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Guest JBauer

alternate payout forms for DB SERPs

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Guest JBauer

Does anyone know whether it's permissible to specify alternate forms of benefit payout that are based on the PV of the benefit at commencement? I'm familiar with the exception to the anti-acceleration rule for de minimis amounts, but my concern deals with the ability to design a plan so that the form of payment, though specified in the plan before amounts are earned, is driven by the PV at the time of commencement. For example, if PV is $25k or less, lump sum; if not, then default annuity.

I'm not finding an answer to this in the prop regs, but I easily could have missed something.

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Keep in mind that DB SERPs are usually nonelective so the time and form of payment must be set prior to a legally binding right attaching, not necessarily before they are "earned" but sometimes there may be no practical difference.

Anyway, IMO I can't see any problem with violating the anti acceleration rule as long as it is clear that the plan will pay out on whatever time is selected that conforms to 409A (e.g. separation from service).

The only potential problem I see the IRS challenging is with the "default" being an annuity there would be a "further deferral" when a lump sum was potentially "available", thus violating either the 409A subsequent election rules or the constructive receipt rules (refer to the Veit I and Veit II tax court cases, and the Martin case). Thus the IRS would argue current taxation of the full lump sum. With the payment form being set in advance of earning, it doesn't seem possible that the IRS could win any legal arguments unless the determination of the PV lump sum is somehow within the control of the employee--i.e. they control the actuarial assumptions used to decide PV, then manipulate the data to defer tax in installments. In order to be safe, I would change the default to lump sum and have the annuity kick in if the PV is over 25K, with a very careful independent evaluation of the determination of PV.

In a post-409A world this design is questionable, but IMO this design would have even looked and smelled pretty bad in a pre-409A world (see the cases cited above). Historically the IRS hates extensions of payments even more than accelerations. Practically speaking, since 409A leaves the general rules of constructive receipt, etc. in place, the door is left open for the IRS to examine cases like this where there is potential for abuse. Because of that potential the safest thing to do would probably be to build in a second election option allowing for a determination of PV and a change in form of payment 12 months prior to the initial payment date. Of course then the P has to wait five years before receving a payment.

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Guest JBauer

Thanks for the response. That was my thinking - as long as the determination of PV is objective and outside the control of the service provider and recipient, and provided in the plan before the right attaches, I don't see why this would be problematic. I was just concerned by the fact that the prop regs are specific in allowing payment form to vary based on the date the trigger occurs, but silent on whether form can be determined based on value or some other objective variable.

Concerning the issue of constructive reciept, I would argue that even though the PV of a benefit might be less than $25k, the participant would have to either separate from service (or, depending on the design, attain a particular age before his benefit becomes available) (at which time it is automatically distributed). Therefore, the participant would not be in constructive receipt. And as long as any redeferral complies with the 409A rules on subsequent deferrals, constructive receipt would be avoided with regard to benefits that would be payable as a lump sum more than 12 months out.

Do you agree?

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In a simple situation, you might have a plan that will pay out on the later of attainment of age 65 or separation of service; if 65--annuity, if separation--lump sum. Assuming that passes 409A muster, then in that case, since nothing can happen in b/w the LBR and the determinatin of form of payment (except for continued employment) to change the form of payment, there would presumably be no issue. I wonder if the regs are silent because Treasury assumed it was impermissible or that it would be permissible only if the terms were "objective" and predetermined as you say. Maybe the final regs will speak to this. At any rate I would hire an attorney to work in conjunction with an independent actuary. The "wait and see" approach you discuss is creative, but as a result looks risky for obvious reasons and subject to challenge. In this day and age of "backdating" options, do you think the service will give you the benefit of the doubt as to "objectivity" and "predetermined" assumptions?

One other planning tool could be to subject the benefits to SRF until payout (won't this become more of a common planning tool even though executives will no doubt complain?). That way you could pay out benefits in a lump sum (or installments) within 2 1/2 months after year in which the SRF ends, such as separation from service, without regard to 409A and constructive receipt won't be an issue if you plan and operate properly. Then, if you want to do an annuity, it might look better optically to the IRS if the benefits are truly forfeitable when the assumptions are put into place prior to LBR. Remember pre-ERISA-even under qualified plans you could lose your benefit if you didn't stay until retirement age.

I'm not sure what you're second question is. If you have a proper subsequent election provision in the plan, you can change the form of payment. Constructive receipt would only be an issue if there is some way an amount is "made available" and then further deferred in violation of 409A.

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Guest JBauer

Thanks again.

The payment trigger will indeed be designed as a "later of" a specified age (the age for early retirement) or separation, which is designed to match up with the qualified plan. (It would be easiest if we could track the qualified plan's early retirement benefit provision, but the condition that the participant have a specified number of YOS disqualifies this as a permissible trigger).

Unfortunately, the SRF concept won't work for this group and lump sum payments of the entire benefit isn't a possibility. But I appreciate the suggestion.

On the second question, I think we're saying the same thing. (I read your first response as a suggestion that a participant would be in constructive receipt of benefits payable as a lump sum if the PV is below a specified amount, even though the payment trigger - separation or, if later, attainment of a specified age) has not yet occurred). However, because the amount is not available to him he wouldn't be in CR.

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On the second question, I think we're saying the same thing. (I read your first response as a suggestion that a participant would be in constructive receipt of benefits payable as a lump sum if the PV is below a specified amount, even though the payment trigger - separation or, if later, attainment of a specified age) has not yet occurred). However, because the amount is not available to him he wouldn't be in CR.

I guess I assumed that when you said "my concern deals with the ability to design a plan so that the form of payment, though specified in the plan before amounts are earned, is driven by the PV at the time of commencement", you meant there would be a trigger at that time. If not, then I agree no CR issue. I don't mean to beat a dead horse, but the door would still seem to be open for the IRS (if they end up being really aggressive) to claim that the "down the road" determination of PV (even if assumptions are set pre LBR) is really a second election that is not in compliance with 409A. If that happens all amounts for each participant under all non account balance plans not subject to SRF are in immediate violation. Is that really worth the risk? That's what makes extended SRF a little attractive--409A penalties can't begin until a valid SRF ends.

Anyway---good luck!

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Guest JBauer

Thanks again for those thoughts. I can see how using the SRF would be good.

Another question: the NQP itself limits the compensation that's taken into account in designing the plan. Would amending it to raise that limit result in a prohibited redeferral? I'm concerned about this possibility because of the negative inference under the proposed regs on linked arrangements. The regs state that changes to a QP that result in an increase/decrease to the nonqual benefit are not considered impermissible redeferrals or accelerations. (So the question I have is whether changes made to the NQP that increase/decrease the NQP benefit, e.g., amending a limitation on the benefit, would result in an accel/redeferal, or am I perhaps reading the regs too closely?)

I suppose the more basic question is whether amounts that have been deferred can be revised from time to time by agreement, so long as the timing and form of payment are not affected. It seems to me that if a nonqualified benefit can be negotiated down (up), 409A's restrictions on acceleration (redeferral) of payment could be easily circumvented.

Any thoughts would be greatly appreciated!

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I can't think of any reason why an employer couldn't make these types of amendments to a NQP because they are nonelective. The "deferral" is made prior to the employee receving any LBR to the compensation therefore you satisfy 409A requirements. You could even change the form of payment with respect to the new deferrals, I think.

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Guest JBauer

I agree with your response, but seem to be getting caught up on a fundamental concept of deferred comp.

In my specific situation, compensation that's taken into account under the SERP is limited such that, let's say, in 5 years there will be no need for it unless that limitation on compensation is increased. Assuming that some employees' compensation currently exceeds that limit, and that the NQP is then amended to increase that limit, those employees' NQP benefit increases by virtue of the plan amendment.

Are you saying that because the plan specifies the time and form of payment before there is a LBR (as required for nonelective arrangements) to the additional deferred compensation (which results from the increase in the NQP benefit formula), the "increase" would not constitute a redeferral (even though it is essentially attributable to past service) but rather would be a new benefit accrual that's simply subject to the initial deferral rules?

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Are you saying that because the plan specifies the time and form of payment before there is a LBR (as required for nonelective arrangements) to the additional deferred compensation (which results from the increase in the NQP benefit formula), the "increase" would not constitute a redeferral (even though it is essentially attributable to past service) but rather would be a new benefit accrual that's simply subject to the initial deferral rules?

Exactly, but you said it better. From a pure 409A standpoint this seems right to me, but increasing "past" service credit (if that's what is happening) seems to cause other issues involving previously reported w-2 amounts (i.e. what would happen when non taxable deferrals have to be reported code Y?), amounts that were already included in FICA wages and other accounting/actuarial issues. Maybe someone with more accounting or actuarial experience could chime in? It seems to me you would have to separately account for these additional accruals going forward, like in a qualified DB the actuaries have to have to set up separate formulas and track which provisions of the plan applie to each "bucket".

If the SERP is a wrap plan and not paying out when participants go over qualified plan limits (is that what's happening?), then changing the design of the plan to a a cash balance plan with a definition of comp tied to the exectuvites salary and or bonus might accomplish the goal

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