under a
qualified retirement plan
The plan may be funded,
informally funded, or
unfunded
14-7
Supplemental Executive Retirement Plans (SERPs)
•
•
•
A SERP (or top hat plan) is an unfunded plan providing
benefits for select employees (generally only high-level
executives) in excess of those provided by the employer’s
qualified retirement plan
o Benefits are usually based on elements of compensation
not otherwise provided under the qualified plan (such as
a benefit formula with a higher multiple of earnings or
ignoring altogether Social Security integration levels)
SERPs can be used for a broader range of purposes than
excess benefit plans
Unfunded SERPs are exempt from all
but the reporting and disclosure
requirements of ERISA
14-8
Nonqualified Deferred Compensation Tax Implications
To employer
• Deduction when taxed
to employee
• Earnings taxed to
employer
To employee
• Taxed when benefit
constructively received
• Subject to FICA taxes
when constructively
received
14-9
ERISA Requirements for Nonqualified Deferred Compensation Plans
Reporting
and
Disclosure
Participation,
Vesting, and
Funding
Fiduciary
Responsibility
Unfunded Plan
or Trust
Must comply
Exempt if top-hat
plan; must comply
if plan includes
rank and file
Exempt if top-hat
plan; must comply
if plan includes
rank and file
Exempt if tophat plan; must
comply if it
includes rank
and file
Funded Plan or
Trust
Must comply
Must comply
Must comply
Must comply
Government,
Church,
Unfunded
Excess Benefit
Plans
Exempt
Exempt
Exempt
Exempt
ERISA
Plan
Termination
Insurance
14-10
Nonqualified Deferred Comp Funding
Unfunded
• Promise to pay
• Agreement executed prior to service performance
• Available to company creditors
Funded
• Not available to employer’s creditors
• Currently taxable to employee unless substantial risk of forfeiture
Informally Funded
• Employer “informally” dedicates
assets to employee through accounting
device or segregating assets to a trust
• Rabbi Trust an example
14-11
Rabbi Trust
• A rabbi trust is an employer•
•
sponsored irrevocable grantor
trust
Trust has two beneficiaries:
o the employee and
o creditors of the company
Trust earnings are currently
taxable to the employer
14-12
Secular Trust
• Irrevocable fully funded trust established for an
•
•
employee
Employee is vested in contributions,
so current taxation to employee
results
Assets are not subject to
the claims of an
employer’s creditors
14-13
Requirements for Deferral of Taxation
IRS Regulations stipulate three principles that
must be followed for deferred compensation:
1. The agreement to defer compensation must be
made before the dollars are earned
2. The agreement must represent only an unsecured
promise
3. The agreement cannot be funded (i.e., any funds
used to provide the benefit must be held by the
employer as a general asset
available to creditors)
14-14
Substantial Risk of Forfeiture
• Employee’s right to payments must be
•
•
contingent upon future performance of
substantial services (death or disability are not
considered substantial services)
Plan must provide for loss of rights to payments
if substantial services are not performed OR if
employment terminates for reasons other than
death or disability
Generally only
relevant in
funded plans
14-15
Constructive Receipt
• The constructive receipt issue isn’t whether the
•
taxpayer has actually received the income, but
whether he or she has access to it
To avoid constructive receipt, agreements
usually contain specific provisions
establishing substantial risk of forfeiture
(funded plans), or
availability of funds
to company’s
general creditors
(unfunded plans)
14-16
Economic Benefit
• Economic benefit relates to the receipt of
•
•
non-cash property that can be valued in cash
When the employee’s benefit is treated as the
equivalent to the receipt of cash, current
income taxation will result
In unfunded and unsecured plan,
mere promise to pay
does not confer
economic benefit
14-17
Multiple Choice Question 1
Manning Manufacturing wants to implement a
nonqualified deferred compensation plan that
will enable the company to set aside the same
10% they are contributing into the profit
sharing plan for amounts executives earn above
the IRC qualified plan compensation limit.
You would recommend a(n)
a. SERP.
b. death benefit only plan.
c. rabbi trust.
d. excess benefit plan.
14-18
CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Retirement Planning & Employee Benefits
Session 14
End of Slides
©2014, College for Financial Planning, all rights reserved.