Keep executives happy: nonqualified plans may be an effective way to overcome retirement plan restrictions and reduced contribution amounts.

Author:Boma, John C.

When 401 (k) plans were introduced in 1984, most executives took full advantage of the opportunity to defer current income (then taxed at marginal rates of over 50%) into the future, usually until retirement, when tax rates were expected to be much lower. These plans were important investment opportunities because executives could invest a significant amount of income on a pretax basis. However, since their introduction, Congress--almost on an annual basis--has passed laws to reduce the amount of 401 (k) and other qualified plan benefits (profit sharing, money purchase pension, defined benefit) that companies can provide to highly compensated and midlevel executives. As a result of those legislative changes, qualified plans, while still attractive, are only a starting point in successful executive retirement benefit planning.

Nonqualified deferred compensation plans often are the benefit of choice to supplement qualified plan benefits. Regulations issued by the Department of Labor, the Internal Revenue Service and the Securities and Exchange Commission as well as several high-profile court cases have had a significant impact on the design, taxation and structure of nonqualified plans. As a result of these developments, many employers have unwittingly put their nonqualified plans in danger of incurring undesired tax and legal consequences. To help ensure compliance with the applicable rules, CPAs--both inside and outside a company--must assume an increasing responsibility for the design, development and oversight of nonqualified retirement plans.


Companies use nonqualified plans for a variety of reasons. The principal one is to allow a select group of executives to defer income beyond the limits imposed by Congress on qualified plans. Some examples of these limitations are summarized in exhibit 1, page 48. Other reasons companies offer nonqualified plans include avoiding discrimination testing, providing new or additional incentive compensation and targeting benefit dollars to a select group of executives. It is important to note, however, that nonqualified plans are not the same as qualified retirement plans and typically a company should use them only after maximum contributions have been made to qualified plans. For a comparison of the key differences between nonqualified and qualified plans, see exhibit 2, page 49. (As exhibit 2 shows, different and more restrictive rules apply to plans sponsored by tax-exempt organizations.)



To maximize the effectiveness of a nonqualified plan, employers and their advisers must consider a number of factors, including issues of participation, taxation, funding, security and distributions.

Participation. Under the Employee Retirement Income Security Act of 1974, a typical nonqualified plan may be offered only to a "select group of management or...

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