The Top Hat Plan: Risks Ahead!
What is a top hat plan? Do I have one? If you are a well-compensated executive in a company, then you might have a top hat plan.
Top hat plans are unfunded plans maintained by an employer primarily to provide deferred compensation for management or highly compensated employees. These plans are not tax qualified, and the employer selects the employees covered as well as the benefit amount provided. The deferred compensation is not set aside in a trust, and it is subject to the claims of creditors as it remains in the company’s coffers. It is not considered to be a retirement plan, but often is used that way.
Theoretically it is a way for a well-paid employee to spread out income into the future so there is not such a big tax bite in the present. It is possible, in combination with a 401(k), to defer over $60,000 per year. That is the plus side, but there is a downside as you may have detected above. First of all, many of the normal protections of ERISA are not applicable. For example, if the plan administrator refuses or fails to produce top hat plan documents, such as amendments occurring after you left the company, there is no penalty claim that arises. Also, there is an exemption from the typical fiduciary duties, which require administrators to act in the best interests of employees. A final example is that the plan’s unfunded, which means if the company begins to suffer financial losses, those monies are subject to the claims of creditors which will rank above employees claim to that money.
Accordingly, it is critical for top hat plan participants to remain vigilant as to how the company is faring financially and otherwise, and to stay in contact (and remain on good terms) with those running the company. It can provide a good source of deferred compensation for many years but you have to be mindful of the downsides. Below is an example of the dangers from a prior post in February, 2017.
Mr. Taylor worked at NCR. He retired to receive a survivor (top hat plan) annuity yearly benefit of about $29,000 for his life and his wife’s life. Without warning to Mr. Taylor, NCR terminated the plan and paid Mr. Taylor a lump sum benefit attendant with a huge tax bite (The $440,976 was reduced to $254,063.
The IRS did not send a thank you note!). The lump sum benefit ($440,966) had also been reduced to present value at discount rates selected by the plan (Present value is a discount applied to the receipt of money that normally would have been paid in the future over time.). The problem is that the discount rate applied was solely selected by NCR. Mr. Taylor had no say, even though it was his deferred money.
Mr. Taylor sued for benefits, statutory penalties, and attorney’s fees for NCR failing to give him the changes to the plan. The court dismissed all claims after a motion to dismiss was filed. Taylor v. NCR Corp., 2015 WL 5603040 (N.D. Ga. 2015). This case underscores that it is necessary for top hat plan participants to be very vigilant as noted above. There are significant risks. If you see any cause for alarm, you should get counsel from both legal and tax professionals. See www.erisacase.com for more information. Our team of attorneys provide ERISA law services throughout Alabama, Mississippi, and the surrounding states.