A standard part of an executive compensation package can be participation in a nonqualified deferred compensation plan. This is a plan not subject to tax code limitations on qualified retirement plans and not subject to many provisions of ERISA, including the requirement that plan assets be set aside in a trust, protected from company creditors. To be exempt from ERISA requirements a nonqualified deferred compensation plan must be unfunded and maintained “primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.” This group of higher level employees is sometimes called the “top hat” group.
Unfortunately, ERISA does not contain a definition of “select group of management or highly compensated employees.” There have been court cases over the years defining the term. A recent decision from the federal district court for the Eastern District of Kentucky considered the percentage of the total workforce invited to join the plan (less than 1%) and the nature of the plan members’ employment duties (generally high ranking management personnel) to determine that the plan constituted a top hat plan.
What was interesting about the decision was the court’s consideration of an argument that the plan did not qualify as a top hat plan because a few plan participants were not “high ranking management personnel.” The court rejected that argument, holding that so long as the plan was maintained “primarily” for the purpose of providing the deferred compensation for the top hat group, the plan met the “top hat” group requirement.
Although the better practice is to limit participation in nonqualified plans to those who are clearly within the top hat group, this case provides support for an employer who, for whatever reason, finds that a few of the plan’s participants might not meet the top hat requirements.