Ch11 Verified Test Bank Nonqualified Deferred Compensation

Chapter 11

Nonqualified Deferred Compensation Plans for Executives

True / False Questions

1. Excess benefit plans generally have longer vesting periods than SERPs. (Contrasting Excess Benefit Plans and SERPs)

2. Corporate-owned life insurance can be used by employers to recover the costs of nonqualified deferred compensation. (Corporate-Owned Life Insurance)

3. Only ERISA Title I holds provisions setting minimum standards required to qualify pension plans for favorable tax treatment. (ERISA Qualification Criteria)

4. The IRS limits the annual benefit amounts for a defined benefit plans to the lesser of $185,000 in 2017. (Defining Nonqualified Deferred Compensation Plans (NQDC))

5. ERISA Title I specifies minimum standards for participation and vesting protections for participants and beneficiaries. (ERISA Qualification Criteria)

6. Trust funds and insurance contracts do not secure an employer's promise to make future payments. (Funding Status)

7. Funded plans allocate money to trust funds or insurance company contracts in an executive's name. (Funding Status)

8. The Age Discrimination in Employment Act does not forbid employers from setting a mandatory retirement age for employees who are 65 years old. (Mandatory Retirement Age)

9. An employee in a high policymaking role manages the overall company and directs the work of two or more people. (Mandatory Retirement Age)

10. Excess benefits plans can only be funded plans. (Excess Benefit Plans)

11. Top hat plans are unfunded plans. (Supplemental Executive Retirement Plans (SERPs))

12. Constructive receipt guides the timing of an executive's obligation to pay income taxes for funded nonqualified plans. (Funding Mechanisms)

13. Collateral approach is a term used to indicate employer ownership of an insurance policy. (Split-Dollar Life Insurance)

14. A stock option is a company's offering of stock to an employee. (Basic Terminology)

15. Capital gains is the term used to describe the market value of stock options as listed on the NYSE. (Stock Options)

16. The IRS has no impact on nonqualified plans. (Defining Nonqualified Deferred Compensation Plans (NQDC))

17. The Securities Exchange Act of 1934 requires disclosure of company financial information and information about executive compensation practices; all companies must comply. (Securities Exchange Act of 1934)

18. The IRS uses the term “key employees” for nondiscrimination rules in employer-sponsored health insurance plans. (Who are Executives?)

19. For funded plans, executives generally pay federal income taxes when they begin to receive payments from these plans. (Funding Mechanisms)

20. The endorsement approach designates the employer as owner. (Split-Dollar Life Insurance)

21. Secular trusts are subject to a company’s creditors in the event of bankruptcy or insolvency. (Secular Trusts)

22. Stock grant refers to sale of stock by the stockholder. (Basic Terminology)

23. Exercise of stock option refers to an employee’s purchase of stock using stock options. (Basic Terminology)

24. Companies benefit from golden parachute payments because they can treat these payments as business expenses. (Golden Parachutes)

25. Companies use platinum parachutes to avoid legal battles or negative media publicity by paying off a CEO to give up his or her post. (Platinum Parachutes)

26. The Securities Exchange Act of 1934 is also commonly referred to as the Dodd-Frank Act. (Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act))

27. One of the objectives of nonqualified plans is restoration. (Defining Nonqualified Deferred Compensation Plans (NQDC))

28. Under SERP, nonexecutive employees earn an annual retirement benefit equal to 50% of the highest average annual salary for a consecutive three-year period. Defining Nonqualified Deferred Compensation Plans (NQDC))

29. ERISA Title I exempts nonqualified plans from fiduciary responsibility. (Supplemental Executive Retirement Plans (SERPs))

30. The IRC recognizes highly compensated employees and key employees but only highly compensated employees serve in executive leadership roles and participate in executive compensation and benefits plans. (Who Are Executives?)

31. According the U.S. Treasury Regulations, the term “officer” means an administrative executive who is in regular and continued service and holds the authority of an officer, regardless if they hold the title of an officer. (Key Employees)

32. Qualified plans allow executives to accumulate substantially more money for retirement than nonqualified plans. (Defining Nonqualified Deferred Compensation Plans (NQDC))

33. According to the IRS, for nonqualified plans employers typically deduct expenses only when the employee receives income from the plan in the future. (Defining Nonqualified Deferred Compensation Plans (NQDC))

34. Executive retirement plans adhere to ERISA’s nondiscrimination rules. (ERISA Qualification Criteria)

35. With unfunded plan, executives may forfeit retirement benefits when a company becomes bankrupt or financially insolvent or following a change of company ownership. (Funding Status)

36. A funding mechanism is synonymous with funded plans. (Funding Mechanisms)

37. When considering funding mechanisms, employee-owned annuities offer the highest level of security. (Funding Mechanisms)

38. Funding mechanisms provide the financial resources only for funded plans. (Funding Mechanisms)

39. Disposition is the sale of stock by the stockholder. (Basic Terminology)

40. A company may choose to add to the vesting period a performance criterion for determining whether to award stock options or stock units, commonly referred to as restricted stock units. (Restricted Stock Plans and Restricted Stock Units)

Multiple Choice Questions
 

41. This type of executive retirement plan is unfunded and can be issued upon retirement, termination, or death, but the assets must be released to creditors if the company files for insolvency or bankruptcy. (Rabbi Trusts)
A. Employee-owned annuities
B. Secular trusts
C. Rabbi trusts
D. Corporate-owned life insurance

42. Nonqualified retirement plans for executives are generally divided into these two broad classes. (Nonqualified Retirement Plans for Executives) A. Top hat plans and supplemental executive retirement plans
B. Excess benefit plans and supplemental executive retirement plans
C. Offset benefit plans and supplemental executive retirement plans
D. Target benefit plans and supplemental executive retirement plans

43. What was the IRS limit for annual earnings amount for determining qualified plan benefits in 2017? (Objectives of Nonqualified Plans)
A. $150,000
B. $170,000
C. $200,000
D. $270,000

44. Which of the following ERISA Title I parts does not apply to nonqualified plans? (Supplemental Executive Retirement Plans (SERPs))
A. Funding
B. Reporting and disclosure 
C. Fiduciary responsibility
D. Administration and enforcement

45. Which is not a factor associated with the decision to fund a nonqualified plan? (Funding Status)
A. Shareholder expectations
B. Costs
C. Liability management
D. Press coverage

46. Which of the following is not a feature of excess benefits plans? (Excess Benefit Plans)
A. Extended provisions of existing qualified plans
B. Increased retirement benefits by the amount lost due to limits set by the Internal Revenue Service
C. Funded excess benefit plans are subject to ERISA regulations
D. Unfunded excess benefit plans are subject to some ERISA regulations

47. Top hat plans are exempt from which ERISA Title I regulation? (Supplemental Executive Retirement Plans (SERPs))
A. Funding
B. Reporting and disclosure
C. Continuation coverage
D. Administration and enforcement

48. Which one of the following is a funded plan? (Secular Trusts) A. General asset approach
B. Secular trusts
C. Corporate life insurance
D. Rabbi trusts

49. 
A. Employee pays for most or the entire premium
B. Employer has the right to borrow against the cash value of the policy for business purposes
C. Executive reimburses the employer for aportion of the premium cost
D. Employer names itself as beneficiaryWhich of the following is not true of the endorsement approach under the split dollar insurance plan? (Split-Dollar Life Insurance)

50. Which of the following is not a type of stock option plan? (Stock Options and Stock Purchase Plans)
A. Stock appreciation rights
B. Phantom stock plans
C. Restricted stock units
D. Profit sharing

51. A. Provide income to executives at the end of a designated period, much as with restricted stock options B. Executives always have to exercise their stock rights to receive income
C. The company simply awards payment to executives based on the difference in stock price between the time the company granted the stock rights at fair market value to the end of the designated period, permitting the executives to keep the stock
D. Neither the employee nor employer pays taxes when stock appreciation rights are grantedWhich one of the following is not true about stock appreciation rights? (Stock Appreciation Rights)

52. Rabbi trusts are characterized by which one of the following features? (Rabbi Trusts) A. Is a revocable grantor trust
B. Employer maintains ownership
C. No financial lending institutions are involved
D. Are funded plans

53. Which one of the following is not a characteristic of employee owned annuities? (Employee-Owned Annuities)
A. Offers financial security
B. Third party vendors are involved
C. Employee pays the cost of the annuity
D. Not subject to ERISA provisions

54. Which of the following is not one of the objectives of SERP? (Supplemental Executive Retirement Plans (SERPs))
A. Use of SERPs as a tool in executive-level succession planning
B. Rewarding substantially higher retirement benefits
C. Compensating for long-term employment
D. Compensating for older new hires

55. Nonstatutory stock options are characterize by which one of the following features? (Stock Options) A. They qualify for favorable tax treatment
B. They are awarded at discounted prices
C. Executives do not have any ownership control over the disposition of the stock for 5 to 10 years
D. Executives pay taxes in the future when they choose to exercise their nonstatutory stock options

56. Which one of the following is not a feature of corporate owned life insurance? (Corporate-Owned Life Insurance)
A. Employers use it to recover cost of qualified plans
B. Designated amount paid to designated beneficiaries of deceased
C. The goal is to purchase policies that match the amount of deferred compensation promised to executives
D. Using it does not create a funded plan

57. A phantom stock plan is characterized by which one of the following? (Phantom Stock Plans)
A. Board of directors compensate executives
B. There are no specific conditions for converting these into shares
C. There are no tax advantages
D. Retirees’ income tax is higher

58. These clauses in the employment agreement provide pay and benefits to executives after a termination that results from a change in ownership or corporate takeover. (Golden Parachutes)
A. Platinum Parachutes
B. Mandatory Retirement
C. Golden Parachutes
D. Top Hat

59. According the Internal Revenue Code, this person was a five percent owner at any time during the year or the preceding year; or, for the preceding year, the employee had compensation in excess of $120,000 in 2017 and was in the top-paid group of employees. (Highly Compensated Employees)

A. Highly compensated employee

B. Key Employee

C. Bona fide executive

D. High policymaker

60. This provides income to executives at the end of a designated period and executives never have to exercise their stock rights to receive income. (Stock Appreciation Rights)

A. Restricted stock plan

B. Stock appreciation rights

C. Phantom stock plan

D. Nonstatutory stock options

Essay Questions
 

61. Who are executives? Explain. (Defining Executive Employment Status)

Main Points

• From a tax regulation perspective, the Internal Revenue Service (IRS) recognizes two groups of employees who play a major role in a company’s policy decisions: Highly compensated employees and key employees
• The IRS uses the term “key employees” to determine the necessity of top-heavy provisions in employer-sponsored qualified retirement plans
• The IRS uses the term “highly compensated employees” for nondiscrimination rules in employer-sponsored benefits
• The term key employee means any employee who at any time during the year is either of the following:
  • An officer having annual pay of more than $175,000
  • An employee who in 2017 is either of the following
    • A 5% owner of the business
    • A 1% owner of the business whose annual pay is more than $150,000
• The IRS defines a highly compensated employee as one of the following, during the current year or preceding year:
  1. A 5% owner at any time during the year or the preceding year, OR
  2. For the preceding year:
     • The employee had compensation from the employer in excess of $120,000 in 2017, AND
     • If the employer so chooses, the employee was in the top-paid group of employees where top-paid employees are the top 20% most highly compensated employees
• Normal retirement age is the lowest age specified in a pension plan
• Upon attaining this age, an employee gains the right to retire without the consent of the employer, and to receive benefits based on length of service at the full rate specified in the pension plan.
• The Age Discrimination in Employment Act forbids employers from setting a mandatory retirement age for virtually all employees, except for:
  • Any employee who has attained 65 years of age and who, for the two-year period immediately before retirement, is employed in a bona fide executive or a high policymaking position, if such employee is entitled to an immediate nonforfeitable annual retirement benefit from a pension, profit-sharing, savings, or deferred compensation plan, or any combination of such plans, of the employer of such employee, which equals, in the aggregate, at least $44,000.
  • A bona fide executive primarily manages the overall company and directs the work of two or more people
  • An employee in a high policymaking position plays a significant role in the development of company policy, but does not have direct line control (for example, over business functions such as accounting, finance, human resources, and so forth).
• Students may choose from among the following types of funding mechanisms:
  • General-asset approach (unfunded)
    • Companies fund NQDC plans with general assets of the company, including cash and company stock.
    • This method provides the least amount of security as assets must be turned over to creditors in the event of bankruptcy and the agreement is not protected by ERISA.
  • Corporate-owned life insurance (unfunded)
    • Employers purchase whole life insurance policies on the lives of executives and name themselves as beneficiaries with the goal of matching deferred compensation amounts to the amount of the insurance coverage – used to recover the costs of NQDC plans.
    • Companies still pay executives using general assets so this method is unfunded.
  • Split-dollar life insurance (unfunded)
    • These policies provide separate life benefits and death benefits with the employer and executive sharing the premium payment.
    • The endorsement approach designates the employer as the owner of the policy and the collateral approach is when the executive maintains ownership.
  • Rabbi trusts (unfunded)
    • This is an irrevocable grantor trust with the employer as the grantor who maintains ownership – established to provide compensation upon retirement or termination without cause.
    • In the event of company bankruptcy, it must release assets, including rabbi trusts, to creditors.
  • Secular trusts (funded)
    • Similar to rabbi trust but with one exception – secular trusts are not subject to a company’s creditors in the event of bankruptcy.
    • Secular trusts are funded plans that meet ERISA provisions.
  • Employee-owned annuities (funded)
    • These offer executives the greatest degree of financial security because the executive, not the company, owns the annuity – the company pays for the annuity in the executive’s name.
    • Not subject to ERISA as they are owned by an individual, not a company.
• Separation agreements specify compensation and benefits an executive will receive after the company’s board of directors terminates the executive. These agreements are negotiated during the hiring process, approved by the board of directors, and subsequently documented by written contract.
• Golden parachutes and platinum parachutes are the most well-known types of executive separation agreements.
  • Golden parachutes provide pay and benefits to executives after a termination that results from a change in ownership or corporate takeover, that is, the merger or combining of two separate companies.
  • Platinum parachutes are lucrative awards that compensate departing executives who have been terminated for unsatisfactory performance with severance pay, continuation of company benefits, and even stock options – typically used to avoid long legal battles or critical reports in the press, essentially by paying off a CEO to give up his or her post.
• Companies maintain top hat plans “primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.”
• Practitioners have adopted the term top hat as a convention to reference unfunded plans. It was not created in any legal or tax regulation definition.
• The design and implementation of top hat plans are exempt from three parts of ERISA’s Title I:
  • Minimum standards for participation and vesting
  • Funding
  • Fiduciary responsibilities
• Exemption from these ERISA provisions requires that employers maintain top hat plans as being unfunded and offer them exclusively to a “select group of management or highly compensated employees.”
• Meeting these criteria can be challenging because ERISA does not contain definitions of “unfunded” or “select group.”
• Instead, companies currently rely on Department of Labor Advisory Opinion letters or on often-conflicting court rulings for guidance