Do We Have to Make It a Top Hat Plan?

Employers and their compensation advisors often assume that an arrangement to pay employees in the future for work done over time will be subject to the rules for ERISA pension plans unless it is limited to a “select group of management or highly compensated employees,” a so-called “top hat” plan. In many cases, however, this is not true.

An arrangement that is treated as a pension plan for ERISA purposes generally must, among other requirements, be funded through a trust or similar arrangement. This requirement conflicts with the tax rule that rights to future compensatory payments are taxed up front unless they are unfunded. This needle is often threaded by ensuring that a compensatory arrangement which would be a pension plan is a top hat plan, as top hat plans are exempt from ERISA’s funding requirements for pension plans.

But many plans styled as top hat plans would not be pension plans. That is because of two definitional provisions. First, the ERISA definition of “pension plan” requires that a plan provide retirement income or result in a deferral of income to or beyond termination of employment. Second, the regulation explaining the term “pension plan” says that the term does not include “bonus programs” unless payments are “systematically deferred to the termination of covered employment or beyond, or so as to provide retirement income to employees.” Many compensatory plans with a deferral element have nothing to do with retirement income and do not result in a deferral of income to or beyond termination or are bonus programs that do not systematically defer payment to or beyond termination. Such plans would not be ERISA pension plans. To give a notable example, a 2020 ERISA Advisory Council Report to the Secretary of Labor made available on the Department of Labor’s website says specifically that “an employer’s unfunded, unsecured promise to pay $X to an employee in 5 years will ordinarily not be considered a pension plan but rather a bonus program that is outside the ambit of ERISA.”

Many arrangements that pay in the future for work done over time are designed to be “short-term deferrals” for tax purposes, meaning that payment is made within a short, specified period following vesting. For example, most so-called Section 457(f) plans of tax-exempt employers provide only for short-term deferrals that are not treated as a deferral of compensation subject to Section 457(f). These short-term deferral plans also typically do not provide retirement income or result in a deferral of income to or beyond termination of employment, so they are typically not ERISA pension plans. Nevertheless, employers and their advisors may incorrectly assume that such plans must be top hat plans.

As a result, there are some plans written as top hat plans, including retention incentive plans and long-term incentive plans, that do not need to be top hat plans. In other words, some employers, perhaps guided by overly conservative advice, needlessly refrain from offering plans with a deferral element to personnel who do not belong to a select group of management or highly compensated employees. If there might be a business reason to offer such a plan more widely, their advisors would do well to examine the plan’s features under the ERISA definition of “pension plan” and the exception for bonus programs, as interpreted by the courts. A thorough and careful review of relevant case law can be found, for example, in Shafer v. Morgan Stanley (S.D.N.Y. Nov. 21, 2023), a decision the Second Circuit recently left untouched on appeal (2^nd Cir. July 9, 2025). Of course, if there is any doubt about whether a plan might be a pension plan, and there is no reason to offer it on a broader basis, there is no harm in limiting it to a top hat group and filing the required statement with the Department of Labor.

If you have questions about whether a compensatory arrangement needs to be a top hat plan, please contact a member of Verrill’s Employee Benefits and Executive Compensation practice group.