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What are Top Hat Plans?

Money Manager | Monday, August 2nd, 2010

The term “top hat plan” refers to special non-qualified retirement plans that are sometimes set up by companies for selected groups of individuals, who are usually key executives within the company. These plans are reserved for just this select group of individuals, who are generally in management or have highly compensated positions within the company. These plans are not considered by the Internal Revenue Service (IRS) to have tax-qualified status. These plans were originally developed in order to make up for the lack of benefits which may be restricted for highly compensated employees under many other kinds of plans. Those who receive a high salary are often not eligible to participate in plans such as a standard 401(k) plan, because their income exceeds the plan’s income limits. However, although this was the original intent of the “top hat” plans, over time companies have continued to add perks and benefits to these plans, which can sweeten the deal for these executives considerably. In some cases, shareholders of a corporation might not even be fully aware of all the details surrounding their own company’s top hat plan offerings for key personnel. Many companies use top hat plans as a means of retaining executives and other employees who are critical to the company’s operation. There could be a number of different benefits bundled into a typical top hat plan.

Are there different kinds of top hat programs and how are they beneficial?

Basically there are two kinds of top hat plans. Nonqualified Deferred Compensation Plans (NQDC) operate in fashion that is similar to a standard 401(k) plan. However, these plans generally allow highly compensated individuals to defer an unlimited amount of their income into these plans. There are also Supplemental Executive Retirement Plans (SERP). These plans are set up by the employer and are completely funded by the company, without the use of the employee’s own money. SERPs are usually set up according to a defined benefit that was offered to the individual. Overall, these plans provide key executives and other highly compensated employees with preferential treatment. Companies may also match a higher amount when these employees contribute to their own NQDC plan, or the vesting period might also be shortened or completely eliminated.

How are Top Hat plans funded and regulated?

Funding for a company’s top hat plans is handled completely differently than how other standard plans are dealt with. These plans are unfunded liabilities, so in reality, the company’s shareholders are paying for these plans. Most companies consider these plans to be just an expected expense for their business. Accounting rules often allow companies to bundle the expenses for these plans in with the expenses for other plans, so shareholders might not even know how much money is actually being spent on these plans. There might not be a requirement for these plans to conform to government regulations, as least not to the same extent as other kinds of plans. If a company does not properly document their top hat programs, they could incur fines, penalties and other costs. However, it’s not always clear what regulations they are required to adhere to.

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