What is a Top Hat Plan?

Top hat plans are a form of retirement plans that are not offered to the general employees of a corporation. Instead, this nonqualified retirement plan is offered only to a limited group, and it's usually reserved for key executives and occasionally a select few other employees, depending on the structure of the plan.

This type of retirement plant is different from a standard one in several ways. First, it does not enjoy the tax-qualified status that national revenue agencies routinely extend to the opt-in retirement plans that are offered to all employees of a company. Second, the ability to participate in the plan is not necessarily automatic for all people holding a similar level of responsibility within a company. For example, being an executive may not be enough to receive an invitation to participate. Depending on the limits of the plan, there may be additional provisions to meet, such as the place of the executive in the operating structure of the company and the salary currently commanded by the employee.

There are essentially two types of top hat plan configurations offered today. The first is known as a Nonqualified Deferred Compensation plan, which will allow participants to defer any amount of income into the plan during each calendar year. There is not necessarily any matching contribution made by the employer.

The second common type functions a little differently. Known as a Supplemental Executive Retirement Plan, the employer provides the funding for the annual contributions to the plan. There are usually limits based on such factors as annual salary that will determine the exact amount of funding that is provided.

Unlike the retirement plans offered to employees, a top hat plan often does not have to comply with as many governmental regulations. This means the rate of interest associated with the plan may be higher than that with a traditional 401K retirement plan. Executives may not have to endure a period of vesting before being considered full participants in the plan, and there may also not be penalties that affect the worth of the participation if the executive chooses to leave the employ of the company.

It is possible to bundle the actual cost of this sort of plan in with the costs associated with any other general retirement plans offered by the company, so the amount of assets that flow into it may not be easily identified by shareholders. In fact, shareholders may not even be aware that this retirement plan option is even available.