Investment options in a Nonqualified Deferral Plan (NQDP) are the various ways in
which gains or losses to a participant's nonqualified deferral account may
be measured. The most common investment options used in an
NQDP are hypothetical, or phantom, investment options.
The investment options are referred to as hypothetical because
they are only a measure of the amount owed the participant - the participant's
account will be credited with gains or losses based upon the activity
of the hypothetical investments. These account balances will then become
the plan liability. The plan sponsor is not obligated to invest
the contributions according to the participant's investment selection.
In fact, they are not obligated to invest the contributions at all.
If they are obligated to follow the participant's selection, the
plan may be considered funded for ERISA purposes, and violate the ERISA
top hat exemption (a top hat plan is a plan which is unfunded
and maintained by an employer primarily for the purpose of providing deferred
compensation for a select group of management or highly compensated employees).
If the exemption is violated, the plan would be subject to a great many
of the qualified plan provisions of ERISA, without the benefit of deductible
contributions. (See Funding, for a detailed discussion
of sponsor alternatives for financing the plan).
The plan sponsor (or trust, if one is
utilized) remains the sole owner of any plan contributions
and any earnings generated by such contributions. The plan document will stipulate this
point in great detail.
The earnings crediting method varies widely among existing NQDP's. A
plan may offer participants the choice of investing deferrals across
a number of mutual funds, similar to their 401(k) plan options. Other
plans mirror the returns of a particular stock index, such as the S&P
500©. Some plans provide a periodic interest credit to
a participant's account, and do not offer a choice of investments.
The crediting method will usually determine how often gains or losses
are credited to a participant's account. Plans that use mutual funds
or stock indices most often offer daily valuation - the participant's
account balance will fluctuate daily along with the mutual fund or index
being tracked. Plans that credit periodic interest will usually
credit interest monthly or quarterly.
Typical Plan Investment Set-Up
Flexibility is the operative term when it comes to investment
options offered to plan participants. As stated above, a plan could
offer only one investment choice, or a number of investment choices for
Most plans will offer a choice of accounts for investment of deferrals.
The accounts will be earmarked for variety of purposes, such as:
- A retirement account for retirement savings.
- A post-retirement medical account for accumulating funds for health
insurance after retirement.
- An education account to accumulate funds for dependent education.
An account is a repository, or container for investments. Each
account may contain a variety of investments
(stocks, bond, mutual funds, etc.).
- A participant may elect to split his deferral across the accounts
in any proportion desired.
- Each account may or may not contain
matching contributions (i.e., the
employer will match a portion of the participant's deferrals), with
its own vesting schedule.
- The participant may choose the same or different investments for each
- Each account will have its own distribution options (time and
method of payout).
Investment options may range from a single investment choice to an array
of accounts and investments. A plan sponsor should bear in mind
that a more complex investment setup will require a sophisticated
administrative process and record keeping system.