How To Give Extra Pay To Top Employees

Let’s say you are an employer and you want to give your top managers an extra financial benefit, separate from the company profit sharing and 401(k) plan. Some obstacles are in your way, especially ones regarding taxes. What do you do? We asked Bruce Bell, an attorney at the Chicago office of Schoenberg Finkel Beederman Bell Glazer, for some pointers.

Larry Light: I suppose there are differences from the standard benefit arrangements and the type we are looking at.

Bruce Bell: There are. Qualified retirement plans, such as profit sharing and 401(k) plans, have a lot of legal rules. But the ones we are contemplating here, called non-qualified deferred compensation plans, or NQDPs, have far fewer such restrictions. Nevertheless, they do have some statutory restrictions. Not satisfying them can lead to big tax penalties.

Light: What are these rules for NQDPs?

Bell: For one, the employer can distribute money only after specific events occur, such as death, disability, termination of employment, change in control of the company, or on a certain date or other triggering event.

Also, distribution of plan benefits can’t be sped up except in limited circumstances. And if the plan is discontinued, restrictions apply as to when participants can receive their plan benefits. What’s more, participants generally can’t change their previously designated form of distribution.

Light: What are the penalties?

Bell: Higher taxes. Participants in a NQDP will be taxed at their regular income tax rates, plus an additional 20% income tax and interest on the tax. Plan defects can be fixed but this must be done relatively soon after it occurs. Because operational failures with NQDPs are often not discovered until one or more years have passed, the tax cost can be crippling.

Light: What else should I, as the employer, be on guard for?

Bell: Qualified plan rules have reporting and disclosure and other requirements that could still apply to NQDPs. A NQDP sponsor will typically want to structure the plan to avoid them. The most common way to do that is to limit plan participation to a select group of highly paid employees.

Because there no strict guidelines as to what constitutes high pay, compare the people you want in the NQDP plan with the total number of company employees. Suffice it to say that the number of NDPQ participants must be a lot less than the employee total.

Light: What else?

Bell: Basic plan design. You must decide how much to contribute to be made to the plan, and whether the company will make them, the employees or both. Also, whether to include a vesting schedule so that employees are encouraged to remain with the company. And if participants must forfeit their benefits if they leave and compete with you or try to poach your employees or customers.