The QSERP: gaming the nondiscrimination rules to provide larger qualified benefits for executives.
I. INTRODUCTION II. BACKGROUND A. Defined Benefit Retirement Plan Overview B. Background on the Evolution of Retirement Plan Regulation C. The Current Nondiscrimination Requirements 1. Amount Limits on Pay and Benefits 2. Nondiscrimination Testing i. A Permitted Level of Discrimination ii. Increasing the Discrimination Permitted in a Qualified Plan iii. Integrated Plans and Permitted Disparity iv. Nondiscriminatory Plan Amendments 3. Penalties for Discriminatory Plans D. Supplemental Executive Retirement Plans (SERPs) E. The "Qualified" Supplemental Executive Retirement Plan (QSERP) F. Section 409A III. ANALYSIS A. The Problematic Status of the Current Nondiscrimination Rules for Plan Amendments B. The QSERP Runs Contrary to the Purpose of ERISA and Executive Compensation Laws IV. RECOMMENDATIONS A. The Internal Revenue Service Must Become More Aggressive Toward Plan Amendments 1. Expand the Resources to Monitor Plan Amendments 2. Impose Heightened Standards on Employers Submitting Amendments for IRS Approval B. Interpret or Amend [section] 409A to Explicitly Prevent QSERPs V. CONCLUSION
Retirement-plan regulation must walk a fine line. On one hand, the federal government wishes to incentivize private retirement benefits since they promote the general worker welfare, (1) so the government provides incentives for employers to provide retirement plans. (2) On the other hand, to ensure that these benefits promote the general worker welfare, the Federal Government imposes complex and strict regulations on these plans. (3) Section 401(a)(4) of the Internal Revenue Code illustrates one particular policy underlying these regulations--qualified benefits cannot discriminate in favor of highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). (4) To this end, the Internal Revenue Service (IRS) and the U.S. Department of the Treasury (Treasury) have issued numerous complex requirements to ensure that qualified plan benefits do not discriminate in favor of HCEs. (5)
Employers still can enjoy great flexibility in how they choose to compensate their employees, but the government incentives granted to an employer are for providing a qualified benefit plan to promote the general worker's welfare. (6) If an employer wishes to discriminate in its benefits, it can forego the government incentives and provide a nonqualified benefit plan. (7) The nondiscrimination rules seek to ensure that discriminatory plans do not enjoy qualified status.
However, strategic manipulation of the rules can actually allow an employer to discriminate in its qualified benefit plan, and even transfer benefits from a nonqualified plan into a qualified plan. A Qualified Supplemental Executive Retirement Plan (QSERP) uses loopholes in the nondiscrimination rules to allow discriminatory nonqualified benefits to gain the preferential qualified treatment. (8) Despite being contrary to [section] 401(a)(4) of the Code, the QSERP is not explicitly illegal. (9) In the end, this practice allows executive benefits greater security and preferential tax treatment at the expense of the rank-and-file workers and taxpayers, who subsidize this strategy. (10) Given the current scrutiny of executive compensation (11) and the poor funding status of retirement plans, (12) there is no reason the government should continue to allow these manipulative techniques to be legal.
This Note demonstrates how employers execute the QSERP under the current nondiscrimination rules, and further explains why this practice violates fundamental principles of ERISA and [section] 401(a)(4) of the Code. Part II of this Note provides a background on retirement plan regulation and explains how the nondiscrimination rules and the IRS allow the QSERP to exist. Part III demonstrates the problematic status of testing plan amendments for nondiscrimination and demonstrates that the QSERP violates numerous principles of retirement plan regulation. Finally, Part IV provides two potential solutions to the QSERP problem: either the IRS should change its policy towards the approval of plan amendments, or Congress should pass an amendment to [section] 409A explicitly barring the QSERP.
A QSERP strategically manipulates pension laws to place executive benefits into a tax-qualified retirement plan. (13) To understand how the QSERP works, it is necessary to provide an overview of defined benefit retirement plans, a background on the Employee Retirement Income Security Act (ERISA), and the nondiscrimination regulations that apply to defined benefit retirement plans. The QSERP is complex and technical, but simple examples will help explain how it works.
A. Defined Benefit Retirement Plan Overview
A defined benefit retirement plan provides a determinable benefit to the recipient upon retirement. (14) The plan has a formula that uses a participant's work information to determine how much of a benefit that person receives. (15) Usually the plan rewards long employee service by tying the percentage received upon retirement to the number of years of service. (16)
For example, a plan may offer three percent of an employee's final salary per year for every year that employee has worked for the employer. under that plan, if a person had 30 years of service upon retiring, that person would receive 90 % (30 years x 3%) of their final salary as a life annuity. This is particularly advantageous for employees because they know they will receive a retirement benefit for the rest of their lives after they retire.
While advantageous to employees, these plans pose significant risks if not properly managed by the employers. (17) For example, an employer must ensure that it always has sufficient assets to pay for the accumulated benefits owed to retirees. (18) If an employer does not properly invest and allocate assets to their retirement plan, the beneficiaries under the plan could lose their primary means of retirement support.
B. Background on the Evolution of Retirement Plan Regulation
The federal government started to provide preferred tax treatment for retirement plans in 1921. (19) The Revenue Act of 1921 treated contributions to a stock bonus or profit sharing trust established to maintain a retirement plan as tax exempt. (20) This legislation had little documented history, but it appeared that its focus was to match the timing of the employee receipt to the taxation period. (21) The idea was not to subsidize a private pension plan, but simply to tax earnings when paid to employees, not when set aside into a retirement trust. (22)
By the 1970s, the tax incentives for employers to contribute to retirement plans became much more directed at promoting worker welfare. ERISA states that "the continued well-being and retirement income security of millions of workers, retirees, and their dependents are directly affected by [retirement] plans." (23) As a result, these plans "are afforded preferential Federal tax treatment." (24) The tax subsidy promoted the general welfare by giving employers an incentive to provide retirement plans for all of their workers.
However, the preferential tax treatment was not unconditional. Prior to ERISA, private pensions were subject to a variety of major risks simply due to a hands-off regulatory approach. (25) Agency risks caused plan managers to mishandle, misuse, and sometimes steal plan assets. (26) Forfeiture risks caused some employees to lose their retirement benefits simply because of lopsided plan provisions. (27) Default risk caused some plans to deplete their assets, so employers could no longer pay out the benefits promised to retirees. (28) Finally, there was a discrimination risk that only executives and officers could participate in the tax advantaged plan, which undermined the social purpose of the tax subsidy. (29) ERISA implemented a number of ways to address these concerns. It requires plan managers to be fiduciaries, (30) which greatly reduces the agency risk. It requires minimum coverage (31) and vesting standards, (32) which address forfeiture risk. ERISA imposes minimum funding standards (33) to prevent risk of default by requiring a plan to maintain a specified minimum allocation of assets in a fund toward future benefits. Finally, Congress also enacted several nondiscrimination provisions (34) to ensure the benefits do not favor highly compensated employees.
The nondiscrimination regulation of private retirement plans began with the Revenue Act of 1942. (35) These first rules were very broad and simple--often easy to manipulate. (36) As Congress investigated pensions in the 1970s, it discovered that, essentially, employers were able to negotiate with the IRS districts as to what "was and was not discrimination in a pension plan." (37) In response, Congress wanted to "[tighten] the rules to insure a broader coverage of low paid workers." (38) As a result, ERISA's nondiscrimination requirements were very technical and based mostly on objective standards. (39) This trend continued when Congress passed the Tax Reform Act of 1986. (40)
C. The Current Nondiscrimination Requirements
In the pension context, the concern with discrimination is that the retirement plan favors highly compensated employees over the average rank-and-file workers. Consequently, the regulations have a number of ways to promote equity in retirement benefits. However, the QSERP strategically manipulated the nondiscrimination regulations to provide larger qualified benefits to executives rather than the rank-and-file workers. (41) To provide a foundation for understanding the QSERP, this Note provides an overview of the HCE nondiscrimination regulations.
1. Amount Limits on Pay and Benefits
A few sections of the Internal Revenue Code cap the amount of compensation used to determine the benefit under a defined benefit plan. (42) Section 401(a)(17) caps the compensation for determining a qualified benefit for 2008 at $230,000. (43) This limitation prevents employers from using larger salaries to calculate qualified benefit amounts.
In addition to pay limits, [section] 415 also limits the annual benefit amount a defined benefit plan can provide. For 2008, the limitation is $185,000. (44) This limitation also ensures that no highly paid employee can obtain an excessive benefit under a qualified defined benefit plan.
2. Nondiscrimination Testing
The IRS requires that qualified plans not discriminate in favor of HCEs. (45) To enforce this general principle, the Treasury Regulations specifically list that an employer must not discriminate in plan benefit amounts, (46) must make plan benefits available in a nondiscriminatory manner, (47) and must not discriminate in plan amendments. (48) Each of these three types of discrimination has its own test to ensure that a qualified retirement plan is nondiscriminatory. (49) For the QSERP, the nondiscrimination-of-benefit-amount test is of particular importance.
An employer has great flexibility in how it wishes to compensate its employees, and it will pass nondiscrimination testing automatically if its retirement plan has a safe harbor design as described in the Treasury Regulations. (50) Generally, these safe harbor plans provide uniform benefits that the Treasury and IRS consider per se nondiscriminatory. (51) A safe harbor design can reduce risk and administration costs in a retirement plan, but it also requires certain restrictions in the plan's design. (52) However, a plan does not need to meet these strict standards to pass the general nondiscrimination testing. (53) The general test for nondiscrimination-in-benefit-amounts allows some flexibility.
Plans that do not fall under any safe harbor need to comply with the general test. (54) In essence, the general test compares the level of benefit accruals between HCEs and NHCEs to ensure that plans do not significantly discriminate in favor of the HCEs. (55) Though a person could write volumes on the general test, this Note will focus on the extent that the test allows the QSERP.
The important factor of the general test for nondiscrimination of benefit amounts is that it aims to prevent significant discrimination in favor of HCEs. (56) It does not provide any sanction for a plan that discriminates beneath the threshold defined by the test. (57) In addition, there are a number of different ways to perform the general test, so companies can manipulate it to pass. 58 The manipulation of the test and the permitted level of discrimination are what allow an employer to create a QSERP. (59)
i. A Permitted Level of Discrimination
The general test inherently allows a degree of discrimination. The testing formula requires that the proportion of HCEs at an accrual rate (60) not be greater than 70% of the proportion of NHCEs at the same or greater accrual rate. (61) Accrual rates are not necessarily uniform and many NHCEs can have high accrual rates because of salary increases. (62)
To illustrate, take the following simplified example: employees HCE1 and NHCE1 both participate in a one-percent-of-final-compensation-per-year-of-service defined benefit plan. HCE1 has ten years of service in 2007, makes $500,000 in 2007 and makes $530,000 in 2008. NHCE1 has 6 years of service in 2007, makes $45,000 in 2007 and makes $52,000 in 2008. Under the 1% formula, HCE1 has a benefit of $22,500 (63) in 2007, and a benefit of $25,300 (64) in 2008. Under the same formula, NHCE1 has a benefit of $2700 in 2007, and $3640 in 2008. To find the accrual, subtract the 2007 benefit from the 2008 benefit. (65) Finally, each employee's accrual rate is found by dividing the accrual by the employee's compensation in the testing period (in this case, 2008 compensation). HCE1 has an accrual rate of 1.217%66 and NHCE1 has an accrual rate of 1.808%. (67) Therefore, with the pay cap applied to the HCEs, along with greater proportional salary increases for an NHCE, the NHCE can have a much higher accrual rate even though the plan formula is uniform. (68)
The employer must calculate every employee's accrual rate (69) under the general test. (70) Then the test forms groups for every HCE in the plan. For each HCE, the group--called a rate group--is every employee (HCEs and NHCEs) with an accrual rate greater than or equal to the HCE's accrual rate. (71) The plan passes the general test if the proportion of NHCEs in that rate group is 70% or more of the proportion of HCEs in that group, when compared to the total employee population. (72)
To illustrate, recall HCE1 from the previous example with an accrual rate of 1.217%. In HCE1's plan, assume there are nine other HCEs with an accrual rate of 1.217% or greater, and ten below. For NHCEs, assume there are 60 above 1.217%, and 100 below. For HCE1, his rate group consists of ten HCEs and 60 NHCEs. The proportion of HCEs in the rate group is 50%, (73) and the NHCE proportion is 37.5%. (74) The ratio of these proportions is 75%. (75) Since 75% is greater than the 70% required by the test, HCE1's rate group passes the general test. If every HCE rate group passes the general test, the entire plan passes. (76)
However, a plan can still pass the general test even if it provides discriminatory benefits. If the employer wanted to inflate a particular HCE's benefit, it would still pass the general test as long as the accrual rates of the NHCEs were high enough to make each HCE' s rate group still pass the 70% ratio test. The benefits cannot be so discriminatory that the plan fails that general test, but it can still favor HCEs.
Recall HCE1 and NHCE1, who have accrual rates of 1.217% and 1.808%, respectively. Both employees have the same benefit of 1% of compensation per year of service, but both have two very different accrual rates. If HCE1 had $1359.30 of additional accrual added to his pension benefit, both HCE1 and NHCE1 would have the same accrual rate. Since the general test takes the cumulative accruals of the entire plan into account in applying the ratio test, (77) if there are enough NHCEs with high enough accrual rates, HCE1 can obtain this additional inflated benefit and the plan can still pass the general test. Accordingly, a "nondiscriminatory" plan can discriminate.
ii. Increasing the Discrimination Permitted in a Qualified Plan
In addition to the test itself having an allowable range of discrimination, many permitted methods allow an employer to pass the general test. With more tools to pass the test, an employer has a greater opportunity to discriminate in providing qualified benefits. If an employer wished, it could use these methods to justify placing a QSERP into a plan that otherwise was completely nondiscriminatory.
First, an employer can cross-test its plan. (78) In short, this means that the employer
can test a defined benefit plan on a defined benefit basis, or a defined contribution basis. (79) The same applies for defined contribution plans; an employer can test its plan on a defined benefits basis or a defined contributions basis. (80) The difference is how the test values the benefit accrual. A defined benefits basis values the accrual as the increase in the employee's annual benefit at normal retirement age; (81) the defined contributions basis values the accrual as the increase in a hypothetical retirement account held for the employee. (82) The actuarial factors and assumptions adjust the benefit to value the accrual differently. (83) This new method can produce different results for the test, potentially allowing an employer to discriminate in favor of specific employees and still pass nondiscrimination testing. (84)
Second, if an employer offers more than one retirement plan, the employer can aggregate the plans to pass nondiscrimination requirements. (85) As LaBombarde notes, "formal merger of the plans is not required, even if the aggregated plans cover separate groups within the employer, maintain separate funds, are of different types (e.g., defined contribution versus defined benefit), use different contribution or benefit formulas, or are different in any other way." (86) ultimately, this provides another method for an employer to have a discriminatory plan pass the nondiscrimination test. When an employer combines a failing plan with a passing plan, the resulting hypothetical plan can possibly pass the general test. There is no sanction even though the first plan was discriminatory.
Third, the Treasury Regulations permit three different measurement periods to use when calculating accrual rates. (87) To calculate the general testing accrual rates, the employer can choose the current plan year, the current plan year and all prior years, or the current plan year and all prior and future years. (88) The measurement period must be the same for every employee, but the employer can be change the method each year. (89) Each calculation can produce different outcomes. If a plan failed the general test under one method of calculating accrual rates, the employer could select a different method that potentially could make a plan pass.
iii. Integrated Plans and Permitted Disparity
An employer can create a specific plan formula to coordinate the private benefit with the employee's Social Security benefit. (90) This type of plan ensures that there will be adequate total retirement income for all employees. (91) However, employers can use this integration with Social Security to provide higher benefits to HCEs. (92)
The principle behind these plans is that the private benefit coordinates with an employee's Social Security benefit so that each employee will have income in retirement that is a target percentage of their current salary. (93) For example, a plan may target a replacement ratio of 80%. Hypothetical Employee A makes $2000 per month, and receives $1500 per month from Social Security upon retirement. Since the replacement ratio for this plan is 80% of his salary, his employer then would only provide a benefit of $100 to make up for the difference between his target benefit and the Social Security provided benefit. The employer will contribute 6.25% (94) of A's retirement income. Contrast A with Employee B, who makes $20,000 per month. B's Social Security benefit will comprise a much smaller amount relative to his final salary. (95) Now, B's target retirement income is $16,000, (96) so the employer's plan must provide a benefit of $11,000 to employee B. The employer provides 68.75% (97) of employee's retirement income. Despite the fact that B's private benefit is much larger in dollar amount, and as a percentage of retirement compensation, this plan is nondiscriminatory because when integrated with Social Security, they both provide 80% of the participant's final salary.
This type of plan has faced valid criticism, (98) but it is still considered a qualified plan under ERISA. (99) In extreme cases, the integration with Social Security has eliminated a lower-income worker's entire private retirement benefit. (100) Earlier versions of ERISA sought to eliminate these integrated formulas, but "the language was struck in the conference on the final draft of the law." (101) Congress enacted a few changes to the tax laws to limit the degree that Social Security can influence an employee's benefit, (102) but the practice of integrating Social Security with private qualified benefits still allows the possibility of employer discrimination in favor of HCEs.
On top of providing lopsided benefits, a plan integrated with Social Security can use advantageous adjustments to accrual rates to pass the general test for nondiscrimination of benefit amounts. (103) The adjustment amount differs depending on whether a person's annual compensation is above or below covered compensation. (104) Consequently, an HCE has a different adjustment than an NHCE. Since the accrual rates are the basis for determining if a plan passes the general test, if the NHCE accruals are adjusted higher than the HCEs, the plan can more easily pass the general test. (105) Such a scenario is not farfetched. The Treasury Regulations' own example shows that an employer can adjust the rates to help pass the general test. (106) Thus, integrating a plan with Social Security can make it even easier for an employer to provide discriminatory benefit amounts.
iv. Nondiscriminatory Plan Amendments
If a plan amendment or series of amendments discriminates significantly in favor of highly compensated employees, the plan is likely to fail nondiscrimination requirements. (107) However, "even if only HCEs receive higher accruals or only NHCEs receive lower accruals under the amendment," (108) the amendment does not necessarily fail nondiscrimination testing. (109) For example, a plan that previously did not integrate its benefits with Social Security can choose to adopt an amendment to integrate with Social Security. The end result of the amendment would greatly favor highly compensated employees, but it does not necessarily violate the nondiscrimination rules.
While the entire plan cannot violate the nondiscrimination rules, the IRS does not apply the same standard to plan amendments. Instead, the IRS uses a "subjective assessment based on all relevant facts and circumstances" to evaluate a plan amendment's nondiscriminatory character. (110) There are a number of common factors investigated, but the essence of the test is subjective and difficult to predict. (111) LaBombarde has even described the rule as "like the loaded chamber in a game of Russian roulette. A plan can fully satisfy objective standards under all other rules, yet still be at risk." (112)
Yet, evidence suggests that employers are willing to play this game of Russian roulette by attempting to pass discriminatory amendments. Employers have a few ways to increase their chances of gaining IRS approval. (113) Recently, an official from the United States Treasury said, "[w]ith too little staffing to check the dozens of pages of actuaries' calculations, the IRS generally accepts the companies' assurances that their pension plans pass the discrimination tests." (114) In addition, the employers that submit these proposed amendments for IRS approval can conceal a discriminatory outcome within complex and numerous amendments. (115)
Even if the IRS approves a discriminatory amendment, the plan still needs to pass the nondiscrimination tests for benefit availability and amount. (116) This still creates considerable risk to the employer. If a discriminatory amendment coincides with a shift in the plan's demographics, the plan may fail nondiscrimination testing. (117) However, as previously described, the employer can enhance the plan's ability to pass the nondiscrimination tests. (118)
3. Penalties for Discriminatory Plans
Failure to follow the qualification rules of [section] 401(a) can lead to many sanctions. Tax deductions may not be allowed for certain contributions, (119) plan earnings may become taxable, (120) employer contributions may be included in the employee's income, (121) the vested accrued benefit of a highly compensated employee may be included in that person's income, (122) or tax-free rollovers may not be allowed. (123) The IRS singles out nondiscrimination violations as "demographic failures," and violators face special sanctions. (124) These penalties "generally require a corrective amendment to the plan that adds benefits or increases existing benefits." (125) These amendments may be tremendously expensive in both administrative and benefit costs.
D. Supplemental Executive Retirement Plans (SERPs)
A private employer has great flexibility in how it compensates its employees. Employers can freely discriminate in their benefits, but these plans cannot enjoy tax-qualified status. Many employers still want to provide benefits for highly paid employees that suit their compensation, but cannot because of the imposed limitations on qualified plans. (126) As a result, they often turn to supplemental executive retirement plans (SERPs) to provide a benefit beyond what is provided by the qualified plan. (127)
For example, say hypothetical employee HCE2 makes $300,000 per year and participates in both a qualified plan and SERP plan offered by his employer. As mentioned earlier, [section] 401(a)(17) limits the amount of compensation used under the qualified plan formula ($230,000 for 2008). (128) HCE2 has a benefit under the qualified plan based on that $230,000 of his compensation. The SERP can provide an additional benefit based on the $70,000 of his compensation that was above the [section] 401(a)(17) compensation limit. (129) When combining the SERP with the qualified plan, the employee has his entire compensation factored into his retirement benefit. (130)
Since SERPs do not satisfy ERISA provisions on compensation limits and nondiscrimination, they do not enjoy the preferential status of qualified plans. (131) The IRS taxes an employee's SERP plan benefits as nonqualified benefits, not qualified tax benefits. (132) While an employer is free to offer this type of nonqualified plan, it does not enjoy the tax benefits of a qualified plan. (133)
E. The "Qualified" Supplemental Executive Retirement Plan (QSERP)
Following a discussion of SERP plans, qualified supplemental executive retirement plans seem to be a misnomer. SERPs are by their definition nonqualified because they exist outside the [section] 401(a) requirements. (134) Thus, a QSERP seems to be an oxymoron. However, strategic manipulation of benefits can allow SERP benefits into a qualified plan.
To illustrate, consider HCE2 again. (135) HCE2's qualified plan provides 1.5% of his final salary per year of service upon retirement, but it is subject to the qualified plan limitations. Now, let us say HCE2 has 20 years of service. HCE2's benefit would be his capped salary ($230,000) times the percent multiplier (1.5%) times his years of service (20 years), giving him a total benefit of $69,000 (136) per year under the qualified plan. If the pay limits were not recognized, HCE2 would have received a benefit of $90,000. (137)
If the employer wants HCE2's benefit to be in the qualified plan, it can adjust his benefit with a discriminatory plan amendment. The simplest form of amendment can provide a dollar increase to his benefit payable at retirement. (138) HCE2's employer could create a discriminatory amendment to provide him $21,000 in additional retirement income in the qualified plan as long as the employer does not put HCE2's accrual rate so high that it causes the employer's plan to fail nondiscrimination testing. (139) The employer can perform the nondiscrimination test calculations on its current plan population to figure out the degree to which it can inflate benefits for selected employees so it will still pass nondiscrimination testing even after providing discriminatory benefits through the amendment. The employer can game the nondiscrimination rules this way.
Even if the plan is close to failing the general test, the flexibility allowed in the test can still provide a way for employers to create a QSERP. (140) The plan could be cross-tested, (141) use different measurement periods, (142) or be aggregated with another plan to satisfy the test. (143) The employer could also change the plan formula to integrate with social security, and the increased imputed disparity factors could allow even greater benefits to favor selected executives. (144) All of these characteristics of the nondiscrimination test actually permit an employer to create discrimination in favor of HCEs. Since the IRS has a lax enforcement policy toward discriminatory plan amendments, (145) and the general test has enough leeway to allow some degree of discrimination, an employer can choose to inject favorable executive discrimination into its qualified plan and remain in compliance with all the pertinent nondiscrimination requirements. In essence, this is how the QSERP works.
Thus, an employer may manipulate these laws to discriminate in providing benefits. To compound the abuse, the employer creating a QSERP sometimes accompanies the increase in qualified benefits with a reduction in its liabilities under the SERP plan. (146) In the end, the employer has taken SERP benefits and manipulated these benefits into the qualified plan. On its face, it would seem contrary to the primary principle of [section] 401(a)(4), that employers may not provide discriminatory benefits. (147)
F. Section 409A
Section 409A imposes new rules on nonqualified deferred compensation. (148) The final regulations published by the IRS and Treasury took effect December 1, 2009, (149) but have an ambiguous stance on how they treat QSERPs. (150) The final regulations have one section that could potentially permit QSERPs, and one that could potentially prevent QSERPs. (151)
The QSERP creates new obligations for a qualified plan while often extinguishing obligations in the nonqualified plan. (152) However, the QSERP is also an amendment that raises qualified benefits while potentially reducing the offsetting nonqualified benefits. (153) Section 409A makes it illegal to create new obligations to satisfy existing nonqualified deferred compensation obligations. (154) Since the QSERP could be considered to fall under this section, there is potential to interpret [section] 409A as barring the QSERP. However, the regulations also allow benefits in a nonqualified plan to be decreased when an employer increases qualified benefits. (155) It is uncertain whether the QSERP is considered a decrease in nonqualified benefits as a result of increasing qualified benefits, or a new obligation created to settle a nonqualified deferred compensation obligation. (156)
The QSERP uses the amendment process to illegitimately manipulate the nondiscrimination rules' flexibility to obtain tax-qualified status. (157) This is primarily because the nondiscrimination requirements for amendments are out of date and lack proper IRS resources to enforce them. The QSERP violates and abuses many of the benefits intended for rank-and-file employees, and the amendment process is how it is accomplished. The entire purpose of the nondiscrimination requirements is to prevent qualified plans from favoring HCEs. There is no reason why the QSERP should remain an allowed practice.
A. The Problematic Status of the Current Nondiscrimination Rules for Plan Amendments
The current legal framework the IRS provides for nondiscrimination of pension plan amendments has the same problems that pension plans had in the 1970s. The original 1942 nondiscrimination rules were criticized as too simple, too broad, and easy to manipulate. (158) When Congress passed ERISA in 1974, it sought to clarify and inhibit discriminatory practices in how employers administered and provided pension benefits. (159) The current rules for plan amendments, however, are very similar to the old and ineffective general pension rules ERISA tried to displace. (160) The current rules permit an amendment based on the proposal's "facts and circumstances." (161) A plan sponsor can hide the nature of an amendment, making it difficult to determine the facts and circumstances surrounding it and make the amendment so complex that it is difficult to fully understand its true purpose. (162)
The IRS's limited resources compound the problem. The IRS has a limited staff available to check the complex actuarial calculations involved in these amendments. (163) Even if the IRS had adequate personnel resources, employers often hide a discriminatory provision within many valid provisions, making it even more difficult for the IRS to catch a violation. (164) Similar to the pre-ERISA rules, (165) these limitations and flexibility give employers the ability to manipulate the nondiscrimination rules.
B. The QSERP Runs Contrary to the Purpose of ERISA and Executive Compensation Laws
Once an employer passes an amendment that executes a QSERP, it creates a discriminatory qualified benefit. (166) The Treasury specifically designed the lengthy and complex nondiscrimination provisions so that employers could not selectively provide benefits only to highly paid employees under a plan and still have that plan enjoy tax-qualified status. (167) However, the QSERP--a process essentially created by the regulations--allows exactly what the regulations sought to prevent. (168)
First, the end result provides selected employees with preferential treatment over other employees. It is facially discriminatory, but technically permitted. (169) Slight discrimination is permitted for a two reasons: the complexity of the retirement systems and differing approaches in an appropriate benefit. (170) However, neither of these reasons validate the use of a QSERP.
In fact, the QSERP only exists because employers exploited the permitted flexibility in the nondiscrimination rules with a plan amendment. (171) Generally speaking, the nondiscrimination rules aim to treat every employee equally, without regard to their level of compensation. However, retirement systems and plans are so complex that a simple uniform plan for every participant is impractical. (172) As a result, the rules allow for some flexibility. (173) The QSERP essentially injects discrimination into a plan to favor executives. Due to the nature of the nondiscrimination tests, a retirement plan has some leeway to provide selected qualified benefits for certain employees and still be considered "fair." The QSERP makes a discriminatory amendment that increases the qualified benefit for a specific person or specific people, but not so much that it will no longer pass testing. (174) It exploits the technical test to make the plan more discriminatory. (175)
Qualified retirement plans provide advantageous treatment for private retirement plans that do not discriminate. (176) However, through a loophole in the technical nondiscrimination rules, the QSERP gives an incentive to discriminate. (177) The QSERP facially discriminates in favor of specific employees but still enjoys advantageous treatment, contrary to ERISA's purpose.
Once an employer transfers a nonqualified SERP benefit into a qualified plan, the executives' benefits gain a number of additional advantages. However, none of these advantages were ever supposed to apply to excessive compensation. (178) This results in a general taxpayer subsidy for employers and employees that utilize this strategy and a potential risk to the other rank-and-file members of the qualified plan.
The employer also gains advantages when it shifts liabilities from a SERP plan to a qualified plan via a QSERP. The amount of tax deductible contributions an employer can make to its qualified plan is based on the liabilities owed to the plan participants. (179) However, a nonqualified plan has no tax deduction for payments or contributions until the employee recognizes the amount as gross income. (180) When the employer shifts its payment obligations from a nonqualified plan to a qualified plan, it creates an immediate tax deduction out of liabilities in the nonqualified plan. The employer can then take a greater (181) qualified tax deduction and eliminate the transferred liability from the SERP plan.
This deduction in principle runs contrary to the purpose of ERISA. The compensation limits, benefit limits, and nondiscrimination rules all indicate that the benefits in qualified plans are for rank-and-file employees, and not as pretext for providing greater benefits for HCEs. The Code clearly grants the tax incentive for the distinct purpose of providing a nondiscriminatory plan. (182) This advantage is not to apply to nonqualified benefits. (183) The QSERP is a mechanism by which the employer is able to gain a tax advantage for these nonqualified benefits.
Beyond the employer's tax deduction, the employee also enjoys several benefits from the QSERP transferring liabilities into a qualified plan. First, the employee's benefit is much more secure in a qualified plan. (184) If an employer fell into financial trouble, creditors can lay claim to that employer's assets. (185) However, in the interest of protecting employees' retirement benefits, the assets in a qualified plan are legally protected from those creditors. (186) Often, nonqualified benefits are not funded--the employer does not set aside the money to pay benefits before they are paid. (187) As a result, nonqualified benefits can be subject to a substantial risk of forfeiture if the employer runs into financial trouble. However, when the employer transfers the benefit into the qualified plan, an employee can utilize this legal advantage to secure the benefit.
Further, the employee also gains a tax advantage when the employer contributes to the qualified plan. (188) Participants in a tax-qualified plan do not have their benefits taxed until the money is paid out. (189) For a defined benefit plan, this offers a few advantages. First, it helps fund the promised benefit. The amount of money that the IRS would have taxed upon contribution is now passed into the retirement trust. The trust earns a rate of return and over time it accumulates to provide the employee's benefit. By delaying the taxation, the fund earns a higher investment and interest return. This increases the plan's assets and improves the funded status of the plan. Second, deferring taxation until payment usually results in a lower marginal income tax rate. (190) The employer pays these benefits upon employee retirement, when the employee is not earning any income from working. As a result, total income is lower and more likely to be taxed at a lower marginal rate. (191)
Alternatively, the IRS taxes nonqualified benefits as deferred compensation. (192) The employee is subjected to the more complex deferred compensation laws that generally make the benefit taxed when vested, when constructively received, or when the economic benefit is conferred. (193) This makes the taxes due sooner and is therefore more costly to the employee. (194)
Finally, the transfer of liability to the qualified plan creates a risk that benefits will not be available or funded for the average participants in these plans. On average, an executive that has a SERP benefit is older and highly paid. (195) The QSERP creates additional liabilities for the qualified plan, (196) but these liabilities are particularly high because of the age and compensation of the executive. The benefits amounts cannot be excessively large or they will trigger nondiscrimination sanctions, (197) but generally, the executive's benefit is larger than the typical qualified plan participant's benefit. In addition, since the executive is older and closer to retirement, there is only a short period to discount the new liabilities placed upon the qualified plan. The liability will be disproportionately large compared to typical accrued liabilities in the plan.
The transfer of liabilities raises the contributions required to keep the plan free from sanctions. Under the Pension Protection Act, and employer will face sanctions if the funding percentage falls below 80%, and stricter sanctions if the percentage falls below 65%. (198) The employees participating in the plan can lose lump sum options and other various optional forms of benefit, and have future accruals curtailed or eliminated. (199) This harms the entire participating group's benefit, and with other sanctions and complications in administering the underfunded plan, the employer may choose to ultimately freeze or close the plan.
To illustrate how the QSERP can potentially harm the plan, say Qualified Plan A has $80,000 of assets and $100,000 of present-value liabilities. The funded status is 80%. (200) Now, if a QSERP adds $20,000 of liability for an executive benefit into this plan, the funded status is now 67%. (201) The plan will be subject to sanctions simply due to the transfer of liability. (202)
Further, the employer will now have to calculate minimum contributions to the plan based on $120,000 of liability instead of $100,000. The increased obligation may not always be a strain for the employer, but since the regulations aim to ensure rank-and-file employees' benefits are secure, there is no reason to allow an employer to execute a QSERP. It can only harm the benefit promised to every other worker in the plan.
A. The Internal Revenue Service Must Become More Aggressive Toward Plan Amendments
Even with all of the flexibility in the nondiscrimination testing, the QSERP cannot function without a discriminatory plan amendment. (203) The IRS enforces the rules ensuring that qualified plans do not provide discriminatory benefits, but it does not adequately regulate the amendment process. (204) The IRS could improve regulating plan amendments by expanding its resources or by placing a heightened requirement on employers seeking to amend their plans.
1. Expand the Resources to Monitor Plan Amendments
As discussed earlier, the IRS simply does not have the staff and resources to thoroughly check all amendments submitted for approval. (205) The simplest fix would be to increase the number of staff dedicated to checking the nondiscriminatory nature of each plan amendment. However, this solution seems to solve only part of the issue. Employers have been clever about making the amendments complex and secretive, providing other additional information to disguise the discriminatory plan amendment. 206 Simply increasing the staff would allow more eyes to scrutinize these complex amendments, but it would not alleviate the issue altogether.
2. Impose Heightened Standards on Employers Submitting Amendments for IRS Approval
Additionally, the IRS should raise the standard required for employers seeking to amend their retirement plans. If the IRS cannot keep up with checking all the calculations and testing required to properly approve these amendments, that work could be transferred to the employer. An employer could be obligated to make a clear, signed submission to the IRS demonstrating the effect of their amendment for nondiscrimination purposes. Under this process an employer would be defrauding the IRS, instead of just submitting a complicated amendment, when the employer obtains a QSERP. However, Intel directly disclosed their movement of retirement liabilities from the SERP to the qualified plan, and the IRS acquiesced. (207) The Intel example indicates that even if all the information is provided, the IRS may still approve the QSERP. As a result, it seems the way to ensure QSERPs are no longer allowed is a change in policy.
B. Interpret or Amend [section] 409A to Explicitly Prevent QSERPs
It would be a simple matter for Congress to amend [section] 409A or for the Treasury to issue regulations to prevent the QSERP. As mentioned earlier, the final [section] 409A regulations issued have unclear suggestions on how they treat QSERPs. (208) One interpretation says that substitution of a new obligation to replace a nonqualified deferred compensation agreement is invalid. (209) Another section says that it is permissible for an employer to increase benefits in a qualified plan and simultaneously reduce nonqualified benefit obligations. (210) Neither Congress, the Treasury, nor the IRS explicitly reject or accept the QSERP.
However, the provision allowing an increase in qualified benefits to accompany a decrease in nonqualified benefits is unlikely to have meant that QSERPs are valid. Any nonqualified plan linked to the compensation not covered by a qualified plan will have its benefits reduced if the qualified plan's benefits are increased. A qualified plan increase must be allowed to have a nonqualified decrease accompany it--otherwise if any employer had a qualified plan and a related nonqualified plan, simply amending the qualified plan would actually discriminate in favor of the participants in the nonqualified plan. The likely reason for this provision in the final [section] 409A regulations was to allow plans to keep using the nonqualified plans that were connected to their qualified benefits, not to provide QSERPs. It would be a simple process for the Treasury to issue a regulation clarifying that the QSERP is considered a substitution of a nonqualified deferred compensation obligation, and thus impermissible under [section] 409A.
As the saying goes, it is hard to see the forest for the trees. The complexity of the nondiscrimination rules can shift sight from the reason for their implementation. This Note tried to make the general process as simple as possible to show the QSERP exploitation, but in the depth of all the technical analysis it helps to step back to gain perspective. All of the complex nondiscrimination tests are merely a construct of the IRS and Treasury to enforce one sentence in 401(a)(4), which says that benefits provided under a qualified retirement plan must not discriminate in favor of highly compensated employees. 211 It is ironic that the regulations provided to enforce that single sentence are what create the discriminatory QSERP.
Excessive executive compensation and concern over the status and security of retirement benefits are both areas of primary concern. The QSERP is a problem on both fronts: it increases executive compensation while raising risks to rank-and-file retirement benefits. There is no valid reason to allow this practice to continue.
(1.) 29 U.S.C. [section] 1001(a) (2006).
(2.) G. NEFF MCGHIE III, DEFINED BENEFIT ANSWER BOOK Q1:2 (2003).
(3.) See generally I.R.C. [section][section] 401^436 (2008) (describing federal regulations of retirement plans).
(4.) I.R.C. [section] 401(a)(4).
(5.) See generally Treas. Reg. [section] 1.401(a)(4) (2008) (explaining the nondiscrimination tests).
(6.) See 29 U.S.C. [section] 1001(a) (2006) ("The Congress finds that the ... economic impact of [employee benefit] plans ... affect[s] ... national public interest.").
(7.) RSM MCGALDRY, INC., MANDATED BENEFITS 2007 COMPLIANCE GUIDE [section] 27.02 (2007).
(8.) See infra Part II.E (explaining how a QSERP works).
(9.) See id. (demonstrating how a QSERP does not violate retirement plan laws or regulations).
(10.) See infra Part III.B (explaining the benefits gained by the QSERP).
(11.) Remarks by President Barack Obama on Executive Compensation with Secretary Geithner (Feb. 4, 2009), http://www.whitehouse.gov/the-press-office/remarks-president-barack- obama-executive-compensation-with-secretary-geithner.
(12.) A Milliman study of 100 companies shows their retirement plans were 81.7% funded in 2009. JOHN W. EHRHARDT & PAUL C. MORGAN, MILLIMAN, MILLIMAN 2010 PENSION FUNDING STUDY (April 2010), http://www.milliman.com/expertise/employee-benefits/products-tools/pension- funding-study/pdfs/pensionfunding-study.pdf.
(13.) A tax-qualified plan is a plan that satisfies all the requirements of [section] 401(a). I.R.C. [section] 401(a). Such plans receive preferential tax treatment for both employees and employers. Id. [section] 404.
(14.) EVERETT T. ALLEN, JR. ET AL., RETIREMENT PLANS: 401(k)s, IRAs, AND OTHER DEFERRED COMPENSATION APPROACHES 49 (10th ed. 2007).
(15.) Michael J. Collins, Reviving Defined Benefit Plans: Analysis and Suggestions for Reform, 20 VA. TAX REV. 599, 605 (2001).
(17.) Joshua A. Rodine, Does the Cash Ever Balance After Conversion?: An Examination of Cash Balance Pension Plan Conversions and ADEA Claims, 9 ELDER L.J. 285, 292-93 (2001).
(18.) Id. at 293.
(19.) Patricia E. Dilley, The Evolution of Entitlement: Retirement Income and the Problem of Integrating Private Pensions and Social Security, 30 LOY. L.A. L. REV. 1063, 1143 (1997).
(23.) 29 U.S.C. [section] 1001b(a)(2) (2006) (detailing congressional findings regarding termination insurance systems).
(24.) Id. [section] 1001(a) (discussing congressional findings regarding benefit plans).
(25.) JAMES A. WOOTEN, THE EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974: A POLITICAL HISTORY 4 (2004) (explaining how the "personnel theory" led to considerable risks for worker's retirement benefits).
(26.) Id. at 43-46.
(27.) See id. at 55-56 (illustrating the Kaiser-Frazer Corporation's scheme to avoid plan liabilities by exploiting the forfeiture risk of the retirement plan).
(28.) Id. at 4 (giving background on pension risks in the 1950s and 1960s).
(29.) Dilley, supra note 19, at 1150 (discussing legislative efforts to provide nondiscrimination rules).
(30.) 29 C.F.R. [section][section] 2509.75-8 (2008) (answering questions regarding ERISA).
(31.) I.R.C. [section] 410(b) (2008) (providing minimum coverage requirements for employee benefit plans).
(32.) Id. [section] 411 (providing minimum vesting standards for retirement benefits).
(33.) Id. [section] 412 (providing minimum funding standards for benefit plans).
(34.) Id. [section] 401(a)(4) (giving requirements for qualified plans); id [section] 414 (giving special rules for certain plans); I.R.C. [section] 415 (2008) (stating limitations on benefits under qualified plans).
(35.) Evelyn A. Petschek, Panel Discussion: The Role of Regulation in Pension Policy, in The Future of Pensions in the United States 279 (Ray Schmitt ed., 1993).
(39.) Id. at 279-80.
(40.) BARBARA J. COLEMAN, PRIMER ON ERISA 19-20 (4th ed. 1993).
(41.) See infra Part II.E (explaining how a QSERP works).
(42.) I.R.C. [section][section] 401(a)(17), 415 (2008).
(43.) I.R.S. News Release IR 2007-171 (Oct. 18, 2007), available at http://www.irs.gov/newsroom/article/0,,id=174873,00.html.
(45.) I.R.C. [section] 401(a)(4) (2008) (giving requirements for qualified pensions).
(46.) Treas. Reg. [section] 1.401(a)(4)-1(b)(2) (2008).
(47.) Id. [section] 1.401(a)(4)-1(b)(3).
(48.) Id. [section] 1.401(a)(4)-1(b)(4).
(49.) See id. [section] 1.401(a)(4)-2 to -5, -8 (explaining the specific tests for each type of discrimination).
(50.) Treas. Reg. [section] 1.401(a)(4)-3(b) (2008).
(51.) Id. [section] 1.401(a)(4)-3(a)(1) (providing an overview of nondiscriminatory rules).
(52.) Adrien R. LaBombarde, A Guide to Nondiscrimination Requirements for Qualified Pension and Profit-Sharing Plans, PENSION PLAN GUIDE, Dec 12, 1991, at 213.
(53.) Treas. Reg. [section] 1.401(a)(4)-3(a)(1).
(55.) See STEPHEN J. KRASS ET AL., THE 2007 PENSION ANSWER BOOK Q4:9 (2007) (providing a summary and example of the general test).
(58.) See LaBombarde, supra note 52, at 239-302 (providing an overview of the general test with numerous different ways the test can be performed).
(59.) See infra Part II.C.2.i-iv (discussing how QSERPs are created).
(60.) The accrual rate is the amount of benefit accrued in the testing period divided by the average compensation in the testing period. LaBombarde, supra note 52, at 255.
(61.) Treas. Reg. [section] 1.401(a)(4)-3(c)(1) (2008) (requiring that each rate group satisfy [section] 410(b)); I.R.C. [section] 410(b) (2008) (providing the 70% test for qualified plans). The plan may alternatively satisfy the "average benefits test," I.R.C. [section] 410(b)(2), but that discussion is tangential and unnecessarily complex for this analysis of the QSERP.
(62.) To contrast, the HCE salary for the test is capped by the [section] 401(a)(17) pay limit. Treas. Reg. [section] 1.401(a)(4)-3(d)(1)(i) (explaining that the numerator of the fraction used to determine the accrual rate is the employee's accrued benefit, which is capped under I.R.C. [section] 401(a)(17)). This limit is only increased by indexation to the cost of living adjustment provided by the Commissioner. I.R.C. [section] 401(a)(17)(B). As a result, the pay and accrual rates of NHCEs can increase more quickly than HCEs.
(63.) $225,000 x 1% x 10 years. Recall that HCEs pay under the formula is capped by the [section] 401(a)(17) limit. Supra Part II.C. 1.
(64.) $230,000 x 1% x 11 years.
(65.) $2,800 for HCE1 and $940 for NHCE1.
(66.) $2,800 / $230,000.
(67.) $940 / $52,000.
(68.) There are numerous other factors that can lead to the same result, this example is just meant to simply illustrate the general concept.
(69.) The employer must also calculate the Most Valuable Accrual Rate. Treas. Reg. [section] 1.401(a)(4)-3(c)(1) (2008). However, that additional step is not relevant to the concept illustrated here.
(70.) Treas. Reg. [section] 1.401(a)(4)-3(c)(1).
(72.) Id. (requiring that each rate group satisfy [section] 410(b)); I.R.C. [section] 410(b) (2008) (providing the 70% test for qualified plans).
(73.) 10 HCEs in the rate group divided by 20 HCEs in the plan total.
(74.) 60 / 160.
(75.) 37.5% / 50%.
(76.) KRASS et al., supra note 55, at Q4:17.
(77.) Treas. Reg. [section] 1.401(a)(4)-3(c)(1) (2008).
(78.) See KRASS et al., supra note 55, at Q4:21 (discussing the process of cross-testing).
(81.) For example, an increase from $100 to $120 payable at normal retirement age.
(82.) LaBombarde, supra note 52, at 287-93 (discussing conversion of benefits basis to contribution basis, or cross-testing). In general, this is the actuarial present value of the benefit increase. Since defined benefit plans usually define the benefit as an amount payable at retirement, this method converts that amount to a present value adjusted for interest and mortality.
(83.) AMY L. CAVANAUGH & THOMAS E. POJE, COVERAGE AND NONDISCRIMINATION ANSWER BOOK Q11:7 (2002) (explaining that cross testing converts the benefit using certain actuarial assumptions). The actuarial assumptions are used to "normalize" the benefit for the test. Id at Q11:8.
(84.) Id. at Q11:5.
(85.) LaBombarde, supra note 52, at 293-99 (discussing plan aggregation).
(86.) Id. at 293.
(87.) Treas. Reg. [section] 1.401(a)(4)-3(d)(1)(iii) (2008).
(89.) Id. [section] 1.401(a)(4)-3(d)(1)(iv).
(90.) COLEMAN, supra note 40, at 48-50.
(91.) LaBombarde, supra note 52, at 169.
(92.) See Dilley, supra note 19, at 1141 ("The integration rules represent the escape hatch out of the nondiscrimination rules for employers who want to provide higher benefits to high-wage workers.").
(93.) COLEMAN, supra note 40, at 49.
(94.) $100 / $1600.
(95.) Hypothetically $5000 per month. Social Security benefits are only calculated based on salary below the Social Security Wage Base. Higher-paid employees will get a lower percentage of their income replaced by Social Security than lower-paid employees will. ALLEN, supra note 14, at 310.
(96.) 80% x $20,000.
(97.) $11,000 / $16,000.
(98.) Dilley, supra note 19, at 1179-81.
(99.) CAVANAUGH & POJE, supra note 83, at Q10:1.
(100.) COLEMAN, supra note 40, at 49. This type of plan was challenged in court for violating ERISA nonforfeiture provisions, but the court held that these plans were permissible so long as the assumptions used to calculate the Social Security benefit were not unreasonable. See Dameron v. Sinai Hosp. of Baltimore, Inc., 815 F.2d 975 (4th Cir. 1987) (upholding the integrated plan when calculation assumptions are reasonable).
(101.) COLEMAN, supra note 40, at 50.
(103.) Treas. Reg. [section] 1.401(a)(4)-7(a) (2008).
(104.) Id. [section] 1.401(a)(4)-7(c)(i). "Covered compensation is defined as the average Social Security taxable wage base for the 35 years ending with the participant's normal retirement age under Social Security." DAN M. MCGILL ET AL., FUNDAMENTALS OF PRIVATE PENSIONS 156 (8th ed. 2000).
(105.) See supra Part II.C.2.i (describing the general test).
(106.) The example shows a HCE with an unadjusted accrual rate of 1.7% and a NHCE with a 1.48% unadjusted rate. Treas. Reg. [section] 1.401(a)(4)-7(c). After the imputed disparity adjustments, the HCE's rate is 1.88% and the NHCE's rate is 2.23%. Id. The NHCE went from accruing 0.22% less than the HCE, to accruing 0.35% more. Id. Changing the rates in this manner greatly improves the plan's ability to pass the general test. See supra Part II.C.2.i (describing the general test).
(107.) LaBombarde, supra note 52, at 163.
(110.) Id. at 165.
(112.) LaBombarde, supra note 52, at 165.
(113.) Ellen E. Schultz & Theo Francis, Companies Tap Pension Plans to Fund Executive Benefits, Wall St. J., Aug. 4, 2008, at A1, available at http://www.corpwatch.org/article.php?id=15148.
(116.) Treas. Reg. [section] 1.401(a)(4)-1(b)(2)(i) (2008); id. [section] 1.401(a)(4)-1(b)(3).
(117.) Watson Wyatt Worldwide, QSERPs: A Quirky Executive Perk Gains Interest, INSIDER, Oct. 1999, available at http:// online.wsj.com/public/resources/documents/watsonwyatt-ceofund-01102007.pdf (cautioning employers of the risks involved with a QSERP).
(118.) See supra Part II.C.2.ii. (discussing ways that an employer can increase its ability to pass the general test).
(119.) I.R.C [section] 404(a) (2008).
(120.) Id. [section] 501(a).
(121.) Id. [section] 402(b)(1).
(122.) Id. [section] 402(b)(4)(A).
(123.) Id. [section] 402(c).
(124.) Rev. Proc. 2008-50, 2008-35 I.R.B. 464.
(125.) KRASS et al., supra note 55, at Q19:5.
(126.) ALLEN et al., supra note 14, at 244.
(127.) Id. at 247.
(128.) I.R.C. [section] 401(a)(17) (2008); I.R.S. News Release, supra note 43.
(129.) BARRY K. DOWNEY ET AL., NONQUALIFIED DEFERRED COMPENSATION ANSWER BOOK Q1:21 (2010).
(131.) ALLEN et al., supra note 14, at 246.
(132.) DOWNEY et al., supra note 129, at Q1:2.
(134.) See supra Part II.D (explaining SERPs).
(135.) See id. (describing HCE2 for example purposes).
(136.) $230,000 x 20 x 1.5%.
(137.) 1.5% x 20 x $300,000.
(138.) See Watson Wyatt Worldwide, supra note 117 (explaining how to execute a QSERP).
(139.) See supra Part II.C.2 (discussing the general test).
(141.) See supra Part II.C.2.ii. (describing cross testing).
(144.) See supra Part II.C.2.iii. (showing how integrated plans using imputed disparity can more easily pass the general test).
(145.) See supra Part II.C.3 (noting the difficulty the IRS has in policing plan amendments).
(146.) Intel Corp., Definitive Proxy Statement (Form DEF 14A), at 35 (Apr. 2, 2008), available at http://online.wsj.com/public/resources/documents/intel-08042008.pdf.
(147.) I.R.C. [section] 401(a)(4) (2008).
(148.) Association for Advanced Life Underwriting, "Qualified" Supplemental Executive Retirement Plans, Wash. Rep. (Aug. 18, 2008) at 3, available at http://www.rosscompanies.com/file/WashingtonReport/Bulletin08-76.pdf.
(152.) See supra Part II.E (explaining how a QSERP works).
(154.) "[T]he payment of an amount as a substitute for a payment of deferred compensation will be treated as a payment of the deferred compensation." Treas. Reg. [section] 1.409A-3(f) (2008). The regulation further explains that a right to a payment will have the same effect as "payment." Id.
(155.) Id. [section] 1.409A-3(j)(5).
(156.) See Association for Advanced Life Underwriting, supra note 148 (showing the conflicting positions in relation to the QSERP).
(157.) See supra Part II.E (explaining how a QSERP works).
(158.) Petschek, supra note 35.
(160.) See supra Part II.C.3 (explaining the nondiscrimination rules as applied to plan amendments).
(161.) 26 C.F.R. [section] 1.401(a)(4)-5 (2008) (listing numerous factors considered under the "facts-and-circumstances test).
(162.) Schultz & Francis, supra note 113.
(165.) Petschek, supra note 35.
(166.) See supra Part II.E (describing the QSERP).
(167.) Petschek, supra note 35.
(168.) See supra Part II.E (describing the QSERP).
(170.) Some employers just provide a benefit while others take a "replacement ratio" approach that integrates with other forms of retirement compensation to create a total retirement package. See supra Part II.C.2.iii (discussing the replacement ratio).
(171.) See supra Part II.E (describing the QSERP).
(172.) See supra Part II.C.2 (describing the policy of allowing flexibility in plan benefits).
(174.) See supra Part II.E (explaining the QSERP). The plan must still pass general testing, so the increased discrimination must not be large enough to fail the general test. See supra Part II.C.2.i (explaining the general test).
(176.) I.R.C. [section] 401(a)(4) (2008).
(177.) Schultz & Francis, supra note 113.
(178.) See, e.g., I.R.C. [section] 401(a)(4) (stating that qualified pension, stock, and profit-sharing bonus plans must not discriminate in favor of highly compensated employees); id. [section] 401(a)(17) (creating a maximum amount of compensation to be used in calculating retirement plan benefits).
(179.) Id. [section] 404(o) (defining the maximum deductible contribution); id. [section] 430(d)(1) (defining the "funding target").
(180.) Id. [section] 404(a)(5).
(181.) Other things equal, the immediate deduction is greater because of the time value of money.
(182.) I.R.C. [section] 401(a)(4) (2008).
(184.) HENRY A. SMITH, III ET AL., NONQUALIFIED DEFERRED COMPENSATION ANSWER BOOK Q1:35 (4th ed. 2000) (explaining that if "nonqualified plan benefits are paid out of an employee's general assets, those assets are subject to the claims of all of the employer's bankruptcy and nonbankruptcy creditors").
(186.) MCGILL ET AL., supra note 104, at 185 (citing I.R.C. [section] 401(a)(13) (2008) and 29 U.S.C. [section] 203(g) (2006)).
(187.) ALLEN, JR., ET AL., supra note 14, at 260.
(188.) KRASS ET AL., supra note 55, at Q1:6.
(190.) MARGARET MILNER RICHARDSON, ERNST & YOUNG LLP, THE ERNST & YOUNG TAX SAVERS GUIDE 2003 4 (Peter Bernstein ed., 2003).
(192.) BRIAN KOPP, NIXON PEABODY LLP, NEW TAX RULES FOR NONQUALIFIED DEFERRED COMPENSATION PLANS 1 (2004), available at http://www.nixonpeabody.com/linked_media/publications/BA_10122004.pdf (discussing new rules for nonqualified deferred compensation plans effective in 2004).
(193.) BRUCE R. ELLIG, THE COMPLETE GUIDE TO EXECUTIVE COMPENSATION 84-85 (2007).
(194.) Vesting, constructive receipt, or conferral of the economic benefit typically happens before the retirement benefit is paid.
(195.) CALVIN MORRILL, THE EXECUTIVE WAY 34 (1996).
(196.) See supra Part II.E (explaining how the QSERP works).
(197.) See supra Part II.C.4 (listing the penalties for discriminatory plans).
(198.) The "funded percentage" is the ratio of assets to liabilities. 29 U.S.C. [section] 1085(i)(2) (2006).
(199.) See Letter from the Board of Trustees of the Cleveland Bakers and Teamsters Pension Plan to Participants, et al., (Feb. 1, 2008), available at http://www.dol.gov/ebsa/pdf/c-notice0420080009.pdf (describing the limitations of the plan falling into critical funded status).
(200.) $80,000 / $100,000.
(201.) $80,000 / $120,000.
(202.) The hypothetical is just to illustrate the danger of injecting executive liabilities into a qualified plan. In practice the transfer of liability would have to be much smaller to avoid failing [section] 401(a)(4) nondiscrimination testing. See Part II.C.2.i (explaining the procedure for [section] 401(a)(4) nondiscrimination testing).
(203.) See supra Part II.E (describing the process of creating a QSERP).
(204.) See supra Part II.C.3 (noting the difficulty the IRS has in policing plan amendments).
(205.) See Schultz & Francis, supra note 113 and Part III.A (describing the problem of staff resources at the IRS).
(206.) See supra Part II.C.3 (noting the difficulty the IRS has in policing plan amendments).
(207.) See supra Part II.E (discussing Intel's QSERP).
(208.) See Association for Advanced Life Underwriting, supra note 148 (showing the conflicting positions in relation to the QSERP).
(211.) I.R.C. [section] 401(a)(4) (2008).
Mark E. Carolan, J.D., The University of Iowa College of Law, 2010; Associate of the Society of Actuaries, 2005; B.B.A University of Wisconsin-Madison, 2004
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|Title Annotation:||qualified supplemental executive retirement plan|
|Author:||Carolan, Mark E.|
|Publication:||The Journal of Corporation Law|
|Date:||Jun 22, 2010|
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