Certified Plan Sponsor Professional (CPSP) Practice Exam

Under what condition are nonqualified plans exempt from ERISA coverage?

1. When the plan is terminated early

2. When the plan qualifies for the top-hat exemption and is unfunded

3. When all employees are participants

4. If the plan limits participation to managers

The correct answer is: When the plan qualifies for the top-hat exemption and is unfunded

Nonqualified plans can be exempt from ERISA coverage under specific conditions, one of which is qualifying for the top-hat exemption while being unfunded. The top-hat exemption applies to certain unfunded plans maintained primarily for a select group of management or highly compensated employees. This exemption recognizes that these plans are intended to provide deferred compensation to a specific group and are not designed to benefit the general employee population. Being unfunded means that the plan is not maintained through a trust or similar arrangement, which would create a legal obligation to participants. Instead, benefits are often paid from the employer's general assets. Since these plans do not create the same fiduciary responsibilities and complexity as funded plans that cover a broader spectrum of employees, they can be exempt from ERISA, allowing more flexible terms. Other options do not satisfy the conditions set forth by ERISA's regulatory framework. For example, terminating a plan early does not inherently provide an exemption, nor does limiting participation solely to managers unless the funding conditions are also met. Similarly, having all employees as participants does not relate to the considerations of being a top-hat plan.