Keep Good Guys - Strong Incentives to Retain Key Employees at Little or No Cost to the Employer

Employers, imagine this: providing such strong incentives for key employees to stick with you, that they will find it hard to leave and go to work for your competitor. Then imagine that the cost of these incentives is next to nothing! It is possible to dangle a huge carrot  in front of any valued employee that you wish - without the need to do so for any other employee or group of employees - making him think twice before moving on.

These plans are referred to as "Golden Handcuffs", Supplemental Executive Retirement Plans (SERPs), Deferred Compensation, forfeitable benefits, "Top Hat Plans", etc. The IRS calls them 409(a) plans - 457(f) plans for non-profit organizations. They can be as simple as a written agreement between the employer and the employee, providing benefits at death, disability, or retirement, if the employee meets the conditions of tenure, performance milestones, etc. These are unsecured, conditional benefits from the company, and they don't have to involve anything more than a promise by the employer to pay certain amounts under certain conditions, without any formal requirement for the employer to set aside funds in advance to cover these potential expenses.

Most 409(a) and 457(f) plans, however, in order for the employer to establish credibility and be taken seriously by the executive he is trying to inspire, do provide for informal funding throughout the plan years. The employee must believe that the company or organization will be around, and is setting aside the resources to ensure promises can be kept. Actuarial firms may act in an auditing capacity to evaluate funding rates, investment performance, and risk factors against potential benefits to be paid. For a small business, such services don't have to be expensive. One firm charges a $2,000 set-up fee and $1,000 per year for up to 4 employees.

Since employers are probably going to informally fund 409(a) plans, and since such plans also tend to contain provisions for not only retirement, but also early death and /or disability of the executive, cash value life insurance is often the vehicle of choice. Indexed Universal Life Insurance (IUL), including a Waiver of Specified Premium Rider, can address all three components of such plans. Most businesses keep a minimum of ready cash at all times, which can provide all or most of the funding. Properly-structured, and  using the right product, the leverage capabilities of IUL may allow the employer to "have his cake and eat it too".

While there are some requirements by the IRS, they are nothing like those for 401(k), Simple IRA, SEPs, and other qualified plans.

Executives may not achieve income tax deferral unless their rights to benefits are not able to be transferred. He must also be subject to a substantial risk of forfeiture.

For a SERP, ERISA allows two exemptions: Top-Hat plans, and Excess Benefit Plans.

Top-hat plans that are not formally funded, and are designed to benefit a “select group of managers or highly-paid employees” are exempt from most Title I ERISA requirements for nonqualified plans. Not being "formally funded" doesn't lessen the desirability of informally setting aside money in some way. The executive needs to believe that those benefits will be there some day! If properly designed, top-hat plans are also excluded from Parts 2, 3 and 4 of Title I of ERISA. The plan administrator can  comply with Part I through a simplified reporting procedure. Employees elible for top-hat plans are generally not more than 15% of the total workforce. In some instances, courts have held that an executive earning more than $115,000 may still be included in a top-hat group even if his presence swells the ranks in excess of 15%. In addition to being highly compensated, they have been construed to possess at least some role in the decision-making of their company.

An Excess Benefit Plan helps to provide retirement benefits not available to top executives due to contribution limits for the company's qualified plan(s). Thanks to ERISA §4(b)(5), such unfunded Excess Benefit plans are free from all the requirements of ERISA Title I. ERISA §3(36) says that an Excess Benefit Plan is: “A plan maintained by an employer solely for the purpose of providing benefits for certain employees in excess of the limitations on contributions and benefits imposed by I.R.C. §415….”

In any event, when one of these plans is deemed exempt from ERISA Title I, adoption and ongoing reporting requirements are minimal. Conditions that may be imposed by the employer for the executive to receive benefits are likewise quite flexible.  (Back to IUL Table of Contents)