Originally, Nonqualified Deferral
Plans (NQDP's) were designed for high-level
executives in a particular company, such as:
- Presidents and chief executive officers
- Executive and senior vice presidents
- Vice presidents
- Members of the board of directors
Over the past few years, companies have become more aggressive in offering
NQDP plans to middle management, since:
- An increased number of executives are being affected by the limitations
of qualified plans.
- Executives are in high demand in competitive industries, and a NQDP
plan is an excellent tool for attracting and/or retaining key executives.
The selection of the appropriate group to participate in the plan is
critical to qualifying for the top hat exemption , and thereby
bypasses the complex restrictions and limitations ERISA imposes. If the exemption is
violated, the plan would be subject to a great many of the
provisions of ERISA
that are applicable to qualified plans, without the
benefit of tax-deductible contributions.
A top hat plan 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.
The following provides information
with regard to the select group question. Please see Investment Options
for more information about what it means for a plan to be unfunded.
In general, to qualify for the top hat
exemption under ERISA, an NQDP
plan must be restricted to a select group of management or highly compensated
employees. The term highly compensated does not necessarily take
on the same meaning as it does in the qualified plan regulations. Instead,
it is intended to identify a limited number of executives who may qualify
for participation in the plan.
According to the Department of Labor (DOL), a separate determination
must be made for each employer based on the compensation and management
demographics of the employee population. The objective is to limit participation
to a relatively small group of
highly paid executives. If the eligible group becomes too
large, the plan will be required to satisfy the restrictive
requirements of ERISA
and defeat the objectives of the plan.
The DOL has never issued a
clear definition for the terms "management", "select group", or " highly compensated". They
have issued opinion letters in the past, but have since stated that these opinions
may no longer be relied on for guidance. As stated above, a
separate determination must be made for each employer based on
the compensation and management demographics of the employer's total work
Here are some guidelines for selecting the participants:
- In general, the plan should limit participation to a small group of
highly paid executives, relative to the total employee population. In addition, an employee, to be considered
management, should have definitive management
responsibilities and duties.
- Plan participants should be key
employees, and should be designated as key employees by the
company - usually by the board of directors.
- A minimum salary level should be
set for participation. This would aid in demonstrating that
the plan is for a select group of highly compensated
- If there were any doubt as to the
viability of the group selected, it would be advisable to
establish separate plans for employees who would undoubtedly
qualify, and those who may not qualify. This would "protect"
at least the major plan, if the other plan is deemed to
violate the top hat provision.
- An NQDP should also contain what is commonly called an unwind provision,
which states that if a plan participant is found not to be a member
of the select group for any reason, then the participant's account balance
would be distributed immediately.