Estate Planning for Deferred Compensation
Many executives receive, as part of their compensation packages, arrangements that provide compensation at a later date, often dependent on achieving corporate goals, such as income or sales levels. Payments may be made after a few years or at retirement or termination of employment. Funding may be from the employer’s general funds, through a fund set aside or through life insurance.
Most executives receive their payments during life and treat them as ordinary income or capital gains, depending on the structure used. But deferred compensation arrangements often have a provision for payment in the event of the executive’s death. Depending on the particular arrangement, the deferred compensation arrangement can be a significant portion of the executive’s estate.
In most deferred compensation arrangements, there will be a provision for naming a beneficiary to receive deferred compensation after the executive has died. Like qualified retirement plans, IRAs and life insurance, the determination of who receives the benefits is made pursuant to the beneficiary designation rather than the executive’s will (unless the executive has named the estate as the beneficiary). The beneficiary designation is really a form of will, because it governs the disposition of assets at death. It should be planned as another element of the executive’s overall estate plan. Questions of tax deferral and disposition of assets must be viewed by looking at the will as well as the various beneficiary designations. Many people forget to combine these documents when planning their estates, and most people can’t find their beneficiary designations and have forgotten what they say. In fact, if a lawyer keeps a copy or the original of a client’s will, the same file should contain a copy of all beneficiary designations.
Speaking of deferred compensation, a new and extensive regulatory framework was enacted in 2004, providing rules for deferred compensation arrangements of all types and including significant penalties if those rules are not followed. Because of the extensive nature of those rules, and the hundreds of pages of regulations issued to interpret the new statute, the Treasury and IRS gave several extensions of the time period to bring arrangements into compliance with the new law. That extension of time to assure compliance, which includes a grace period to make changes in arrangements, will come to an end on December 31, 2008. That means that there are only a very few months before all deferred compensation arrangements must be brought into compliance. In doing so, it’s first necessary to decide what arrangements exist, and then to decide whether and how they should be changed. This is a big task, and lawyers whose clients have deferred compensation arrangements need to check now to see that the compliance process is under way
Robert H. Louis