FP512 MODULE 5 – STUDY GUIDE
3 Principles that must be followed for a deferred comp plan to be effective - Answer -1)
The agreement to defer comp must be made before the dollars are earned
2) The agreement must represent only an unsecured promise
3) The agreement cannot be funded
The biggest advantage of a nonqualified plan - Answer -It is not subject to the
nondiscrimination and other requirements of the IRC and ERISA
Constructive Receipt Doctrine - Answer -Money that will be considered taxable income
to an executive who has unrestricted access to it, whether or not they receive it, as long
as there is no substantial risk of forfeiture
Compensation is subject to substantial risk of forfeiture if it is conditioned on - Answer -
- Future performance of substantial services by an executive, or
- The occurrence of a condition related to organizational goals
*In order for tax deferral to occur, the possibility of forfeiture must be substantial.
Economic Benefit Doctrine - Answer -Occurs when the employer irrevocably places
funds for the benefit of the employee, beyond the reach of the employer's creditors.
Income is thus received even if the employee does not have actual or even constructive
receipt.
IRC Section 409A - Answer -States that all amounts deferred under a non-qual plan
must be includible in gross income if they are NOT subject to substantial risk of
forfeiture.
Requirements for elections to defer comp - Answer -- Must occur in the year prior to the
tax year of the delivery of services
- Employees have 30 days after they first become eligible to participate
- When the comp is performance-based (i.e. incentive plan) the deferral must be made
no later than 6 months prior to the end of the 12 month performanc eperiod.
Plan Distributions - Answer -Under the ACJA of 04', only payable when:
- Separation of service
- At death
- Upon disability
- At a change of ownership
- When an unforeseeable emergency (IRS) occurs
- At the age, date, or fixed schedule specified
- At termination, or liquidation of the plan
, Acceleration of benefits test - Answer -Does not allow any modification decreasing the
period required to qualify for benefit distribution
Benefits of non-qual plans to employers - Answer -They are used to recruit, retain, and
reward key employees.
Qualified Plans - Answer -The employer receives a deduction at time of contribution;
subject to ERISA and can non discriminate.
Non-qualified Plans - Answer -Employer only receives a deduction when the employee
reports income from the plan, usually at retirement.
Benefits of nonqual plans to employees - Answer -Designed to benefit a select group of
employees,
Three types of non-qualified plans - Answer -Unfunded, Informally Funded, and Funded
Unfunded non-qual plans - Answer -Represents merely a promise by the employer to
pay. Supported by general assets of the company only, and fully subject to claim of
creditors. Because of this, the assets are subject to substantial risk of forfeiture and thus
none of the deferred comp is taxable income to the employee until it is paid.
Informally funded plans - Answer -Considered an unfunded plan for ERISA purposes.
More preferred for executives because the employer typically builds these funds
through a general reserve that is set aside. However, it is still deferred because the
funds remain subject to assets of the employer's creditors. Remember- the primary
focus of this plan is to avoid the application of constructive receipt through the
imposition of forfeiture provisions. Includes RABBI trusts and COLI.
RABBI Trust - Answer -Alleviates an employee's concern that a hostile buyer or new
management may try to avoid paying the deferred comp benefits that have been
promised. Established at an independent financial institution which acts as trustee as an
informally funded plan. Employer is grantor and owner. Still subject to
insolvency/creditors, thus substantial risk of forfeiture.
COLI - Answer -Another type of informally funded plan. Employer purchases cash-
value life insurance. Employer is the owner and pays premiums and is also beneficiary.
Because the employee-participants have no contractual rights under the policy, the plan
is considered unfunded for ERISA. The cash values accumulate on a tax-deferred
basis. Reduces strain on employer's cash flow when plan distributions are due. Due to
tax law changes, interest on loans over $50K are not deductible, and MEC rules apply
(LIFO).
Surety bonds, letters of credit, and indemnity insurance - Answer -Other ways to
informally fund a non-qual plan. They are third party guarantees, but the only one
approved by the IRS is indemnity insurance
3 Principles that must be followed for a deferred comp plan to be effective - Answer -1)
The agreement to defer comp must be made before the dollars are earned
2) The agreement must represent only an unsecured promise
3) The agreement cannot be funded
The biggest advantage of a nonqualified plan - Answer -It is not subject to the
nondiscrimination and other requirements of the IRC and ERISA
Constructive Receipt Doctrine - Answer -Money that will be considered taxable income
to an executive who has unrestricted access to it, whether or not they receive it, as long
as there is no substantial risk of forfeiture
Compensation is subject to substantial risk of forfeiture if it is conditioned on - Answer -
- Future performance of substantial services by an executive, or
- The occurrence of a condition related to organizational goals
*In order for tax deferral to occur, the possibility of forfeiture must be substantial.
Economic Benefit Doctrine - Answer -Occurs when the employer irrevocably places
funds for the benefit of the employee, beyond the reach of the employer's creditors.
Income is thus received even if the employee does not have actual or even constructive
receipt.
IRC Section 409A - Answer -States that all amounts deferred under a non-qual plan
must be includible in gross income if they are NOT subject to substantial risk of
forfeiture.
Requirements for elections to defer comp - Answer -- Must occur in the year prior to the
tax year of the delivery of services
- Employees have 30 days after they first become eligible to participate
- When the comp is performance-based (i.e. incentive plan) the deferral must be made
no later than 6 months prior to the end of the 12 month performanc eperiod.
Plan Distributions - Answer -Under the ACJA of 04', only payable when:
- Separation of service
- At death
- Upon disability
- At a change of ownership
- When an unforeseeable emergency (IRS) occurs
- At the age, date, or fixed schedule specified
- At termination, or liquidation of the plan
, Acceleration of benefits test - Answer -Does not allow any modification decreasing the
period required to qualify for benefit distribution
Benefits of non-qual plans to employers - Answer -They are used to recruit, retain, and
reward key employees.
Qualified Plans - Answer -The employer receives a deduction at time of contribution;
subject to ERISA and can non discriminate.
Non-qualified Plans - Answer -Employer only receives a deduction when the employee
reports income from the plan, usually at retirement.
Benefits of nonqual plans to employees - Answer -Designed to benefit a select group of
employees,
Three types of non-qualified plans - Answer -Unfunded, Informally Funded, and Funded
Unfunded non-qual plans - Answer -Represents merely a promise by the employer to
pay. Supported by general assets of the company only, and fully subject to claim of
creditors. Because of this, the assets are subject to substantial risk of forfeiture and thus
none of the deferred comp is taxable income to the employee until it is paid.
Informally funded plans - Answer -Considered an unfunded plan for ERISA purposes.
More preferred for executives because the employer typically builds these funds
through a general reserve that is set aside. However, it is still deferred because the
funds remain subject to assets of the employer's creditors. Remember- the primary
focus of this plan is to avoid the application of constructive receipt through the
imposition of forfeiture provisions. Includes RABBI trusts and COLI.
RABBI Trust - Answer -Alleviates an employee's concern that a hostile buyer or new
management may try to avoid paying the deferred comp benefits that have been
promised. Established at an independent financial institution which acts as trustee as an
informally funded plan. Employer is grantor and owner. Still subject to
insolvency/creditors, thus substantial risk of forfeiture.
COLI - Answer -Another type of informally funded plan. Employer purchases cash-
value life insurance. Employer is the owner and pays premiums and is also beneficiary.
Because the employee-participants have no contractual rights under the policy, the plan
is considered unfunded for ERISA. The cash values accumulate on a tax-deferred
basis. Reduces strain on employer's cash flow when plan distributions are due. Due to
tax law changes, interest on loans over $50K are not deductible, and MEC rules apply
(LIFO).
Surety bonds, letters of credit, and indemnity insurance - Answer -Other ways to
informally fund a non-qual plan. They are third party guarantees, but the only one
approved by the IRS is indemnity insurance
