CEBS Executive Compensation & Nonqualified Plans 1 — Questions and Answers
Question 1: Which IRS code section governs nonqualified deferred compensation plans and imposes strict rules on deferral elections and distributions?
- Section 401(k)
- Section 409A (Correct answer)
- Section 457(b)
- Section 125
Correct answer: Section 409A
Section 409A governs nonqualified deferred compensation, requiring initial deferral elections before compensation is earned and limiting permissible distribution events.
Question 2: A Supplemental Executive Retirement Plan (SERP) is best described as:
- A qualified defined benefit plan available to all employees
- A nonqualified plan that provides retirement benefits above qualified plan limits (Correct answer)
- A Section 403(b) annuity for nonprofit executives
- A federally insured executive savings account
Correct answer: A nonqualified plan that provides retirement benefits above qualified plan limits
A SERP is a nonqualified plan that supplements qualified plan benefits, typically provided to key executives whose retirement income would otherwise be limited by IRS caps.
Question 3: Under ERISA, a 'top-hat' plan is exempt from most ERISA requirements because it:
- Is funded exclusively through insurance contracts
- Covers only a select group of management or highly compensated employees (Correct answer)
- Has fewer than 25 participants
- Is maintained by a tax-exempt organization
Correct answer: Covers only a select group of management or highly compensated employees
Top-hat plans are exempt from ERISA's vesting, funding, and fiduciary requirements because they cover only a select group of management or highly compensated employees who can negotiate for themselves.
Question 4: A rabbi trust used in a nonqualified deferred compensation plan provides:
- A tax-free distribution to the executive upon retirement (Correct answer)
- Protection against employer insolvency for deferred compensation assets
- Security from employer creditors in the event of bankruptcy
- An irrevocable set-aside of assets outside the employer's reach
Correct answer: A tax-free distribution to the executive upon retirement
A rabbi trust protects deferred compensation from employer discretion (e.g., a change of heart by a new owner) but assets remain subject to claims of the employer's general creditors in bankruptcy.
Question 5: Which of the following is the primary disadvantage of a secular trust compared to a rabbi trust for nonqualified deferred compensation?
- Assets in a secular trust are not protected from employer creditors
- The executive is taxed on contributions when they are made to the secular trust (Correct answer)
- Secular trusts cannot hold life insurance contracts
- Secular trusts are prohibited under Section 409A
Correct answer: The executive is taxed on contributions when they are made to the secular trust
Contributions to a secular trust are immediately taxable to the executive because assets are beyond the reach of the employer's creditors, triggering constructive receipt.
Question 6: Split-dollar life insurance arrangements in the executive benefits context are primarily used to:
- Provide group term life insurance to all employees on a tax-free basis
- Share the cost and benefits of a permanent life insurance policy between employer and executive (Correct answer)
- Fund a qualified pension plan for highly compensated employees
- Replace 401(k) matching contributions for executives
Correct answer: Share the cost and benefits of a permanent life insurance policy between employer and executive
In a split-dollar arrangement, the employer and executive share the premium costs and policy benefits of a permanent life insurance policy, providing death benefit protection and cash value accumulation.
Question 7: Under the economic benefit doctrine applicable to nonqualified plans, an executive is taxed when:
- The plan is established and employer contributions begin
- The executive receives a transfer of property or an economic benefit with ascertainable value (Correct answer)
- The executive reaches the plan's stated retirement age
- The employer deducts contributions from its taxable income
Correct answer: The executive receives a transfer of property or an economic benefit with ascertainable value
The economic benefit doctrine taxes the executive when a taxable economic benefit of ascertainable value is conferred, even if no cash is received, such as when assets are placed in a secular trust.
CEBS Executive Compensation & Nonqualified Plans 1
Which IRS code section governs nonqualified deferred compensation plans and imposes strict rules on deferral elections and distributions?