Nonqualified Plans and Estate Taxes

Nonqualified retirement plans provide an alternative method of providing additional retirement benefits for select executive or highly compensated employees. Under such plans, these special employees enter into contracts or agreements with their employers that provide deferred compensation to the employee, usually when the employee retires.

Because of the high sums of money involved, it goes without saying that it is vital to coordinate these retirement funds with estate planning techniques.

Many of these contracts also provide for the payment of specified sums to a named beneficiary (usually the employee's spouse) if the employee dies before retirement. After all, if an employee is worthy of getting extra compensation, they should be sharp enough to ensure that the extra compensation doesn't slip through their fingers because of a little technicality like dying.

The IRS has attempted to include the value of payments under this scenario, otherwise known as death benefits, in the estates of the employees as property owned by the employee at death. However, most courts have held that these payments are not includible in a deceased employee's estate because the interest in the employment contract is deemed to terminate at death. The IRS has faired just as poorly under other theories it has used to include death benefits in a deceased employee's estate.

Income taxes. Death benefits are treated as taxable income and the recipient is taxed upon receipt of the benefits.