1. ©2015, College for Financial Planning, all rights reserved. Session 14 Fundamentals of Deferred Compensation CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Retirement Planning & Employee Benefits

2. Session Details Module8 Chapter(s)1, 2 LOs8-1 Identify characteristics of a nonqualified deferred compensation plan. 8-3 Identify characteristics of a given form of informal funding for a private, unfunded nonqualified deferred compensation plan. 14-2

3. 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

4. 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

5. Nonqualified vs. Qualified Plans CharacteristicQualified PlanNonqualified Plan Internal Revenue Code Requirements DiscriminationPlan may not discriminatePlan may discriminate ERISA RequirementsAll plans must satisfy ERISA and IRC requirements Certain plans are partially exempt from ERISA Tax Treatment Employer deductionAvailable in year of plan contribution Available in year of employee taxation Employee deferralTax-deferred until plan distribution; rollovers allowed Tax-deferred only if unfunded or funds are at risk; no rollovers Fund earningsEarnings accrue tax-deferred until distribution Earnings usually are currently taxable to employer DistributionsTaxed at ordinary rates; averaging may be available on lump sums Taxed at ordinary rates; averaging not available on lump sums 14-5

6. 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

7. 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

8. 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

9. 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

10. ERISA Requirements for Nonqualified Deferred Compensation Plans ERISA Reporting and Disclosure Participation, Vesting, and Funding Fiduciary Responsibility Plan Termination Insurance Unfunded Plan or Trust Must complyExempt if top-hat plan; must comply if plan includes rank and file Exempt if top- hat plan; must comply if it includes rank and file Funded Plan or Trust Must comply Government, Church, Unfunded Excess Benefit Plans Exempt 14-10

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. ©2015, College for Financial Planning, all rights reserved. Session 14 End of Slides CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Retirement Planning & Employee Benefits