NQDC in connection with other plans; split-dollar and 401(k) wrap plans

• Author: Marla J. Aspinwall - Michael G. Goldstein
• Pages: 303-313

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CHAPTER XII

NQDC IN CONNECTION WITH OTHER PLANS;

SPLIT-DOLLAR AND 401(k) WRAP PLANS

I. NQDC AND SPLIT-DOLLAR

A.

Need for Both Retirement Benefits and Death Benefits. When designing benefits,

an initial consideration is frequently whether the death benefit portion of a plan should be

provided through a NQDC plan or a split-dollar plan. Typically, a NQDC plan is primarily

designed to provide retirement benefits, and a split-dollar plan is primarily designed to provide

death benefits. Since most employees will expect to both retire and die, most employees will be

interested in both retirement benefits and death benefits. Thus, the relevant question is whether

there is an advantage to combining a split-dollar arrangement with a NQDC plan in order to

provide benefits in the most advantageous way.

B.

NQDC Alone — Problems with Death Benefit. A NQDC plan is a very effective

way to provide retirement benefits to an employee. From the employee’s point of view, under a

NQDC plan, pre-tax money will grow tax free1 until the employee retires after attaining normal

retirement age. The funds will not be subject to income tax until the amounts are paid to the

employee as retirement benefits.

However, if the employee dies before retiring, or dies after retiring but before receiving

all the retirement payments, the tax consequences of the death benefit will not be favorable. The

employee’s beneficiary will be required to pay income tax on the payments received.2 Also, the

death benefits under the NQDC plan will be included in the employee’s gross estate.3 This may

increase the estate tax to be paid and may reduce the total amount of money that will be left for

the employee’s family.

Thus, the NQDC plan provides a tax-advantaged retirement benefit, but does not provide

a tax-advantaged death benefit.

C.

Split-Dollar Alone.

1.

Split-Dollar in General. Although a detailed discussion of split-dollar life

insurance is beyond the scope of this book, a brief discussion is included here for the purpose of

1 As discussed in detail in Chapter III, “Income Taxation of NQDC for the Employee,” a NQDC plan can be

structured so that the employee will not be taxed on the accrued benefits until the benefits are actually

received by the employee. Also, earnings can be credited to the employee’s deferred compensation

account. Thus, the deferred compensation can grow tax free.

2 The death benefit would be considered income in respect of a decedent (“IRD”) so that the beneficiary

would be entitled to an income tax deduction for a portion of the estate tax paid. IRC § 691(c)(1)(A). For a

more detailed discussion, see Chapter V, “Tax Consequences of Death Benefits Paid Under NQDC Plans.”

3 IRC § 2039(a).