Planning for Retirement Needs

1. Planning for Retirement Needs Nonqualified Deferred-Compensation Plans Chapter 15

2. Less favorable tax treatment Employer deduction when employee taxed Deferral of tax is allowed but employer deduction deferred More design flexibility Limit coverage to executives Lower administrative costs Nonqualified vs Qualified Plans

3. Employer’s deduction at time employee has taxable income Plan is usually designed to defer income tax until benefit receipt Earnings on assets set aside are taxed as earnings to the employer Tax Treatment

4. Substantial risk of forfeiture (no tax) If no risk of forfeiture then tax still deferred unless Economic benefit doctrine Constructive receipt (409A) Tax Considerations

5. Taxes deferred if substantial risk of forfeiture “A substantial risk of forfeiture is a significant limitation or duty that requires the fulfillment of a meaningful effort by the executive, and there must be a definite possibility that the event that will cause the forfeiture could occur.” A traditional vesting provision is clearly a substantial risk of forfeiture. -Requiring that an executive continue to provide consulting services to a company after retirement may or may not be a substantial risk of forfeiture, depending upon the specific facts and circumstances. Substantial Risk of Forfeiture

6. Participant has current income if arrangement provides current economic benefit even if no current right to receive benefit Irrevocable trust with nonforfeitable benefits results in current income tax Plan assets typically stay in the name of the employer Rabbi trust is allowed since assets can be accessed by claims of the sponsor’s creditors Economic Benefit Doctrine

7. Failure to satisfy distribution, acceleration of distribution, and deferral election rules results in current income tax and an additional 20 percent penalty tax. Distribution only upon stated events Separation from service Disability Death of the employee A time specified under the plan. A change in ownership or control. Occurrence of an unforeseeable emergency. Constructive Receipt 409A

8. Plan may not allow acceleration of distributions except Payments for domestic relations order A de minimus cashout of up to $10,000 Payments for FICA taxes Employees’ elections to defer Election to defer must generally be made in preceding year Rules require time and form of distributions determined at initial deferral Plan can specify form and timing or give participants a choice Exception allows a participant to delay existing benefit as long as election is made 12 months before 409A

9. FICA taxes on the later of Date services are performed or No longer a substantial risk of forfeiture Issues Different timing than income tax rules Nonduplication rule—tax only paid once FICA Taxes

10. Golden handshakes—induce retirement Golden handcuffs—stay with company Golden parachutes—soften landing upon takeover Incentive pay—bonuses for meeting goals Plan Design--Objectives

11. Salary reduction Similar to 401(k) salary deferrals To defer taxes Systematic savings SERP DB or DC Additional benefit Offset (reduce by qualified-plan benefits) Types of DeferredCompensation

12. Forfeiture (not for salary deferrals) Continued consulting Retaining executives Do-not-compete clause Design ConsiderationsFrom the Employer’s Perspective

13. Takeover trigger (golden parachute) Immediate vesting Hardship withdrawals Binding arbitration for disputes Design ConsiderationsFrom the Employee’s Perspective

14. Benefit structure Eligibility Disability Retirement age Death benefits Other Design Considerations

15. Impact of “funding” Informal funding Rabbi trusts Defer taxation Meet security concerns Secular trusts Irrevocable trust Current taxation Surety bonds Funding

16. Assets available to creditors Irrevocable or springing irrevocability No insolvency triggers Notify trustee of pending financial problems that trigger suspension of benefits Rabbi Trust

17. Tax-free inside buildup Protects against premature death Life insurance proceeds tax free Funding flexibility—use cash value or keep in force and receive death benefits Company ownership eliminates tax problems Life Insurance

18. Corporate resolution Plan document Rabbi trust ERISA notice sent to DOL Installation

19. Generally satisfy “top-hat” exemption “Plan must be unfunded and maintained by an employer, primarily for the purpose of providing deferred compensation for a select group of management and/or highly compensated employees.” ERISA Considerations

20. Nonqualified plan sponsored by tax-exempt or governmental entities subject to Code Sec. 457 457(b) Salary deferrals can’t exceed $15,500 (in 2007) Catchup elections allowed 457(f) Conforming salary deferrals Tax when no substantial risk of forfeiture 457 Plans

21. Also called Sec. 162 plans No coverage requirements Employee is the policyowner, insured and chooses the beneficiary Employer simply pays a bonus equal to the premium Employee has taxable income and employer gets a deduction Double bonus—employer pays premium and taxes on payment Executive Bonus Life Insurance

22. Step 1: State target premium $10,000.00 Step 2: Specify the applicable tax rate .40 Step 3: Subtract step 2 from 1.00 = .60 Step 4: Divide the step 1 amount by the step 3 amount to find the amount of both bonuses: $16,666.67 Double Bonus Example

23. 1. xxIncentive stock options 2. Golden parachutes 3. Golden handshakes 4. SERP 5. Surety bonds A. Supplemental plan to replace employment income at retirement B. Options to acquire stock with no tax consequences at the time of stock acquisition C. Benefit package at retirement to induce early retirement D. Payments to an executive upon change of ownership E. Agreement by a third party to guarantee benefit payments Quick Quiz—Match the following:

24. 6. “Funded” plan 7. Golden handcuffs 8. Rabbi trust 9. Salary reduction plan 10. Constructive receipt F. Funding instrument in which assets are subject to employer’s creditor G. Plan in which executives agree to defer current compensation H. Taxation at the time contributions become vested I. Opportunity to receive compensation regardless of actual receipt J. Discouraging termination of employment by requiring additional service to vest in plan benefits Quick Quiz—Match the following:

25. Salary deferral type nonqualified plans will typically have a deferred vesting schedule. Code Sec. 409A allows distributions at the time of a participant’s disability. Nonqualified plans may have the objective of providing benefits in excess of the qualified plan contribution or benefit limits. A nonqualified plan will be considered funded if assets owned by the corporation are earmarked for funding the required payments. True/False Questions

26. To avoid tax problems a surety bond used to secure funding in a nonqualified plan must be purchased by the executive. A nonqualified plan that is designed to make substantial benefit payments if there is a change in ownership is referred to as a golden handcuffs provision. In a nonqualified plan, income taxes can be deferred if the benefit is subject to a substantial risk of forfeiture even if the plan confers a current economic benefit. True/False Questions