For an NQDC Plan, Being Subject to ERISA May Be A Good Thing

This Sixth Circuit Court of Appeals decision involving a nonqualified deferred compensation plan (NQDC) shows why it can be important for a nonqual plan to comply with Internal Revenue Code Section 409A compliance and the Employee Retirement Income Security Act of 1974 (ERISA) claims procedures.

Fulcrum Partners, a national executive benefits advisory, shares these important insights from attorneys Greg Daugherty and Dave Tumen of Porter Wright, first published: July 31, 2019.

Sixth Circuit Nonqualified Deferred Compensation Plan Decision Highlights Importance of Code Section 409A Compliance and ERISA Claims Procedures

We often receive questions about whether different types of bonus plans and nonqualified deferred compensation plans (NQDC plans) are subject to ERISA. We explain that being subject to ERISA may be a good thing for an NQDC plan, particularly with respect to resolving disputes and claims for benefits. Even if it is questionable whether an NQDC plan is subject to ERISA (i.e., because it arguably does not provide retirement benefits or covers only one person), sometimes it might make sense to include ERISA claims procedures and file a top hat letter. A recent case—Wilson v. Safelite Grp., Inc.—in which the Sixth Circuit held that ERISA preempts state contract and tort law claims, illustrates the benefits of being an ERISA plan.

This case was particularly notable because it also involved violations of Internal Revenue Code Section 409A of the Internal Revenue Code and related guidance (Code Section 409A). While the issue in the case was whether the plan was subject to ERISA, we want to focus on two other important items that may not as easily be noticed. One is the limits of a Code Section 409A “savings clause” in an NQDC plan. The other is the importance of following ERISA claims procedures with respect to NQDC plans.

Code Section 409A Savings Clauses

Most NQDC plans contain what often is called a Code Section 409A “savings clause.” It is a section of the NQDC plan that says that the NQDC plan is intended to comply with Code Section 409A. Code Section 409A imposes penalties on participants in NQDC plans if the NQDC plan document or administration does not comply with strict payment and election timing rules. Those penalties include immediate recognition of deferred income, an additional 20 percent tax on those amounts, and interest equal to the underpayment rate plus one percentage point on the tax deficiency that resulted from not recognizing the deferred income originally. The intended purpose of the savings clause is to make sure that any ambiguity is resolved in favor of a pro- Code Section 409A interpretation.

Ironically, such a “savings” clause will not necessarily save you in the Code Section 409A world. While IRS officials and most practitioners recommend these savings clauses, the IRS still requires that the substantive terms comply with Code Section 409A. If a term a is ambiguous or not clearly defined, a savings clause may tip the balance in favor of a Code Section 409A-compliant interpretation. If, however, a required Code Section 409A term is omitted; a term in the NQDC plan clearly contradicts Code Section 409A; or if the administration of the NQDC plan violates Code Section 409A (regardless of whether the document is compliant), a savings clause (in the IRS’s view) will not override those violations. The IRS likely will still assess penalties, and as mentioned previously, most of those penalties fall on the participant.

That raises a question—if an NQDC plan contains a savings clause that suggested that the NQDC plan complied with Code Section 409A, and either the document or plan administration violated Code Section 409A, could an executive sue his or her employer for breach of contract or a tort in that situation to recover the penalties?

NQDC Plans and ERISA

That was the argument that Dan Wilson, Safelite’s former president and CEO, tried to make. He had participated in Safelite’s nonqualified plan for several years, and when he terminated service with Safelite, his account balance was $9,111,384. The IRS audited Safelite’s NQDC plan and found that Mr. Wilson’s elections under the plan had violated Code Section 409A. Mr. Wilson attempted to sue Safelite for breach of contract and mismanagement of the plan because Mr. Wilson was assessed IRS penalties despite the plan’s language that suggested it was compliant with Code Section 409A.

The District Court held that because the NQDC plan at issue was an ERISA pension plan, ERISA preempted these state law claims. The Sixth Circuit affirmed that decision. The Sixth Circuit decision held that an NQDC plan whose default payment timing was retirement but also allowed earlier in-service payments was an ERISA pension plan that potentially provided retirement benefits. The fact that payments could be made before retirement did not qualify the plan for the bonus program exception to ERISA.

Interestingly, many people’s initial reaction when they hear “ERISA” is to try to find an exemption to ERISA. In many cases, that is understandable. ERISA contains complex rules that prohibit highly compensated employees from benefiting disproportionately compared to non-highly compensated employees, funding requirements, fiduciary rules, and vesting requirements. If a plan is a “top-hat” plan, however, being an ERISA pension plan may actually be beneficial for three key reasons.

  • A “top hat” plan—one whose participation is limited to a select group of management or highly compensated employees—is exempt from many ERISA requirements, such as funding, nondiscrimination in coverage and benefits, vesting and fiduciary rules.
  • A top hat plan is still subject to reporting requirements, but the plan sponsor may satisfy these requirements simply by filing a one-time letter with the Department of Labor.
  • A top hat plan is still subject to ERISA’s claims procedures requirements, which requires an internal review and appeals procedure before a participant may take the claim to litigation. Further, discovery generally is limited to the administrative record developed during the review, and courts tend to be deferential to the internal determinations.

The take-away is that being a top hat ERISA pension plan provides another line of defense for plan sponsors. Mr. Wilson may still recover some or all of the penalties he incurred, but the process would have been easier for him in state court than under the ERISA procedures.

Action Items for NQDC Plan Sponsors

As a response to this decision, we recommend that NQDC plan sponsors take the following actions:

  • Review NQDC plans for compliance with Code Section 409A. It is much better for the employer to catch a mistake early and try to correct it than to have the IRS discover the mistake.
  • Make sure that NQDC plans demonstrate compliance with the applicable ERISA requirements. In particular, make sure that a top hat letter has been filed with the DOL (if applicable), and make sure that the plan has the appropriate claims procedures. If a top hat letter has not been filed, the DOL allows delinquent filings at a fairly small charge. Adding claims procedures could help resolve any potential future litigation much more easily than if there were not claims procedures.
  • Include provisions in the NQDC plan that disclaims responsibility for Code Section 409A violations and requires participants to consult with their own tax advisors regarding how Code Section 409A may affect them.


You can find the original publication of this article by Fulcrum Partners here. https://www.fulcrumpartnersllc.com/2019/09/09/for-an-nqdc-plan-being-subject-to-erisa-may-be-a-good-thing/

How Many Investment Options Should You Offer?

Many plan sponsors struggle with deciding how many investment options to offer in their retirement plans. While people generally like to have lots of options when making other decisions, having too many plan options can potentially lead to poor investment decisions by plan participants. In addition, increasing plan options can also increase plan costs, as well as the administrative paperwork associated with the plan.

In a study on retirement plan options, researchers concluded that it is possible to present plan participants with too many options.1  The researchers began by offering people selections of jams and chocolates. Some were offered a wide variety, while others received less choices. The wide variety of jams attracted more attention from people, but more people purchased jams when offered limited choices. When sampling chocolates, people enjoyed choosing from the larger selection more, but also were more dissatisfied with the choices. Those who sampled from a smaller selection were more satisfied and more likely to buy chocolates again. In other words, as the number of options increased, people became more concerned by the possibility of making the “wrong” choice–they became uncertain that they had made the best choice possible.

Chocolates and jams aren’t very big decisions, but the researchers found that these same behaviors carried over to retirement plans. They examined participation rates for 647 plans offered by the Vanguard Group, a large investment management company, covering more than 900,000 participants. They found that as plans increased the number of options they offered, employee participation decreased. In fact, for every 10 options added to the plan, participation dropped by 1.5-2 percent. Plans offering fewer than 10 options had significantly higher employee participation rates.

In addition, more plan options can increase costs both for participants, in the form of fees, and for plan sponsors, who may face additional administrative charges from third party administrators for additional options. Further, auditing and other costs may increase, since the number of options could increase the time necessary to conduct audits.

It’s important to balance choice overload against the requirements of ERISA Section 404(c) which requires plan sponsors to have at least three diversified investment options with different risk and return characteristics.


1 http://www.columbia.edu/~ss957/articles/How_Much_Choice_Is_Too_Much.pdf