'Informal funding' of NQDC plans

AuthorMarla J. Aspinwall - Michael G. Goldstein
Pages239-246
199
CHAPTER VIII
“INFORMAL FUNDING” OF NQDC PLANS
R. Lee Nunn
Senior Vice President, Aon Hewitt
I. INTRODUCTION
Many companies choose to set aside funds to finance their nonqualified benefit
obligations. Their motivations vary but commonly include a desire to communicate a sense of
benefit security to participants, to hedge accounting results,1 or to provide a source of future cash
to pay benefits. Companies that choose not to set aside funds commonly emphasize the
opportunity cost of any funds that would have been set aside.
II.
NO “FORMAL FUNDING” OF A NQDC PLAN
Companies are not required to set aside funds for a NQDC plan even when amounts have
been voluntarily deferred from an employee’s salary. In fact, tax and ERISA rules discourage
any formal funding.
A.
Tax Rules. Tax rules discourage formal funding by taxing income in the year in
which cash or property is actually or constructively received.2 An unfunded and unsecured
promise to pay money or property in the future is not property.3 Conversely, a funded or secured
promise to pay would create taxable income. For nonqualified deferred compensation
arrangements subject to IRC § 409A, even the existence of a financial trigger that will restrict
assets to the payment of benefits creates taxable income.4 To avoid current taxation to
participants, any funds set aside must be available to general creditors.
B.
ERISA. ERISA discourages formal funding by exempting “top hat” plans from
the participation, vesting, funding and fiduciary responsibilities of Title 1.5 A key requirement
of a “top hat” plan is that it be unfunded.6 The Department of Labor has indicated that IRS
1 US GAAP limits the use of the term “hedge” to certain derivatives. See Codification Paragraph 815-20-25-
45. In the context of this chapter a hedge is an asset intended to neutralize the effect of nonqualified
deferred compensation on earnings.
2 Treas. Reg. § 1.451-1(a); See Chapter III, “Income Tax Consequences of NQDC for the Employee.”
3 Treas. Reg. § 1.83-3(e).
4 IRC § 409A(b)(2).
5 See “excess benefit” and “top hat” plan exemptions under §§ 4(b)(5), 201(2), 301(a)(3) and 401(a)(1) of
Title I of the Employee Retirement Income Security Act of 1974 (ERISA) discussed in greater detail in
Chapter VI, “ERISA and NQDC.”
6 ERISA § 201(2).

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