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Pension benefit arrangements come in all shapes and sizes. Employee pension benefits can be provided through a variety of different plans and packages. Accordingly, there are a variety of different legal frameworks that may govern an employee’s pension benefits, depending upon the type of arrangement entered into with the employer. Considering that each legal framework presents different implications, it is important that an employee first know which laws apply to his or her pension arrangement and then assess his or her potential rights and responsibilities under those laws.

Is the pension benefit arrangement governed by federal ERISA law? For instance, employee pension benefits may be governed by the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). In general, as the U.S. Supreme Court stated in Fort Halifax Packing Co. v. Coyne, 482 U.S. 1 (1987), a pension arrangement will be an ERISA employee benefit plan when it is established or maintained by an employer for the purpose of providing certain benefits and requires an ongoing administrative scheme. This definition distinguishes lump sum arrangements, such as many severance or retention bonuses, and results in many employee pension plans being subject to ERISA. When ERISA is applicable, the plan must comply with certain rules and regulations regarding, among other things, minimum participation, funding, vesting and fiduciary responsibilities.

What’s the top-hat plan exception to ERISA all about? There is an exception to ERISA applying, however, that covers pension arrangements of many executives and upper management employees. These plans, known as “top-hat” plans, are not subject to the rules and regulations of ERISA Title I, including those referenced above. Top-hat plans must be unfunded (paid from the general, attachable assets of the corporation) and be maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. In determining whether a group of employees fit the description, courts generally consider factors such as: (1) the percentage of the total workforce invited to join the plan; (2) the nature of their employment duties; (3) the compensation disparity between top-hat members and non-members; and (4) the actual language of the plan agreement.

Understanding a Supplemental Executive Retirement Plan (SERPs). A common example of a top-hat plan is known as a Supplemental Executive Retirement Plan (“SERP”) that supplements an employee’s ERISA plan benefits. SERPs may calculate a certain pension benefit amount for the employee then offset that amount by benefits the employee receives from ERISA plans and Social Security. As a result of Title I of ERISA not applying, the employer can be flexible as to how the SERP is set up, and may legally provide a vesting schedule that is less protective of the employee than that provided by ERISA.

Negotiating a SERP requires an appreciation of the fundamental framework. Without the protection of ERISA, it is incumbent upon the executive or other employee in a top-hat plan (or SERP) to assure both that the plan is set up in a manner that is fair and will provide sufficient benefits at retirement, and that the employer has controls in place to monitor and secure the administration of the plan. For instance, non-ERISA plans are not subjected to ERISA’s vesting rules. As a result, an employer can potentially set up a pension arrangement so that the executive forfeits his or her rights to benefits under the arrangement if he or she fails to work for the company until retirement. Therefore, the executive or employee must negotiate for some security–which may be in the form of requiring the employer to establish a rabbi trust–that his or her anticipated benefit will be available upon retirement.

And, of course, don’t forget Section 409A. Additionally, when a pension arrangement does not qualify under ERISA, the employee must take heed of Section 409A of the Internal Revenue Code which, if applicable, can result in the imposition of considerable tax consequences–in the form of accelerated income tax, penalties and interest–on the employee if its provisions are not complied with. This differs from ERISA, which generally imposes its penalties on the plan sponsor or administrator. Section 409A provides rules for non-ERISA plans on such matters as plan deferral elections, distributions and funding.

Do you understand the important distinctions that apply to your pension benefit arrangements? While pension benefits are obviously a necessity for employees, not all benefit plans are created, or governed under the law, equally. Employees must be able to identify what body of law applies to their receipt of pension benefits. If the plan, such as a SERP, is not qualified as an ERISA plan, the employee must be familiar with the rules for deferred compensation under Section 409A in order to ensure that the receipt of benefits under the plan will not result in the imposition of potentially severe tax penalties.

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