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What happens when a top hat participant is demoted?


Guest newtobenefits

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Guest newtobenefits

What happens when a top hat plan participant is no longer eligible to participate in the top hat plan, ie. he is demoted? If you yank him from the plan and pay his account, wouldnt this run afoul of 409As prohibition on acceleration? But it would seem that based on ERISA/DOL requirements you'd have to pull him from the program.

Thoughts? Citations to authority is greatly appreciated.

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Loss of eligiblilty for futher accrual is not an event that requires payment, and can't be an event that permits payment. You follow the 409A compliant terms of the plan with respect to payment. I would not worry so much about the accrued benefit causing ERISA problems if everything was compliant during the time of accrual and no monkey business on the side.

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What happens when a top hat plan participant...is demoted

Editorial comment on a dreary Friday afternoon -- He should quit his job and seek employment elsewhere.

Lori Friedman

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We've had situations recently where the person was not demoted per se but did change duties and thus fell out of the eligibility provisions of the plan. I think the plan could arguably have been amended to allow participation of individual's in the employee's new role / management level but nobody wanted to do that. As QDRO suggested, we suspended further accruals but the existing account stays until actual termination of employment. Trick here is to catch the change in status in enough time to stop future accruals. We missed a paycheck or so and, as a result, determined that the amounts should be reveversed. Seems limited 409A self-correction procedures permit that though.

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Cancellation of deferrals is the same thing as acceleration of benefits, and 409A doesn't have a mechanism to stop deferrals mid-year (except hardship or disability). Loss of eligibility isn't a triggering event, either for deferral cancellation or payout. Dan Hogans commented once that there was an opportunity to play games - demote one day/promote the next - which is never good in 409A.

Unfortunately, I haven't seen any other citations one way or the other - my bias is to stop deferrals only upon the next full plan year, providing counsel signs off.

 - There are two types of people in the world: those who can extrapolate from incomplete data sets...

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XTitan,

I appreciate your position but I guess I'm not absolutely convinced that the final regulations prohibit you from terminating participating and thus stopping contributions if the service provider is clearly taken outside of the plan's eligibility provisions. To my mind, there is a distinction to be drawn between simply cancelling existing deferrals versus stopping them in situations where there is a legitimate loss of eligibility without any facts or circumstances to support an abusive arrangement. I understand Hogan's concern about using that as a subterfuge but I thought that was one reaon they included the 24-month wait provision in the initial eligibility language so you at least would be stuck waiting until next year to get back in. In our situation, the employee transferred to a different non-executive job in a different location and was clearly outside of the plan's general eligiblity provision. Seems that you are sort of damned if you do and damned if you don't in that continuing to allow participation for the remainder of the year when nobody else in similar position would be covered and permitted to participate in the plan.

Of course, a good argument could be made that if you have to select between violating 409A versus violating the plan document eligibility provisons, maybe you are better off skirting the eligibility provisons and arguing that you were required to do that to comply with 409A via the general plan provision that cites that the plan is to be interpreted consistent with 409A (for general intent and ambiguity purposes but not as a savings clause / gap filler). It is not clear to me though that the IRS could not make a counter argument that permitting continued deferrals for someone not eligible to participate under the terms of the written plan document required by 409A as being a 409A violation itself.

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From the preamble to the final regulations, 72 Federal Register 19234, 19268 (4/17/07):

"Commentators requested that a service recipient be permitted to cancel a service provider's deferral elections in two situations. First, commentators asked that such a cancellation be allowed when the service provider is transferred to a position that is not eligible to participate in the plan. The Treasury Department and the IRS are not confident that a standard can be established that would clearly distinguish a bona fide transfer to an ineligible position from a pro forma transfer designed to avoid the prohibition on accelerated payments, especially when the underlying plan is specific to the service provider, as in the case of an individual employment agreement, and accordingly the final regulations do not adopt this suggestion."

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You can't have a plan design that is compliant with 409A if you have any way to stop elective deferrals for the year except as expressly provided under 409A. Position eligibility is secondary to the annual deferral election requirement. Section 409A does not care about ERISA. Pick your poison. I would take my chances with potential problems ERISA. You might consider an election to defer "10 percent of my compensation for the year as a vice president" compared to "10 percent of compensation for the year" but it would be risky.

You have more to work with for nonelective deferrals.

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Section 409A does not care about ERISA. Pick your poison. I would take my chances with potential problems ERISA.

Well said. With ERISA you have years of interpretative guidance. With 409A, it's 'a brave, new world'.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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