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.