Key members of the Senate Finance Committee made clear late last week that provisions of Senate legislation that would severely deter use of deferred compensation plans as a retirement tool are not the final word.

Even as the Senate prepared to vote on the measure containing the provisions, Sen. Ron Wyden, D-Ore., and Sen. Charles Grassley, R-Iowa, ranking members of the Senate Finance Committee, admitted in comments on CNBC that the offending language “overreached,” and the provisions will be narrowed before the legislation becomes law.

Wyden and Grassley made their comments on Jan. 31, just after President Bush acknowledged in comments in New York that executive compensation should be more closely tied to performance.

The provisions are contained in S.2, legislation that would raise the minimum wage to $7.25 over slightly more than 2 years. The Senate was expected to pass the bill late on Feb. 1. It is then likely to be sent to the House for action, probably to undergo substantial revision, or, as an alternative, to be revised through a House-Senate conference.

The provisions in the bill were designed to cap annual deferred compensation packages, but because of the way they were written, insurance industry officials termed them “draconian” in communications to members of the Senate.

Specifically, the provisions would amend Internal Revenue Code section 409A to impose a dollar cap on the annual accrual of nonqualified deferred compensation that is the lesser of $1 million or the individual’s average annual compensation determined over 5 years.

Failure to satisfy the cap would trigger ordinary income tax plus the 20% additional tax under section 409A.

The bill also amends the section 162(m) (“million dollar deduction” limit) to treat any former employees (and their beneficiaries) as continuing to be covered by the section 162(m) limits in the future (e.g, after termination of employment).

The provisions would place a cap on the amount that employees could defer in compensation plans that are drawn from upon retirement, and as a result, would “impair the ability of hundreds of thousands of mid- and upper-level employees to save for retirement through nonqualified deferred compensation,” according to David Stertzer, CEO of the Association for Advanced Life Underwriting.

Grassley acknowledged in answering a question from CNBC anchor Sue Herrera that the industry was correct, and the “language overreached,” and the provisions do cover people far down the food chain. “But it will be corrected in the House/Senate conference,” Grassley added.

Wyden said the provisions will be revised to “target” only top executives, and “Sens. Grassley and [Max] Baucus, D-Mont., chairman of the Senate Finance panel, will work to get that done in conference.”

Michael Kerley, senior vice president/federal government relations for the National Association of Insurance and Financial Advisors, said that since the House version of H.R. 2 has no provision related to deferred compensation, “NAIFA is cautiously optimistic” that House and Senate leaders “will find a way to eliminate the Senate deferred compensation language entirely.”

Kerley said the exact process to reconcile the differences appears to be under discussion. “Traditionally, a conference between House and Senate tax writers would be the mechanism of choice, but House and Senate leaders may opt for an alternative process,” he said.

While the House version contains no tax provisions, Kerley said, the “Senate version of H.R. 2 limits the opportunity for many ordinary workers and middle managers to save for future financial security needs through non-qualified deferred compensation plans.

“Fortunately, based on comments made by key senators, the Senate version will not likely be the final word,” he said.

Kerley explained that besides targeting middle management employees, the Senate deferred compensation provision as currently written “would also make life harder for smaller businesses trying to compete with larger companies to attract and retain top talent.

“NAIFA has expressed its concerns with and educated key lawmakers about these unintended consequences,” he said.