Nonqualified Plan Eligibility Guidelines
The following is intended as guidance for the review and determination of employee eligibility for participation in a nonqualified deferred compensation plan.
Parsing DOL Language
Nonqualified deferred compensation plans are generally excluded from the funding, vesting and fiduciary requirements of ERISA as long as the plan is unfunded and is maintained by an employer "primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees."
The Department of Labor (DOL) has not published definitions or additional detail clarifying what constitutes "select," "management" or "highly compensated." Thus, each employer must determine which employees qualify. Determining eligibility should be based on a combination of the below criteria:
- Highly Compensated
- Meets the definition of highly compensated as prescribed by IRC Sec 414(q)(1)(B), ($120,000 or more for 2016)
- Highly compensated in comparison to the general population of the company
- Compensation may be calculated from base salary wages or total gross W-2 income
- Select Group of Management
- Management/ senior level title or position
- Pay grade
- Additional Criteria
- Whether employee 401(k) plan contributions are capped
- Discretion of the board of directors or plan committee
Despite the lack of guidance from the DOL, there are a handful of court decisions that together provide a framework for evaluating nonqualified plan eligibility:1
- Percentage of Eligible Workforce
- Participation eligibility should be limited to a relatively small percentage (for example, less than 15%) of your total workforce.
- Nature of Participants' Employment Duties
- Most, if not all, of your eligible employees should have executive or management authority.
- Compensation Disparity
- Average compensation of your eligible employees should be significantly higher than that of ineligible employees.
- Plan Document Language
- Your plan documents should explicitly state that participation is limited to a select group of management or highly compensated employees.
Typically, once a participant is made eligible for the plan, he/she remains eligible. This is an important consideration for firms where participants receive a significant portion of income from commissions, as they may fluctuate from one year to another.
Employees who were promoted or hired during the year can be enrolled at a time other than the annual open enrollment period. However, IRC §409A requires that enrollment occur within 30 days of becoming eligible. Please refer to your plan document for more information.