White Papers

Determining Eligibility in Non-Qualified Deferred Compensation Plans

Jul 12, 2016

This white paper includes a brief overview of current law and evolving industry standards with respect to determining eligibility for non-qualified deferred compensation plans which qualify for the “top-hat exemption” under the Employee Retirement Income Security Act (ERISA).

Legislative Overview

ERISA provides that to qualify as a “top-hat” plan, such plan must be “unfunded”, and “maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.” (ERISA Section 201(2), 301(a)(3), and 401(a)(1)). ERISA contains no specific definitions of “select group,” “management” or “highly compensated employees."

Department of Labor Advisory Opinions

Certain dated Department of Labor (DOL) Advisory Opinions were released. The Opinions discuss factors such as the percentage of plan participants to total employees, the average salary of plan participants compared to all employees, and whether the participants’ “job title” reveal a knowledge of company finances (and hence the risk of an unfunded plan) or a general financial sophistication. In DOL Advisory Opinion 90-14A, one of the more frequently referenced Opinions, the DOL concluded: “[i]t is the view of the Department that in providing relief for top-hat plans from the broad remedial provisions of ERISA, Congress recognized that certain individuals by virtue of their position or compensation level have the ability to affect or substantially influence, through negotiations or otherwise, the design and operation of their deferred compensation plan taking into consideration any risks attendant thereto, and therefore, would not need the substantive rights and protections of Title I.”

Judicial Interpretation

A small number of court cases discuss the meaning and context of the “top-hat” group requirements.
  • In Belka v. Rowe Furniture Corp. (571 F. Supp. 1249, D. Md. 1983), the District court relied principally upon whether the size of the group of participants as it related to the overall full time work force indicated a “select group”  (the “percentage test”). The court found that between 1.6% and 4.6% of the workforce was covered and concluded that such a percentage was acceptable. The court also considered the average participant salaries that were three to four times the company average and concluded that it indicated a “highly compensated” group. Finally, the court considered participants’ job titles, and noted that the plan covered only a small number of the total positions in the company, which qualified as a “select group.”
  • In Darden v. Nationwide Mutual Insurance Co. (717 F. Supp. 388 (E.D.N.C. 1989), the court considered a deferred compensation plan for all insurance agents who executed the standard agent contract. The court relied upon the percentage test and found that because the plan covered approximately 18.7% of Nationwide’s employees, it was too large to be considered “select.”
  • In Demery v. Extebank Deferred Compensation Plan (B) (216 F. 3d 283, 2d Cir., 2000) case, the court noted that a “top-hat” analysis is “fact-specific.” The court considered job titles within the covered group and found that even though the plan “swept more broadly than a narrow range of top executives, it was nonetheless limited to highly valued managerial employees.” The court opined that “a select group” could be “wider (than just senior management) and targeted at middle management rather than at the very top executives.” The court concluded that while the plan covered 15.34% of the workforce, it was a “top-hat” plan, while acknowledging that 15.34% was probably “at or near the upper limit of the acceptable size for a ‘select group.’”

Industry Standards

Given the absence of a “bright line” test, the executive benefit consulting community has historically utilized a combination of the factors articulated by the DOL Opinions and the courts. Newport Group routinely networks with ERISA practitioners and non-qualified plan design consultants to remain knowledgeable of generally accepted principles currently in use in the area of non-qualified plans. The following guidelines represent current best practice in defining a “top-hat” group.
  • An eligible group of employees that does not exceed 10-12% of the total workforce. Note that the workforce need not be US based, and that independent contractors are not subject to the “top-hat” limits. The group may consist of:
    • Members of senior management with titles of vice president and above, and middle-to-upper management (assistant vice presidents, directors, branch managers) with compensation at least two times the average of the non-eligible group and in excess of the IRC Sec. 414(q) limit ($120,000 in 2016) and:
    • Non-management employees with compensation in excess of the Sec. 401(a) (17) limit ($265,000 in 2016) workforce or with compensation that is at least three times the average of all employees.
More Information
Newport Group employs a staff of professionals who are available to discuss questions you may have regarding mid-year enrollments or your non-qualified deferred compensation plan generally. Please contact your Client Relationship Manager for further information.

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Newport Group, Inc. and its affiliates provide recordkeeping, plan administration, trust and custody, consulting, fiduciary consulting, insurance and brokerage services. Fiduciary consulting services are provided through Newport Group Securities, Inc., an SEC-registered investment adviser and FINRA-registered broker-dealer, and InterServ, LLC, an SEC-registered investment adviser. Newport Group Securities, Inc. and InterServ, LLC are affiliates of Newport Group, Inc. All securities transactions are provided through Newport Group Securities, Inc., in its role as broker-dealer. All fiduciary consulting services are provided through the registered investment adviser. when offering variable insurance products, Newport Group Securities, Inc. acts solely in its capacity as a broker-dealer.
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