Executive Compensation Plan Sponsors–Does Your Plan Need an Audit?

Employers want to offer incentives beyond the traditional 401(k) plan and health care plan benefits. While innovation is key, it is crucial that an employer establishes an executive compensation plan that meets both the goals of the employer (as plan sponsor) and the executive employees (as plan participants).

There are several main types of executive compensation plans, including nonqualified deferred compensation (“NQDC”) plans, long-term incentive plans (“LTIPs”), and equity incentive plans. There is considerable flexibility with regard to executive compensation plan design, but it’s extremely important to make sure the plan design accurately reflects the plan sponsor’s goals.

Whether a plan sponsor already has an executive compensation plan in place or is considering establishing a new plan, it makes sense to consult with legal counsel and a plan design/funding consultant. This is important from both a business and fiduciary duty standpoint.

What is an Executive Compensation Plan?

An executive compensation plan is an elective or non-elective plan, agreement, method, or arrangement between an employer and an employee. NQDC plans and LTIPs are agreements to pay the service provider compensation in the future if certain pre-established criteria are met. Equity incentive plans award service providers in the form of restricted stock, stock options, phantom stock, or other forms of equity interests.

Employers typically offer executive compensation plans only to top management or other highly compensated employees and generally should not cover non-highly compensated employees.

What are the Advantages of Executive Compensation Plans for Employers?

Executive compensation plans can help attract and retain key employees by providing additional benefit incentives and awards for both performance and length of service. Equity incentive plans can provide additional or different incentives in the form of corporate stock or a membership interest.

Many executive compensation plans are largely exempt from most Employee Requirement Income Security Act (“ERISA”) requirements and related reporting requirements. This means there are no limitations on the amounts that can be deferred and no minimum distribution rules. In addition, these plans can discriminate in favor of highly compensated employees and amongst employees at various compensation levels, which is generally impermissible for qualified plans.

What are the Advantages of Executive Compensation Plans for Employees?

Executive compensation plans offer highly compensated and key employees an opportunity to earn performance and equity awards, defer compensation and taxes until a later date, reduce certain payroll taxes, and potentially help facilitate buy-in opportunities for business succession plans.

Why Should a Plan Sponsor Have Its Executive Compensation Plan Audited?

Whether a plan sponsor has recently implemented an executive compensation plan or has had such a plan in place for several years, regular audits are essential. Audits generally look at the following issues:

• Plan design
• Plan operation
• Plan consultants/advisors
• Plan fiduciaries
• Plan funding

As a plan fiduciary, the sponsor has a duty to complete a plan audit on a regular basis (e.g., annually or biannually).

Hiring an independent consultant with executive compensation experience is generally the best practice for purposes of retirement plan audits. Legal counsel can also assist in the process.

The audit process can identify many issues, including potential compliance issues, operational issues and/or alternatives, plan design alternatives, and different funding mechanisms.

Ultimately, the executive compensation plan often results in a streamlined plan design and operation and greater plan efficiencies that benefit the plan sponsor and participants.

For additional information, contact Emily Landon at elangdon@fraserstrker.com.