Before the end of this year, many
companies will need to change how their qualified retirement
plans treat compensation paid after termination of employment.
The IRS has issued new rules limiting the forms of
post-termination compensation that may be taken into account in
a qualified plan. The new rules are part of a larger package of
regulations under Internal Revenue Code Section 415. For plans
that operate on a calendar fiscal year, the new rules become
effective on January 1, 2008. For plans that operate on a
fiscal year that begins between July 1, 2007 and December 31,
2007, some of the rules are already in effect.
Under the new rules, a qualified
plan generally must exclude post-termination compensation.
However, special rules apply to certain amounts paid within 2½
months after the participant’s termination or, if later, by the
end of the plan’s limitation year in which the termination
occurs, as described in the chart below.
|
Form of Post-Termination
Compensation* |
Section 415 Treatment for
Testing and Other Compliance Purposes |
Section 415 Treatment for
Purposes of Determining Contributions or Benefits |
|
Regular pay, overtime,
shift differentials, commissions, bonuses for services
rendered before termination |
Plan must
include |
Optional; include or
exclude per plan document |
|
Accrued bona fide sick,
vacation or other leave |
Optional; include or
exclude per plan document |
Optional; include or
exclude per plan document |
|
Unfunded nonqualified
deferred compensation plan payments that would have been
paid at the same time if employment was not terminated |
Optional; include or
exclude per plan document |
Optional; include or
exclude per plan document |
|
Salary continuation
payments for qualified military service or permanent and
total disability |
Optional; include or
exclude per plan document (not limited to 2½ months/end
of limitation year period) |
Optional; include or
exclude per plan document (not limited to 2½ months/end
of limitation year period) |
|
Severance pay |
Plan may not
include |
Employee deferrals
not permitted; plan should exclude
for all other purposes |
|
Parachute payments |
Plan may not
include |
Employee deferrals
not permitted; plan should exclude
for all other purposes |
|
Unfunded nonqualified
deferred compensation plan payments triggered by
termination |
Plan may not
include |
Employee deferrals
not permitted; plan should exclude
for all other purposes |
*Applies only to compensation paid
within 2½ months after the participant’s termination or, if
later, by the end of the plan’s limitation year in which the
termination occurs.
Employer Action Items
Before year end, employers should
review their plans and payroll procedures to confirm how
post-termination compensation is currently treated for different
purposes. Employers should identify all forms of
post-termination compensation that are currently taken into
account by their plans and determine which of those forms can
and should be included going forward. When considering changes,
employers will have to consider administrative and recordkeeping
constraints, especially payroll system capabilities.
Some issues will require special
and immediate attention:
-
Employers with 401(k), 403(b)
and 457(b) plans should make sure that participants are not
allowed to defer severance pay or other post-termination
compensation except as permitted by the new rules. Some
employers may need to adopt plan amendments to eliminate
non-compliant provisions. These rules become effective
January 1, 2008 for most plans. However, note that these
rules are already in effect for plans that operate on a
fiscal year that begins between July 1, 2007 and December
31, 2007.
-
If an employer wants to amend
its plans to exclude forms of compensation that are
currently included in determining contributions or benefits,
the employer may need to adopt the amendment before the
desired effective date.
-
Many employers that provide
profit sharing or discretionary matching contributions will
need to amend their plans before the end of the current plan
year if they want to make changes of any kind in the
definition of compensation used in allocating contributions
for 2008.
Unfortunately, the new rules are
complex. Employers should consult with their retirement plan
advisors to confirm how and when the new rules will affect their
particular plans.
If you have
any questions regarding this alert or other Employee Benefits
Law related issues, please contact one of our
Employee Benefits attorneys.
