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VOL. 109 | NO. 55 | Thursday, December 21, 1995

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THE BENEFITS OF A TANDEM 401 (k)/NON-QUALIFIED PLAN ARRANGEMENT THE BENEFITS OF A TANDEM 401 (k)/NON-QUALIFIED PLAN ARRANGEMENT By DOROTHY SANDERS WELLS Special to The Daily News Among the tax-qualified retirement plans hardest hit by recent tax law changes are the popular 401 (k) plans Ñ plans which allow employees to defer taxation on salary amounts which they elect to contribute to the plan, thereby reducing their current taxable income. While the overall limit on employeesÕ deferral contributions to 401 (k) plans is $9,500 for 1996, the contributions of Òhighly compensatedÓ employees (HCEs) Ñ generally, corporate officers and management, partners or self-employed persons Ñ are further limited to a certain percentage of the deferral contributions made by non-highly compensated employees (NHCEs). If deferral contributions by HCEs exceed the permitted levels, the employer must either make taxable distributions of the excess contributions to the affected HCEs, or it must make additional contributions on behalf of the NHCEs. Complicating matters further have been a reduction in the amount of compensation used to determine a participantÕs plan benefits or contributions in qualified plans to $150,000 and a cap on deferral contributions which, although normally adjusted for cost-of-living increases each year, was frozen at the 1994 limit of $9,240 for the 1995 year. Given that background, it is not difficult to understand why an employer that sponsors a 401 (k) plan would be looking for alternatives to increase the amount of contributions made on behalf of its HCE group. More and more employers are looking at non-qualified deferred compensation plans as a supplement to their tax-qualified retirement plans. What makes these non-qualified plans attractive? Unlike tax-qualified plans (including 401 (k) plans), non-qualified plans generally have fewer Internal Revenue Service reporting requirements, and participation in non-qualified plans can usually be limited to management and other highly compensated employees. If the plan is a true Òtop hatÓ plan which is limited to a select group of management or HCEs it will not be subject to the funding, vesting and trust requirements for qualified plans under the Employee Retirement Income Security Act (ERISA). But, there is a trade-off: generally, deferral contributions to a non-qualified plan remain part of the employerÕs general assets and are therefore subject to the claims of its general creditors, so amounts contributed to the non-qualified plan are not afforded the same protection as contributions to the 401 (k) plan. Despite the drawbacks, practitioners have struggled to come up with a way that non-qualified deferred compensation plans could work in conjunction with an employerÕs tax-qualified 401 (k) plan. After a series of hit-and-miss attempts by employers, the IRS has recently issued a private letter ruling which ÒblessesÓ an employerÕs proposed tandem 401 (k)/non-qualified plan arrangement. The ruling, PLR 9530038, describes a tandem arrangement which works this way: not later than Dec. 31 of the first year, the HCEs would make two separate, irrevocable salary deferral elections, one to the non-qualified plan and one to the 401 (k) plan, for the following calendar year (the second year). The salary deferral election by an HCE for the non-qualified plan would be for a specific dollar amount or percentage of compensation. An HCE's salary deferral election for the 401(k) plan would be limited to the lesser of: (1) the maximum contribution amount which could be deferred to the 401 (k) plan on behalf of the HCE based on the percentage of contributions made by the NHCE group and subject to the deferral dollar limit ($9,500 for 1996), or (2) the total salary deferrals elected by the HCE under the non-qualified plan for the year. The total amount of the HCEsÕ salary deferrals initially would be deposited to the non-qualified plan. Not later than Jan. 31 of the third year, the employer would complete appropriate testing for the 401(k) plan and determine the maximum amount which could be contributed by the HCEs; by March 15 of the third year, the employer would transfer that amount from the non-qualified plan to the 401 (k) plan. Any deferrals to the non-qualified plan which were in excess of the amounts which could be contributed to the 401 (k) plan would continue to be deferred under the non-qualified plan. No earnings from the non-qualified plan would be transferred to the 401 (k) plan. This type of arrangement could work extremely well in a company where contributions by the NHCE group are historically not high and where the employer typically returns contributions to HCEs. But, an employer that is plagued by low participation by its NHCE group may consider some other incentives to Òbeef upÓ participation by the NHCE group, including matching contributions (even as little as 25 percent of employeesÕ contributions) and limited participant direction of investments. Either one of these ÒperksÓ can go a long way toward increasing participation by the NHCE group, thereby increasing the amount of contributions which can be made by the HCEs. Even if a ÒtandemÓ 401 (k)/non-qualified plan arrangement is not exactly what the doctor ordered for a particular employer, practitioners and employers alike should still keep in mind the benefits of adopting a non-qualified plan to provide supplemental retirement income for HCEs whose contributions have been even further limited by recent tax law changes. Wells is an attorney with Waring Cox, PLC, and practices primarily in the areas of employee benefits and taxation. This article was adapted from ÒConsidering a Non-Qualified Plan as a Supplement to your 401 (k) Plan,Ó with permission from The Benefits Update, an update on employee benefit developments, copyright 1995 Waring Cox, PLC.
RECORD TOTALS DAY WEEK YEAR
PROPERTY SALES 32 176 2,507
MORTGAGES 26 101 1,687
FORECLOSURE NOTICES 10 37 259
BUILDING PERMITS 0 365 5,497
BANKRUPTCIES 16 57 963
BUSINESS LICENSES 0 107 488
UTILITY CONNECTIONS 0 0 0
MARRIAGE LICENSES 0 0 0