Understanding the Types of Plans Under Nonqualified Deferred Compensation

There are two types of plans that have significantly different design and drafting philosophies: salary continuation plans and salary reduction plans. This article will explore their uses, and how each one applies. 

Salary Continuation Plan

A salary continuation plan is a type of nonelective nonqualified deferred compensation plan that provides a benefit payable in the future. A salary continuation plan is a fringe benefit provided by an employer with employer dollars in addition to other benefits and therefore requires no reduction in the covered employee’s salary. For example, the contract might provide:

“At retirement, disability, or death, the XYZ Corporation will pay you or your designated beneficiary $100,000 a year for ten years.”

The salary continuation plan is often used when an employer wants to provide something in place of or in addition to a qualified plan.

The salary continuation plan is usually a defined benefit type of plan. Plan benefits are often measured as a percentage of compensation. For instance, the employee will receive payments based upon average earnings over his final three years of service for the employer. Benefits may also be based upon years of service, so that the longer the employee has worked for the employer, the higher the benefit. Another possibility is that benefits may be based upon the achievement of specified goals.

A salary continuation plan can also be a defined contribution plan. Here the employer makes defined contributions to the plan (e.g., $10,000 each year that the participant remains employed with the employer) without reducing the participant’s salary, and the contributions are credited with interest. The actual retirement benefit depends upon the participant’s plan balance at retirement.

SERP Plans

A Supplemental Employee Retirement Plan (SERP) is a plan for a selected group of executives. A SERP generally provides extra retirement benefits for key personnel. An excess benefit plan is a special kind of supplemental plan. It is a creature of ERISA, and is a plan maintained by an employer solely for the purpose of providing benefits for certain employees in excess of the limitation on contributions and benefits imposed by Code section 415.11 An excess benefit plan can restore parity between the percentage of pre-retirement pay provided to highly paid employees at retirement and the percentage of pre-retirement pay provided to rank and file employees at retirement.

Salary Reduction Plans

A salary reduction plan is a true elective deferral of a specified amount of employee compensation.

Salary reduction plans typically utilize a defined contribution type of formula. An amount is added to the participant’s account each year (funded with employee deferrals). That amount may be an actual accumulation of funds, or simply a bookkeeping account.

If the account is only a bookkeeping account, the employer will often guarantee a specified minimum rate of return on the money credited. The rate of return may be based upon some index beyond the employer’s control– such as Moody’s Bond Index. Alternatively, the rate of return may be tied to the value of the employer’s stock.

Contributions are generally a specified percentage of the employee’s compensation each year or can be designed to meet a target retirement benefit similar to a target benefit qualified retirement plan.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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