Retirement: 8 Deferred Compensation and Stock Plans Flashcards Preview

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Flashcards in Retirement: 8 Deferred Compensation and Stock Plans Deck (196)
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1

Retirement 8-1 Nonqualified Deferred Comp

Employee taxation controls timing of your tax deduction

Lack of security for employees in an unfunded plan

Generally, more costly to employer than paying compensation currently

a. Advantages of NQDC plans

b. Disadvantages of NQDC plans

b. Disadvantages of NQDC plans

2

Retirement 8-1 Nonqualified Deferred Comp

The American Jobs Creation Act (AJCA) was signed into law in 2004, and it created Internal Revenue Code (IRC) Section 409A, which was designed to create strict rules to govern deferred compensation. Unless an exception applies, the term “nonqualified deferred compensation plan” means any plan that provides for the deferral of compensation for any employee. A deferral of compensation generally occurs when a legally binding right to compensation arises in one taxable year and the compensation _____ be payable to employee in a subsequent taxable year.

a. May

b. Must

a. May

3

Retirement 8-1 Nonqualified Deferred Comp

There are severe penalties for failure to meet the new Section 409A requirements including all amounts deferred under the arrangement becoming subject to immediate taxation, interest penalties, and a ____ additional tax on deferrals.

a. 10%

b. 20%

b. 20%

4

Retirement 8-1 Nonqualified Deferred Comp

Much of what is covered under Section 409A is beyond the scope of this module, but here are some of the basics:

Elections to defer compensation must occur in the year prior to the tax year of the delivery of services. When employees first become eligible to participate in a nonqualified plan during the current year (because they were recently hired or a new plan was put into place), they have __ days after they first become eligible to participate to make a deferral election under the plan for the current year.

a. 30

b. 60

a. 30

5

Retirement 8-1 Nonqualified Deferred Comp

Much of what is covered under Section 409A is beyond the scope of this module, but here are some of the basics:

Where compensation is performance-based (that is, under an incentive plan), the deferral election must be made no later than _ months prior to the end of the 12-month performance period.

a. 3

b. 6

b. 6

6

Retirement 8-1 Nonqualified Deferred Comp

Example. Jim Hopkins, age 64 and 8 months, has participated in the nonqualified deferred compensation plan of his employer for the last 23 years. Under the plan, he originally elected to have benefits paid in a lump sum at age 66, the age at which he would begin his Social Security and planned to retire. He now has decided to work until age 71, but isn’t exactly sure how long he will work. He wants to make a subsequent deferral so the original payment will be payable on the later of attaining age 71 or separation from service.

Jim’s new election will be valid if he makes the election on or before his 65th birthday since it will be at least 12 months prior to the original payment date, and any payments to Jim under the new election must be deferred at least ___ years from the previous payment commencement date specified by the plan.

a. 3

b. 5

b. 5

7

Retirement 8-1 Nonqualified Deferred Comp

Example. Lisa Littlehorn, age 63, participates in the Industrial Design Inc. nonqualified deferred compensation plan, and she has done so for over 15 years. Originally she elected to have her plan benefits paid in a lump sum at age 65. She is in excellent health and is concerned about outliving her retirement funds. She has decided to work until age 70, and wants her benefit to be paid over 25 years. She would like to make a subsequent deferral so the series of payments over 25 years will begin on the later of the date she attains age 70 or the date she decides to retire.

Lisa’s new election will be valid if she makes the election on or before her __th birthday since it will be at least 12 months prior to the original payment date and defers the new payment date at least five years. If Lisa terminated at age 67, her payments would begin at age 67, since she terminated.

a. 64

b. 65

a. 64

8

Retirement 8-1 Nonqualified Deferred Comp

An employee (or beneficiary) may change a previously elected time or form of a payment, subject to certain limitations. A change in either the time or form of payment may not take effect for __ months and must provide for a new payment beginning date that is at least five years after the original beginning date. In addition, if the payment is made as an annuity or as installment payments, the election must be made 12 months before the date the first amount was scheduled to be paid.

a. 12

b. 24

a. 12

9

Retirement 8-1 Nonqualified Deferred Comp

Qualified vs. Nonqualified Plans

_____ allow for significant tax deferral, but must meet the stringent requirements of the Internal Revenue Code (IRC), as well as those of the Employee Retirement Income Security Act of 1974 (ERISA). The plan must be nondiscriminatory if it is to qualify for the tax benefits associated with qualified employee benefit plans. These include the ability of the employer to take an immediate deduction for a plan contribution regardless of whether it is included in the employee’s current income, and the deferral of taxation on plan earnings until they are distributed to the participant.

a. Qualified

b. Non Qualified

a. Qualified

Additionally, special tax rules relating to forward averaging and the ability to move assets to another tax-deferred arrangement such as an IRA apply only to qualified plan assets.

10

Retirement 8-1 Nonqualified Deferred Comp

Qualified vs. Nonqualified Plans

A ____ is a contractual agreement between an employer and employee that specifies when and how future compensation will be paid. The plan represents an unfunded and unsecured promise to pay benefits in the future. In the meantime, plan assets remain within the reach of corporate creditors and the employer may not take an income tax deduction on monies set aside to informally fund the plan.

a. Qualified

b. Non Qualified

b. Non Qualified

Nonqualified plans are ideal for individuals such as business owners and key employees, who want to provide compensatory benefits for themselves without having to provide similar benefits to rank-and-file employees. These key employees are also looking to avoid the contribution and participation limits that apply to qualified plans. The price for this freedom of plan design is that the employer cannot take a deduction for payments to a nonqualified deferred compensation plan until the employee reports the payments in income, which is often at retirement. Also, the earnings on plan assets are not tax-deferred; instead, earnings are taxed annually to the sponsor or to the participant.

11

Retirement 8-1 Nonqualified Deferred Comp

Easier and less expensive to implement and maintain than a qualified benefit plan

Can be offered on a discriminatory basis

Can provide unlimited benefits

Allows employer to control timing and receipt of benefits

Enables employer to attract and retain key employees

a. Advantages of NQDC plans

b. Disadvantages of NQDC plans

a. Advantages of NQDC plans

12

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Discrimination: Plan may not discriminate

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

13

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Discrimination: Plan may discriminate

a. Qualified Plan

b. Nonqualified Plan

b. Nonqualified Plan

14

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Compensation limit: Compensation limit applies

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

15

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Compensation limit: Compensation limit does not apply

a. Qualified Plan

b. Nonqualified Plan

b. Nonqualified Plan

16

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Benefit limitations: Applies to both defined contribution and defined benefit plans

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

17

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Vesting: Vesting schedules are required

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

18

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Vesting: Vesting schedules are not required

a. Qualified Plan

b. Nonqualified Plan

b. Nonqualified Plan

19

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Penalties and excise taxes: Penalties and excise taxes apply

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

20

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

Penalties and excise taxes: Penalties and excise taxes do not apply unless the plan violates AJCA (Section 409A)

a. Qualified Plan

b. Nonqualified Plan

b. Nonqualified Plan

21

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

ERISA requirements: Must satisfy ERISA requirements

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

22

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: IRC Requirements

ERISA requirements: Exempt from most ERISA requirements

a. Qualified Plan

b. Nonqualified Plan

b. Nonqualified Plan

23

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: Tax Treatment

Employer’s deduction: Available in year of plan contribution

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

24

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: Tax Treatment

Employer’s deduction: Available in year of plan contribution

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

25

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: Tax Treatment

Employer’s deduction: Available in year employee is taxed on benefits

a. Qualified Plan

b. Nonqualified Plan

b. Nonqualified Plan

26

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: Tax Treatment

Employee deferral: Tax deferred until plan distribution

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

27

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: Tax Treatment

Fund earnings: Accrue tax deferred until distribution

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

28

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: Tax Treatment

Fund earnings: Are currently taxable to the employer in most cases

a. Qualified Plan

b. Nonqualified Plan

b. Nonqualified Plan

29

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: Tax Treatment

Distributions: Ordinary income tax rates apply; capital gains rates for net unrealized appreciation on employer securities

a. Qualified Plan

b. Nonqualified Plan

a. Qualified Plan

30

Retirement 8-1 Nonqualified Deferred Comp

Comparison of Nonqualified and Qualified Plans: Tax Treatment

Distributions: Ordinary income tax rates apply and benefits are taxed as wages

a. Qualified Plan

b. Nonqualified Plan

b. Nonqualified Plan