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Guest Article

Deloitte logo

(From the October 9, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

SERP Shifts and IRC 409A


In recent years, many companies have transferred executives' retirement benefits from nonqualified to qualified plans, using a technique commonly known as a "SERP shift". Doing so provides the executives with greater financial security and more favorable financial treatment, and also often results in tax and accounting benefits for the employer. With the enactment of IRC 409A, which places severe constraints on the design of nonqualified deferred compensation plans, these arrangements need to be scrutinized to make sure that they comply with the new law. Fortunately, the IRS's proposed regulations under IRC 409A offer broad leeway for the continued use of SERP shifts.

Background on SERP Shifts

The type of SERP ("supplemental executive retirement plan") most frequently involved in a shift is joined to a qualified defined benefit plan. Typically, the SERP's benefit formula will be the same as the qualified plan's but will take into account compensation in excess of the maximum ($220,000 in 2006) that a qualified plan may consider. The SERP benefit will then be reduced by whatever the participant is entitled to receive under the qualified plan. A retired executive thus will receive two checks, one from the qualified plan, the other from the employer to satisfy its liability under the nonqualified plan.

In order to "shift" benefits from the nonqualified to the qualified plan, it is only necessary to increase the executive's benefit entitlement under the latter. The SERP liability will then fall automatically to reflect the larger qualified plan offset. It may not be possible to shift the entire liability, because nondiscrimination rules and other qualified plan restrictions limit benefit increases for highly paid employees, but shifting a large portion is very often feasible.

Effect of IRC 409A on SERP Shifts

Section 409A complicates the picture because it requires participants in nonqualified deferred compensation plans to elect at the outset when and in what form benefits will be paid, with very limited ability to make changes afterward. Qualified plans, by contrast, usually give participants a great deal of flexibility to change the timing and manner of distributions almost up to the moment of actual receipt. A SERP shift could be viewed as an evasion of the IRC 409A rules. In effect, the rigid nonqualified plan payout schedule is jettisoned in favor of the more lenient qualified plan rules.

Proposed Regulations Provide Clarification

The IRC 409A proposed regulations, however, clarify that such a shifting of benefits is permitted under the regulations because (1) in certain situations there is no deferral election, and (2) there is no acceleration of payment associated with transfer of liability when the qualified plan benefits offset the nonqualified plan.

Proposed Treas. Reg. 1.409A-2(a)(8) provides that changes in a qualified plan formula are not considered to be a deferral election. A deferral election does not exist when: (1) benefits under a nonqualified plan are calculated based on the same formula as the qualified plan, but without regard for the qualified plan limitations imposed by the Internal Revenue Code, or (2) benefits in a nonqualified plan are offset by benefits under a qualified plan. Moreover, even if the changes increase the amounts deferred under the plan, a deferral election does not exist as long as the time and form of payment do not change.

This rule applies, however, only where the nonqualified SERP initially provides for offsetting benefits by accruals under a qualified plan. A SERP cannot be amended to add a qualified plan offset, unless the offset applies only to SERP benefits attributable to future service.

If, however, a company's non-qualified plan is not linked to a qualified plan as previously described, only benefits accrued in the future may be shifted to a qualified defined benefit plan to offset the nonqualified plan liability. In these instances, future accrued benefits paid only from the qualified plan assets are not subject to 409A. The resultant nonqualified plan with lower future accrued benefits continues to comply.

Proposed Treas. Reg. 1.409A-3(h)(3) states that there is no acceleration of payment if the benefits under a nonqualified plan are offset by some or all of the benefits of a qualified employer plan. An amendment to a qualified plan does not constitute an acceleration of payment even though the benefits deferred under the nonqualified plan are decreased.


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2006, Deloitte.


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