Events during the past two decades have increased executives’ focus on the security of their non-qualified arrangements. This heightened awareness of benefit security comes at a time when companies, shareholders and the media are focused on proper disclosure and managing earnings costs and volatility. This combination of factors has led many companies to review and reconsider past decisions with respect to funding
and securing non-qualified plans.
FORMAL AND INFORMAL FUNDING
The concept of funding non-qualified deferred compensation arrangements typically
means “informal funding” rather than “formal” funding.
When a non-qualified plan is formally funded, plan assets are set aside for the sole
benefit of plan participants. As a result, participants are generally subjected to current
income taxation based on the economic benefit doctrine. Depending on the structure
of the funding, the plan may also be subject to substantial ERISA requirements (i.e.,
well beyond the more limited requirements applicable to unfunded “top hat” plans, as
further discussed below).
In order to avoid these negative tax and ERISA consequences, non-qualified plans are
generally only informally funded, whereby assets can be segregated or “earmarked”
to provide a source of financing for the plan, but remain assets of the company. While
informal funding the plan does not create immediate income taxation for the
participants, it also cannot alleviate benefit security risk entirely. To avoid the plan
being considered formally funded, the assets must remain subject to the claims of the
company’s creditors in the event of corporate bankruptcy/insolvency. This will be
discussed in further detail under the benefit security sections of this article.past decisions with respect to funding and securing non-qualified plans.
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