Academic journal article Journal of Accountancy

Top-Hat Retirement Plans

Academic journal article Journal of Accountancy

Top-Hat Retirement Plans

Article excerpt

Tax-exempt entities may establish as many as three types of tax-favored retirement plans. They may, of course, establish qualified retirement plans. They may also establish Sec. 403(b) plans, generally known as tax-sheltered annuities. The tax law treats distributions from qualified plans and tax-sheltered annuities similarly, a treatment generally familiar to tax practitioners.

Less familiar, though, is me tax treatment of distributions from eligible retirement plans that most types of tax-exempt entities can establish. These eligible exempt entity plans are unfunded plans designed for select groups of management or highly compensated individuals (and are sometimes referred to as "top-hat" plans). Note that governmental units and churches, though tax exempt, may not establish these plans.


The Employee Retirement Income Security Act (ERISA) generally requires that employers fund retirement plans through a trust or custodial account. The top-hat exception to that requirement is the only ERISA funding requirement exception that is consistent with the tax law requirement that eligible exempt entity plans be unfunded.

Though unfunded, eligible exempt entity plans may involve related trusts or other vehicles that invest amounts deferred under the plans and may give plan participants the right to choose among selected investments. However, all property rights in the deferred funds and related income (whether or not segregated or invested) must belong exclusively to the eligible exempt entity and must be subject to the claims of the entity's creditors.

Note that traditional nonqualified retirement plans are not a feasible alternative for eligible exempt entities. Unlike unfunded deferred compensation payable by a taxable entity, deferred compensation payable by an exempt entity under an ineligible plan is generally taxable as soon as it vests.

In treating eligible exempt entities differently, Congress showed that it was aware of the absence of the usual restraints imposed on deferred compensation payable by taxable entities. …

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