Non-Qualified Deferred Compensation Plans: What and Why? Presented by: Justin W. Stemple

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1 Non-Qualified Deferred Compensation Plans: What and Why? Presented by: Justin W. Stemple

2 Qualified Plans 401(k), 403(b), profit-sharing, and defined benefit plans Broad based participation Limits on contributions and benefits Immediate deduction + deferred taxation + tax-deferred earnings

3 Non-Qualified Plans Assorted rules and regulations, 409A Limited participation Unlimited benefits No deduction until paid to employee; earnings are taxable

4 Why Non-Qualified Plans? Employer Recruiting/retention of key employees Performance incentives Equity-like compensation Early retirement incentives Golden parachutes Golden handcuffs

5 Why Non-Qualified Plans? Employee Deferred Income & taxation Payment for retirement or a specific time or event

6 Types of Non-Qualified Plans Account Balance Plans Fixed account with earnings 401(k) style plan Nonaccount Balance Plans Fixed stream of payments Defined benefit style plan

7 Types of Non-Qualified Plans Salary Reduction Plan Bonus Deferral Plan Incentive Plans Golden handcuff Performance goals

8 Types of Non-Qualified Plans Synthetic Equity Stock Appreciation Rights Phantom Stock Plans Non-dilutive of actual ownership Aligns interests with shareholders LLC: equity appreciation rights/phantom equity plans S Corporations Consider valuation

9 Types of Non-Qualified Plans Supplemental Executive Retirement Plan Make up for benefits lost under qualified plans due to IRS limits Compensation limits or excluded compensation Elective deferral limits Nondiscrimination limits Excess Benefit Plan 415 excess only

10 Plan Design Issues Contributions Employee salary or bonus deferrals Employer contributions Discretionary Formula Percentage of pay Match Cash or Stock

11 Plan Design Issues Funding Investment Who decides? How to invest? Hypothetical investments Fixed rate of return Phantom equity

12 Plan Design Issues Vesting No limits Rolling vesting permitted Vesting by time or performance Immediate vesting upon retirement, death, disability, or change in control

13 Plan Design Issues Forfeiture Events Termination for cause Covenant not to compete Confidentiality Non-solicitation of customers Non-solicitation of employees Intellectual property agreement

14 Plan Design Issues Payment Events Separation from service Death Disability Change in control Specific age or time Unforeseeable emergency

15 Plan Design Issues Payment Form Lump sum Installments Annuities Cash or stock

16 Plan Design Issues Elections Employee deferrals Time of payment Form of payment Further deferral

17 Tax Treatment Employee Generally no tax when plan is established if an unsecured promise to pay Securing the promise to pay may create a taxable event Constructive receipt Employer Deduction when employee is taxed

18 Funding Funded v. Unfunded Certainty of payment v. deferred taxation Taxable entities Actual or constructive receipt triggers tax Vesting is irrelevant Tax-Exempt entities Substantial risk of forfeiture Vesting = taxation

19 Funding Employer Alternatives Unfunded Company account Rabbi trust

20 Funding Rabbi Trusts Employer funded Not taxable to employee upon funding Employer may not use assets Subject to the claims of the employer s creditors upon bankruptcy/insolvency IRS model trust Springing trust

21 ERISA ERISA dictates participation, vesting, funding and fiduciary standards if applicable Top-hat exemption for unfunded plans that benefit only a select group of management or highly compensated employees Minor reporting formality top hat letter

22 M&A Golden parachutes Golden handcuffs 280G If change in control benefits exceed three times the employee s base amount (five year average compensation), there is a 20% excise tax on amounts more than one times average compensation Gross-up v. cap

23 (Dreaded) 409A Comprehensive and complex regulation of all non-qualified deferred compensation plans Funding restrictions Deferral elections Time and form of payment Keys: Material terms must be fixed in writing Limited ability to change the deal

24 Questions? Justin W. Stemple