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Voluntary
Deferral and Account Balance Plans - Overview
Deferral Election Requirements
Benefit Payments
Subsequent Elections to Change the Time and Form of Payment
Limited
Acceleration of Benefits
Plans Linked
to Qualified Plans
Future Alerts
On September 29, 2005, the Treasury Department and IRS issued
long-awaited proposed regulations regarding deferred compensation
agreements under Section 409A of the Internal Revenue Code. This alert,
the second in a series regarding Section 409A compliance and the
proposed 409A regulations, discusses the rules governing deferral
elections and the time and form of benefit payments under voluntary
deferral arrangements and other “account balance” plans.
Voluntary Deferral and Account Balance Plans - Overview
One of the most common types of nonqualified
deferred compensation plan is the voluntary elective deferral plan. In
this and other types of “account balance” plans, the participant’s
deferred compensation benefit is based on a bookkeeping account
balance. The participant’s voluntary elective deferrals are credited to
this account, along with any employer matching or other contributions.
Often these plans provide that the bookkeeping account will earn
interest (at a fixed or variable rate). More recently, many of these
plans have been designed so that the bookkeeping account balance will
experience gains or losses based on the performance of one or more
notional benchmarks.
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Deferral Election Requirements
In general, Section 409A provides that an
election to defer compensation for services performed during a calendar
year must be made (and must be irrevocable) by the end of the preceding
calendar year. The deferral election also must specify the time and
form of payment of amounts deferred under the plan.
There are several exceptions to the general
rule, including special provisions covering short-term deferrals, ad
hoc mid-year grants, commissions and fiscal year employers. In
addition:
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Newly eligible participants –
When an individual first becomes a participant in an account balance
plan, he or she may make the initial deferral election within 30
days after becoming eligible. This initial election can only be
applied to compensation for services performed after the
participant’s election. Also, this exception does not apply if the
participant has already been eligible under another account balance
plan maintained by the employer.
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Performance-based compensation – So long as the compensation has
not yet become reasonably certain, a participant may elect to defer
performance-based compensation as late as six months prior to the
end of the performance period. Performance-based compensation
generally means compensation that is contingent on the satisfaction
of pre-established organizational or individual performance
criteria. The performance period must be at least 12 months long.
The deferral election rules apply with equal
force to matching and other non-elective employer contributions to the
participant’s deferred compensation account balance. The employer’s
contribution is treated as the “deferral”, and the time and form of
payment must be specified no later than the time of the deferral. To
satisfy this requirement, the plan may specify the time and form of
payment or it may allow the participant to elect the time and form of
payment.
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Benefit
Payments
Section
409A restricts how an arrangement may define the time and form of
benefit payments. A deferred compensation plan or election must provide
that payments will be made only upon one or more of the following
events:
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A
fixed date or under a fixed schedule – Definitely determinable
amounts may be payable on a date or dates that are objectively
determinable at the time the amount is deferred. For example, a
participant may elect to receive payments in substantially equal
installments beginning on the participant’s 65th
birthday.
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Separation from service – The plan or election may provide that
payments will be made (or begin) when the participant separates from
service. For an employee, this would be his or her bona fide
termination of employment. For an independent contractor, this
would be the bona fide expiration of the contract. If the
participant is a “key employee” of a publicly-traded company,
payments due to separation from service must be delayed at least six
months following such separation from service.
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Death.
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Disability – The plan or election may provide that payments will
be made (or begin) when the participant becomes disabled, based on a
definition of “disabled” under Code Section 409A.
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Change in ownership or control – An arrangement may permit
distribution upon the occurrence of an event that, under IRS
regulations, constitutes a change in ownership, a change in
effective control, or a change in the ownership of a substantial
portion of the assets of a corporation.
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Unforeseeable emergency – An arrangement may allow hardship
distributions, provided that the distribution amount is limited to
the amount reasonably necessary to satisfy the emergency. The
hardship must constitute an unforeseeable emergency under Section
409A.
A deferred compensation arrangement may
provide for payment upon more than one of the events described above.
For example, a plan may provide that benefit payments shall commence
upon the earliest of attainment of age 55, separation from service,
death, disability, or unforeseeable emergency.
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Subsequent Elections to Change the Time and Form of Payment
Subject to certain limitations, a deferred
compensation arrangement may allow participants to change the time and
form of payment. If a plan permits the participant to make a subsequent
election to delay a payment or change the form of payment, it must
impose the following conditions:
1. The participant’s election may
not take effect until at least 12 months after the date on which such
election is made; and
2. With respect to payments to be
made for reasons other than death, disability or unforeseeable
emergency, the participant’s election must delay the first payment for
at least 5 years from the date such payment otherwise would have been
made; and
3. With respect to payments to be
made at a specified time or pursuant to a fixed schedule, the
participant’s election must be made at least 12 months prior to the date
of the first scheduled payment.
These rules may also be used to permit a
participant to “re-defer” receipt of short-term deferrals that
previously have not been subject to Section 409A. In general, a
short-term deferral is an amount that will be paid no later than March
15 of the calendar year following the year the amount is no longer
subject to a substantial risk of forfeiture (or, if later, two and
one-half months after the end of the employer’s fiscal year in which the
amount is no longer subject to such a risk). To re-defer a short-term
deferral, the participant must make an election at least 12 months
before the short-term deferral vests, and payment must be delayed at
least five years from the vesting date.
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Limited
Acceleration of Benefits
A plan may not permit the acceleration of
the time or schedule of any payment except under limited circumstances.
The exceptions allow acceleration:
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to
comply with a domestic relations order,
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to
comply with certain conflict of interest rules,
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to pay
income taxes on benefits that vest under a Section 457(f) plan of a
tax-exempt or governmental employer,
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to pay
certain de minimis payments relating to a participant’s termination
of interest in the plan,
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to pay
employment taxes,
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to
prevent a nonallocation year under an employee stock ownership plan,
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in
connection with the cancellation of deferrals due to an
unforeseeable emergency or hardship, or
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to pay
benefits includible as income for a violation of Section 409A.
The proposed regulations would also allow
accelerated payment upon termination of the arrangement. The proposed
regulations would allow termination of a plan following a qualifying
change in control, upon dissolution of the employer (if the employer is
a corporation), or following the employer’s bankruptcy if the bankruptcy
court approves the termination. An employer can also cease to provide
all deferred compensation of a particular type (e.g., all account
balance plans) if the termination satisfies various requirements and the
employer does not adopt a new arrangement of the same type at any time
during the following five years.
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Plans Linked
to Qualified Plans
401(k) wrap and
excess plans are types of nonqualified account balance plans designed to
coordinate with the employer’s qualified 401(k) plan. Typically certain
amounts are allocated to the account balance plan to the extent that
that they otherwise cannot be contributed to the qualified plan
because of nondiscrimination testing or other plan limits. As a result,
the calculation of amounts allocated to the account balance plan may be
affected by changes made under the qualified plan or adjustments to
applicable qualified plan limits. The proposed regulations provide that
an amendment of the qualified plan to increase or decrease benefits
under that plan, a change in the applicable plan limits and certain
other occurrences under the qualified plan are not treated as a deferral
election or an acceleration of payment under the account balance plan,
even if the action or event results in more amounts deferred.
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Future
Alerts
Future alerts on Section 409A compliance
will cover in greater depth various issues, including exclusions from
Section 409A coverage (e.g. short-term deferrals and severance
and separation pay arrangements), SERPs, employment agreements, bonus
and performance pay arrangements, equity compensation and split dollar.
If you have any questions
regarding this alert or other Employee Benefits Law related issues, please
contact one of our Employee
Benefits attorneys.
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