Partner
Incentive compensation arrangements include an array of employee benefits such as deferred compensation plans, long term incentive plans (“LTIPs”), phantom equity plans, equity option plans, bonus plans and the like. These arrangements are intended to provide compensation incentives and to encourage continued employment. Many employers maintain one or more of these arrangements in order to attract and retain their valued employees. They may be put in place for a single employee in an employment agreement, for a select group of management or other highly compensated employees (a “top-hat plan”), or for a broad cross section of employees. But all of these arrangements (except properly documented top-hat plans) may be subject to the ERISA trap.
The ERISA trap is the classification of your incentive compensation arrangement as an ERISA “pension plan” for compliance purposes.
ERISA defines a “pension plan” as any “plan, fund or program …maintained by an employer…to the extent that by its express terms or as a result of surrounding circumstances such fund, plan or program (i) provides retirement income to employees, or (ii) results in the deferral of income by employees for periods extending to the termination of covered employment or beyond.” Some courts have interpreted this language to apply to bonus and other incentive arrangements which provide both in-service distributions as well as post-termination distributions. Those decisions classify the incentive compensation arrangement as a “pension plan” subject to ERISA. As such, the incentive compensation arrangement is subject to ERISA funding, vesting, coverage and annual reporting requirements just like a 401(k) plan. And that’s the ERISA trap.
The U.S. Department of Labor (DOL) has issued guidance on whether or not a particular bonus plan is a “pension plan” which “systematically deferred” benefit payments until termination of employment and beyond. The DOL looked at factors in addition to the express provisions of the plan including whether or not a high percentage of benefits were paid at or near participants’ retirement age, whether or not the plan is communicated as intended to provide retirement or deferred income, and the length of the payout period (installment payouts look more like a conventional pension). So plan language is important but so is the actual “result” of the plan in terms of participant income deferral.
So how do you avoid the ERISA trap? Generally speaking, an incentive compensation arrangement should not be referred to as a savings or retirement vehicle and it would be best if benefit distributions were made (ideally in a lump sum) exclusively to current employees rather than terminated or retirement age participants. Your incentive compensation arrangement may not satisfy all of these criteria but they are not hard-and-fast requirement to protect your arrangement from ERISA scrutiny. Alternative compliance steps may make sense depending on the specifics of your incentive compensation arrangement.
TAKEAWAYS
Your incentive compensation arrangement may be a top-hat plan as mentioned above. If so, and if that plan is properly documented, it will be exempt from classification under ERISA as a pension plan. All other incentive compensation arrangements may have ERISA exposure if they provide for the distribution of benefits on termination of employment or retirement - even if in-service distributions are also provided. Take a look at your incentive compensation plan and related documents. Consider any appropriate changes to head off a DOL audit – or an ERISA claim by a disaffected former employee.