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33 Cards in this Set

  • Front
  • Back

Describe charasteristics of unfunded nonqualified plans. Explain each briefly.

- written agreement between ER and EE


- May discriminate among EEs. It can pick and choose who it wants in the plan.


- Nonq plans are exempt from many ERISA requirments. Need not follow ERISA formulas regarding vesting.


- ER cannot claim a deduction for its contribution until funds are actually distributed to EE. Less advantageous for employer.


- If the co has set aside assets to informally fund future benefit payments, it must recognize any earnings on those assets as income in the current year. Disadvantage to the company, most cases would like to avoid any taxation on investment earnings. Earnings within LIP and interest from tax-exempt bonds are not subject to income tax.


- EEs who recieve nonq deferred compensation do not enjoy the forward averaging advantages they enjoy under other plans. Instead, all distributions must be treated as ord income. Also, NQDC bens cannot be rolled into a tax deferred account, such as an IRA.

Describe an excess benefit plan and the general purpose for which it is used.

An excess benefit plan is a nonq plan that aims to increase the retirement plans of certain employees. It's maintained by an ER for sole purpose of providing benefits for certain employees in excess of the limitations on contributions and benefits imposed by IRC section 415. An excess ben plan can only be used to make a participant whole for the loss of benefits caused by the IRC section 415 limits---not the loss of beneftis caused by the qualified plan compensation limit. Can be offered to any employee.

What are the income tax implications for the ER who contribs 100k this year to a general fund that is intended to informally fund deferred compensation benefits for employees? The fund is available to general creditors of the ER. None of the EEs are currently taxed on their benefits. What happens to any investment earnings of the fund during the current year?

The company cannot deduct the 100k from current income. Contribs to nonq plans can only be deducted in the year in which EEs are in constructive receipt of the benefits (unlike qualified plans). The fact that funds are availibel to general creditors fo the company means that the employees are not in construtive reciept of the funds.



Chances are that the fund will receive investment earnings during the year. Unlike a qualified plan, in which investment earning are tax deferred, the aernign sof a nonq plan represent taxible income to the employer. (the tax may be avoided, however, if the funds are invested in a cash value life policye. Investment earnings in such a policy accumulate on a tax-deferred basis).

Henri's co has promised to pay him deferred compensation when he retires in 2015. it has not yet, however, put any funds aside for that promeed payment. Explain income tax consequenses for EE.

Henri is able to defer taxation on the promised benefits until they are actually received.

Joanne retired this year and received a 25k distribution of deferred comp. Explain income tax consequenses for EE.

Joane must rec the 25k as ord taxable income. No opportunity to use forward averaging, nor may she defer taxation by rollin gvoer the funds into an IRA or some other qualified plan.

Ralph's co made him a participant in its SERP this year. Under th eterms of the plan, he will lose all deferred comp benefits if he leaves the co prior to 65. The co deposidted funds into a gen acct to meet its future SERP obligations. The account is not protected from general creditors of the company. Explain income tax consequences for EE.

2 aspects fo this situaiton guarantee that Ralph will not have to rec the money set aside by his co as taxible income. The first is his agreement that he will lose all his interst in his deferred comp if he leaves the co prior to retirement; in effect, he is at "substantial risk of forfieture". The seocnd is the fact hatt the gen acct is not protected from the claims of the co's general creditors.

Describe the supplemental employee retirement plan (SERP) and explain how it differs from the excess benefit plan.

-Excess ben plans technically can cover any employeee; SERPs can only be provided for mgnt or highly compensated EEs.


-SERPs and excess ben plans can be funded or unfunded, although SERPs are usually unfunded


-SERPs generally base benefits on element so fcompensation not otherwise provided under the qual plan (such as using a ben formula w/ a higher multiple of employe earnings); in fact, a SERP can provide bens that greatly exceed those provided by the co's retiremnt plan calcs. Thus, the ER can use SERP benefits to recruit mid-career executives who otherwise would be entitled to only modest retirement plan benefits due to relatively few years of service. In contrast, an excess ben plan can be used only to make a participant whole for the loss of bens caused by the IRC Section 415 limits---not for the loss of benefits caused byt he qualified plan compensation limit.


-SERPs can be structured to reward continued employment or to make early retirment more attractive


-SERPs are generally unfunded and, therefore, are generally exempt from most ERISA requirements.


Describe a top hat plan

Unfunded nonqualifeid deferred compensation plan maintained by an er for the purpose of providing deferred comp bens for a select group of mgmt or highly compensated ees only. By definition, a top hat plan must be unfunded. Even though a top hat plan is always unfunded, it is nevertheless subject to the reporting, disclosure, and enforcement requriments of ERISA, although it is not sbjt to other ERISA provisions. The reporting and disclosure requirements can usually be satisfied by a single filing of a brief statement with the department of labor (DOL) or by providing plan documents to the DOL if requested.

About notq deferred comp:


According to the DOL, when is a deferred comp plan considered to be formally funded?

nonq deferred comp plan is considered to be funded (and sbjt to the requirements of ERISA) if an amount is irrevocably placed by the er with a third party for hte benefit of a participant, and neither the er nor any o fits creditors has any current or contingent interest in that amount.

What is the advantage to an employee of a plan being funded? About nonq deferred comp.

Some execs like a funded plan because it assures future payments. The ers promise to pay benefits is, in effect, secured by the funds.

About nonq deferred comp:


What are the tax consequences of the plan being funded?

When a plan is funded, the ee loses the benefit of tax deferral and is considered to be in constructive receipt of the fund---and so must recognize the funds as current income. However, steps can be taken to defer taxes on funded nonqualified plan benefits.

Describe the following requiremnets imposed by IRC section 409A on unfunded nonq plans:



a. deferral election rules


As a general rule, an unfunded NQDC plan must provide that a comp for services to be performed in the next (or a subsequent) taxable year may be deferred at the participant's election only if the election to defer is made no later than the close of the preceding tax year (ie no later than 12/31 of the preceeding year). A new plan participant (whether a new plan or newly eligible) has 30 days to make a deferral election under th eplan.



Where comp is performance based (that is, under an incentive plan), the deferral election must be made no later than six months prior to the end of the 12-month performance period. Also, the incentive plan must be communicated within 90 days of the beginning of the performance period and the plan must have a 12 month performance period and use quantitative measures to assess performance.

Describe the following requiremnets imposed by IRC section 409A on unfunded nonq plans:



Time and form of pmts

As a general rule, the time at which distributions are to be made and the form of payments must be specified is when the initial deferral election is made. Also, a plan may specify the time and form fo payments that are to be made as the result of a distribution event. For example, a participant may elect to receive 25% of his or her acount balance at age 50 and the remaining 75% at age 60. Also, a plan may allow particiapnts to elect different forms of payment for different permissibel distribution events. For exemple, a participant may elect to receive a lump-sum distribution if he or she becomes diabled and an annuity at age 65. If a plan permits a subsequent election to delay a payment or to change the form of a deferred compensation payment, the plan must meet the following conditions:



-The election may not be effective until at least 12 months have elapsed from the date the election was made.


-payments subject to the election must be deferred for at least an addtnl five years from the og date the pmt was scheduled


-The elction may not be made within 12 months of the origionally scheduled pmt

Describe the following requiremnets imposed by IRC section 409A on unfunded nonq plans:



Circumstances under which distributions may be made (permissible distribution events)

Dists from an unfunded NQDC plan may only be made for followign reasons:



-separation from service


-death


-disability


-at the age, date, or fixed schedule specified prior to the first deferral


-at the change of control or effective ownership of the co


-in the event of an unforeseeable emergency


-at plan termination

Describe the following requiremnets imposed by IRC section 409A on unfunded nonq plans:



Prohibition on acceleration of distributions

A dist must be made on acct of a permissible event described in the question preceding; otherwise, an acceleration of distributions is not allowed. As a general rule, changes in the form of a distribution that accelerates payments after they have already commenced violates the rule prohibiting accelration of distributions. Key ees of public corps may not receive benefits until six months have elapsed since separation from service.

What is a death benefit only plan, and what is uniquely different about it when compared to other nonqualified forms of deferd comp?

Unlike other NQDC plans, death ben only (DBO) plans provide no lifetime payment to the Ee. The only benefit is the payment o fa death benefit toa designated beneficiary, and the only if th eemployee dies while in active service to the company.

Expalin what is meant by a "forfeiture provision" in a nonqualified plan

A forfeiture provision is a requirement found in a nonqualified deferred compensation plan which states, in effect, that an ee's right to deferred compensation payments is contingent upon satisfaction of some stipulated condition, such as future service.

XYZ corp has handful of highly paid execs. Under the forumula of the co' squalifed retiremtn plan each should receive retiremtn bens equal to 60% of their final annual salary. Unfortunately, the ERISA cap onteh abolute amount that can be paid to an individual will reduce the retirment benefits of these executives to an amoun tthat ranges from 25% to 40% of their final salires. What can the co do to improve the retiremtn income of these execs?

The situation can be partially remedied by an excess benefit plan, the intention of which is to overcome the limitations imposed by the ERISA cap on individual benefits.



However, an excess ben plan can be used only to make a particpiant whole for the loss of benefits caused by the IRC section 415 limits---not the loss of bens caused by the qualified plan comp limit. Therefore, a top hat plan, not an excess benefit plan, isusually the best choice for employees who earn considerably more than the qualifed plan comp limit.

A merger w/ another corp has forced a large co to thin its managerial ranks in several departments. Early retiremnt, offered on a targeted basis, is one of the devices the company plans to use to reduce its head count. How could nonqualified deferred comp be used for this purpose?

Because nonq plans are exempt from most of the requrements of ERISA, they are highly flexible and may be designed to meet any number of business and employee objectives. They can include some EEs and not others. Theyc an include higher leveles of comp or other conditions to which the employer and employee agree.



To encourage early retiremtn by mgmt or highly compensated ees, for example, the co can emply a SERP. It could be structured to privide regualr income- or a lump sum - to fill the income gap between the date of early retiremnt and the date at which the EE woudl be entitled to receive ss benefits and retiremtn income from the co's qualified retirment plan.

Describe the doctrine of constructive receipt and explain how it can be avoided in a nonq plan

Requirese funds to be taxed to an ee if they are made available or payable to the ee. this doctrine applies evn though the funds are not actually received by or paid to the employee. Construtive receipt can be avoided by including a forfeiture provision in the plan document. The plan documents should also state that the assets are subject to the employer's general creditors.

Describe the caracteristics of an "unfunded" deferred comp plan. Explain pros and cons.

An unfunded deferred comp plan is an agreement in which er promises to pay future benefits to one or more ees from the ers general assets. That promise is not secured or guaranteed in any way.



pros for ee: tax deferral of the beneftis, which aren't recd as current income until they are actually received.



cons for ee: employer may fail to make good (bankrupcy)

Describe the concept of the "informally funded" plan and explain how it differs from funded and unfunded plans.

An informally funded nonq deferred comp plan is a type of unfunded plan. It consists of er-owned assets (ie a reserve of cash, li, securities, etc.) that ay be used to pay plan benefit sin the future. In this sense, it is like a funded plan. However, the assets are subject ot the claims of the ERs creditors, which is typical of unfunded plans.


What are pros and cons of th einformally funded plan for the ee?

pros: not requried to rec the ers contrib to the reserve for tax purposes because the ee has no ability to claim the funds. As a result, the deferred compensation is only taxible when it is recieved.



cons: future bens are only secured by the company's promise

What are some important uses of LI in deferred comp plans?

1 to fund future obligations for pmt


2 make addnl LI coverage availibel to a co's execs

Describe the use of co-owned LI in funding future deferred comp obligations, and explain the unique tax advantage of this form of funding.

Co's can finance their deferred compensation obligations by purchasing cash value insurance policies on the lives of participating ees. The company is both owner and eneneficiary of these policies and makes all premium pnts. Every pmt increases the cash value of the policy; the co can then borrow from the policy's cash value to make prem pmts or to pay deferred comp bens.



in the even to fan ees death, the ben goes to the co.



If the policy is properly structure, cash value life insuranc ehas two benefical tax features for hte co: the earning so f acash value policy grow tax deferred and interest on loans taken by th eco from the policy i stax deductible w/in certain limits

Describe the genral characterists of split-dollar LI

Arrangement between ee and a co whereby the premium pmts and the proceeds of the policy are shared. For instance, if the ee dies while the policy is in force, the death benefit goes to the ees beneficiary, but only after the co has recouped the amt it has spent on premiums. Because of recent legislation and the issuance of restrictive IRS guidleins, most split dollar arrangemnts created under pior law are no longer useful for tax and financial planning purposes

From the ees perspective, ID the broader issues involved in securing an ers promise to pay deferred comp

Biggest issue is fialure to make good on primis. If they want to guarnatee the pmose, the ee must rec any contribs as current income.

Describe the 'rabbi trust' and expalin its pros and cons in securing the ees interest in deferd comp

form of irrevocable grantor trust established by the er. it cna be used to protect the ees interst in future pmts or deffered comp. Contribs are made to the te trust by the ER. Contribs and subsequent earnings (if any) may be used only to pay out deferred compensation. Earnings are taxable to the ggrantor (er). however, should the er become bankrupt or insolvent, assets int eh trust may be used to satasfy the ers obligations to creditors.



- rabbi trust effectivly locks up the assets and reserves them fo rthe benefit of the ee---even as it preserves the tax-deferral benefits that most employees want. A merger or sale of the business will not threaten the ee's deferred compensation. However, bankrupcy or insolvency will unlock the trust, putting ht eees interesbehind those of the company's creditors.

Describe secular trust and compare it to rabbi trust

Secular is fully funded, and places assets off limits to everyone but hte ee for whos benefit is established. Unilike rabbi trust, secular trust reserves assets exclusively for the bneenfit of the named ees. the co could go down in flames or be sold and trhe ee would still be paid their deferred comp. The downdie i sthe athe contribs are currently taxible to ee. If ee is indifferent to the benefit of tax deferral, the greater security provided by the secular trust may be the best way o fsecuring hte er's promis to pay.

what is the purpose of a 3rd party guarantee?

3pg's (bank letters of credit, surety bonds, and indemnity insurane) are supposed to pay an ees promiesed deferred comp benes in the event a co fails to make good on its promise to do so

What is the general rule when deferred comp is placed into an escor wacct for the nenefit of the ee, and how can tax deferral fo rthe ee be acheieved?

The general rule covering adeferred comp placed in escrow is that it will immediately be taxible to the ee if the ees right sto the amount set aside are nonforfeitable. A valid structuring of hte escrow agreement, therefor, places the executives deferred comp in a trusted escrow or fund acct in which the ee is not immediately vested. In this case the excutive reghts to the specified amts ar limited to those of an unsecure dgeneral creditr of the er, not those of a bonafide beneficary.

How can executive avoide consgtrucive reciept under fully funded plan when the interest is nontransferable?

If a funded plan provides substancial risk of forfeiture profision and ithe interst is nontransferable, an exec under such a plan can avoid construtive receipt of th edeferred funds. A substantial risk of frofeiture exists when the ees retention of his or her interest in the trust is predicated on performance, or frefaring from performance, of substaintial servicees for the ER. A requirement that the employee provide consulting services during retirement would establish substantial risk of forfeiture; loss of benefits at death or disability does not constitute a substantial risk of forfeiture. These plans are governed by Section 83 of the IRC and are frequently funded with ER stock

When would an employee-grantor secular trust be appropreate?

If the employee wants more security, especially against an employers insolvency, and does not midn current taxation conseuences, the employee should consider an ee-grantor secular trust. The secular trust is a funded plan that uses an irrevocable trust like the rabbi trust. However, assets in the trust are not availible to the company's general creditors. The EE is thus in constructive receipt of hte deferred funds if there is no substantial risk of forfeiture. The main advantages to the ee are the distribution at a later time is guaranteed and the ee is typically provided w the funds to pay the resulting tax liabilyt. For th eer, the advantage is current tax deduction if there is no substantial risk of forfeiture. Esp for small, closely held corporation, this provides a tax benefit if th ecorporate rate is higher than the ee/shareholder individual rate. An ee-grantor secular trust can avoid paying income tax by investing in LI, an annuity, or tax-exempt bonds.