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A 401(k) wraparound plan is a nonqualified deferred compensation (NQDC) plan that supplements or “wraps around” the already existing tax-qualified 401(k) plan that you offer to your employees. It also allows both you and your employees to make contributions that exceed the limits imposed on contributions made to a qualified 401(k) plan. A wraparound plan usually includes the same features offered through a traditional 401(k) plan, but without any of the restrictions and limitations placed on traditional 401(k) plan contributions.
A wraparound plan must be unfunded and participation limited to a select group of management and highly compensated employees in order to provide the benefit of tax deferral and avoid most of the burdensome requirements of the Employee Retirement Income Security Act of 1974 (ERISA). This is often referred to as a “top-hat” plan.
The American Jobs Creation Act of 2004 enacted important provisions, contained in Internal Revenue Code Section 409A, that impacted almost all nonqualified deferred compensation (NQDC) plans. For the first time ever, there were statutory rules that governed NQDC plan deferral elections, distributions, funding, and reporting. The Act imposed serious consequences for noncompliance: the vested benefits of affected participants would be subject to current taxation, and an interest charge and 20% penalty tax would also be imposed. The Act applied to amounts deferred after December 31, 2004. However, amounts deferred before January 1, 2005, were also covered by the new rules if they were not vested by that date. The new rules also applied to amounts deferred before January 1, 2005, under plans that are materially modified after October 3, 2004.