Non-qualified and Deferred Compensation Plans

    >>> See also: Forms of Executive Compensation / Survey DataTax Laws / Litigation

2018.08.02  Deferred Compensation Data - and Its Implications.  Regarding how employers have responded to 2017's tax reform act, the Plan Sponsor Council of America has issued a press release that presents intriguing survey data.  Several are reproduced in italics below, with blue font being used to highlight insights drawn from them.

  • Two-thirds of employers allow 10 percent or fewer of their total employees to participate in the NQDC plan.
    • Non-qualified deferred compensation plans ("NQDCs") must generally limit participation to a top hat group of highly compensated employees.  Otherwise, ERISA's participation, vesting, and funding rules could create plan disasters - for participants as well as plan sponsors. The 10% limit referenced above reflects what most employers consider to be a safe level of plan participation (based on relevant case law). For more info on ERISA's top hat rules, see the case note below titled "Circuit Split Widens over Select Group for Top Hat Purposes" (added 2017.11.24). Or send an email inquiry.
  • Half of employers allow both employee and employer contributions to the NQDC plan.
    • NQDCs offer remarkable flexibility for plan design purposes - from pure tax deferral opportunities that employees may elect through salary reduction, to employer contributions that may be formula and performance-based, that may vest based on future performance measures, and that may be deferred until after a participant terminates employment (in order to serve as leverage for the honoring of non-competition and other post-employment covenants. >>> Further information here
  • Immediate full vesting increased 10 percentage points from 35.7 percent in 2016 to 45.9 percent.
    • This finding may reflect escalating use of "hold-backs" of annual bonuses for deferred delivery after employment terminates.  There are certainly advantages for employers, because deferred payout structures enable employers to encourage not only the honoring of post-employment covenants, but also good workplace conduct. See "Hitting Workplace Harassers Where It Hurts."  
  • Nearly 60 percent of plans set money aside to fund benefits.
    • In order to provide executives with a sense that their deferred compensation will be paid (absent company bankruptcy), employers may create and fund rabbi trusts, or set them up such that funding "springs" upon a change in corporate control.  See "Executive Insecurity" for a general discussion.
  • A little more than half of plans use the same investment lineup in the NQDC plan as in the qualified plan.
    • ​This mirroring of investment choices between NQDC and tax-qualified plans makes sense in order to defuse litigation risks that could come from rank-and-file employees who feel their investment alternatives are not only worse than those for executives, but reflect a breach of fiduciary duty.

2017.11.24  Circuit Split Widens over "Select Group" for Top Hat Purposes. Is an executive's ability to negotiate plan terms required as an ERISA top hat plan?  The 3rd Circuit has disagreed with the 2nd, 6th, and 9th Circuits - and agreed with the 1st Circuit in finding that bargaining power is not necessary because the test for top heavy status depends only on weighing these two factors: (1) quantitatively, does the plan cover "relatively few employees," and (2) qualitatively, does the plan restrict participation to "a select group of management or highly compensate employees." For detailed analysis of these considerations, see Sikora v. UPMC (3rd Cir.). 

2016.10.22  Monitoring Incentive Compensation: Either Create a Tail, or Chase Yours.  Last week, the president of the New York Federal Reserve understandably warned banks to continually assess their incentive compensation structures. He said, “If the incentives are wrong and accountability is weak, we will get bad behavior and cultures.”  Those responsible for designing incentive compensation structures may be tempted to focus on anticipating perverse employee behaviors – and rooting them out through ever more specific plan precautions.  Unfortunately, hindsight is often more valuable when it comes to discovering abuses.  In more practical terms, the best answer to providing the “right” incentives likely comes from greater use of performance-based deferred compensation.  
      There is nothing new here. For years, and increasingly, long-term incentives have been subject to varying forms of vesting, such as “bonus banks” with forfeiture risks, and other upside or downside adjustment factors tied to future corporate, divisional, or individual performance.  In the wake of executive pay abuses, many cry for clawing-back amounts already paid. That is another losing proposition, because over a decade of experience has shown that clawback policies and Sarbanes-Oxley rules generally work only in the most extreme, egregious cases.  

      Overall, those who design incentive compensation should consider shifting significant portions of annual incentive pay into deferred compensation that has a “tail” vesting period for payout.  In this way, they will avoid having to chase down every potential for employee abuse in annual incentive structures.  In addition, employers may protect key business goals through deferred compensation, by imposing forfeiture risks on those who violate trade secret or post-employment restrictive covenants such as non-competes and non-solicits.  Careful documentation is needed, of course, in order to comply with laws ranging from state and federal wage protections to ERISA to Code Section 409A.  That will be a small price to pay, however, for incentive pay that truly encourages employees to achieve productive, long-term corporate goals.