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457f Plan - Deferral Elections


austin3515

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Plan design is this: Participants are able to choose between a cash bonus today, or an Elective Deferral to the Plan in the same amount as the bonus PLUS a matching contribution.

The idea is that if people would prefer the cash in their pocket they can take it, but if someone is comfortable with a 3 year rolling vesting schedule they will get the extra match as a kicker.

Anyone have a problem with the participant signing this election form on or before the date the contribution is funded? 1.409A-2(a)(5) seems to suggest that this is ok.

Now I also have a provision that the participant will vest upon termination without cause. I believe in order to comply with the above, I have to "insist" that the termination without case take place greater than 12 months after the initial deferral election.

Thoughts?

Austin Powers, CPA, QPA, ERPA

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The IRS has expressed concern about voluntary deferrals to a 457(f) plan. See this extract from Notice 2007-62 https://www.irs.gov/pub/irs-drop/n-07-62.pdf:

Section 1.409A-1(d)(1) provides that an amount is not considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compensation, unless the present value of the amount made subject to a risk of forfeiture is materially greater than the present value of the amount the recipient otherwise could have elected to receive absent such risk of forfeiture. This is because, absent tax considerations, a rational participant normally would not agree to subject a right to amounts that may be earned and payable as current compensation, such as salary payments, to a condition that subjects the right to the same payments to a real possibility of forfeiture. Accordingly, in this situation, agreement to subject the amount to a substantial risk of forfeiture indicates that the recipient of the compensation is confident that there is not a real risk of forfeiture and is only subjecting the amount to the purported risk of forfeiture as a means of avoiding taxation. Thus, amounts that an individual could have elected to receive under a salary deferral election generally cannot be made subject to a substantial risk of forfeiture under the rules of § 409A beyond the date or time the salary would otherwise have been received.

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

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Agree with XTitan. A risk of forfeiture associated with a voluntary deferral of compensation may generally be treated as substantial under Section 83, but not under Section 409A unless, as mentioned above, the present value of the projected payment amount is materially greater than the amount deferred.

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I don't understand where the concern comes from. Did you notice I mentioned a Match? They are doing it specifically because the Employer will give them more. So they can get a $5,000 bonus, or make a $5,000 deferral and receive a $2,500 match. They increased what they get out of it by 50%. That's pretty much the ratios that are being discussed in my example.

Austin Powers, CPA, QPA, ERPA

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The concern is that employers who have a 457 plan don't have the same incentives as other employers. They won't care about taking deductions on contributions and so they're more likely to enter into arrangements that defer compensation and hence defer the taxation on the compensation. I'm not saying you're not giving them a good deal; I'm saying you should run it by an attorney to get their opinion on 409A issues.

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"Section 1.409A-1(d)(1) provides that an amount is not considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compensation, unless the present value of the amount made subject to a risk of forfeiture is materially greater than the present value of the amount the recipient otherwise could have elected to receive absent such risk of forfeiture."

You're telling me a 50% match would leave doubt??

Austin Powers, CPA, QPA, ERPA

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Geeze, if I look at the words used by the IRS I just don't see how it doesn't fit in perfectly. If I don't defer, I don't get the match. If I get the match, my expected payment is greater than what I otherwise would have received.

I have to tell you, if the option were provided to me, I would take the match. I like my job, I have no intention of leaving. I fully expect to be here for 3 more years. And that's an extra $2,500 for just being patient.

Austin Powers, CPA, QPA, ERPA

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Austin – An alternative / added design consideration, if the executive(s) are healthy, is taking the plan after-tax through an executive owned institutional life insurance (ILI) funded program with a REBA (Restricted Employee Bonus Agreement) for the match / vesting.



Executive contribution and match go into the policy. Policy has 98% to 105% cash surrender value to premium in year 1 so no liquidity / nonqualifed 409A distribution penalty exposure. Executive controls the amount of policy contribution capacity, investment allocation and beneficiary designation. Employer has a collateral assignment to secure its unvested match repayment on executive termination of employment. Executive has access to their cash without the 20% 409A penalty exposure. Many executives choose an increased policy contribution capacity to accommodate moving personal funds from taxable brokerage accounts. The value advantage to the executive is the cost-of-insurance has less impact on investment gains than taxes – why corporation and banks invest in ILI (COLI/BOLI). For executives already in the maximum tax brackets – short-term the plan is net cash neutral plus they have some added financial protection. For executives not in the maximum tax brackets – the plan can result in higher net cash as the executive is not risking bracket creep on 409A distributions plus they have the added financial protection.



So, not a “life insurance” program, but a 7702 based after-tax investment alternative employers are using as a 409A complement, or alternative where 409A is not a fit for the employer or the executive. I say 409A complement as many employers are making their 409A participants aware of this personal access to ILI and many enroll today to commence creating a container to accommodate the after-tax value of their 409A distributions for life-after-career cash and risk management.

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  • 2 months later...

I know this is old, but the proposed 457 regulations deal with this issue. They allow elective deferrals only if the election meets all of the following requirements:

  • The present value of the amount to be paid upon the lapse of the substantial risk of forfeiture must be materially (at least 25%) greater than the amount the employee otherwise would be paid in the absence of the substantial risk of forfeiture.
  • The substantial risk of forfeiture must be based upon the future performance of substantial services or adherence to an agreement not to compete. It may not be based solely on the occurrence of other types of conditions (for example, a performance goal for the organization). However, if there is a sufficient service condition, the arrangement can also impose other conditions. For example, the substantial risk of forfeiture could continue until the later of two years or when a performance goal was met.
  • The period for which substantial future services must be performed may not be less than two years (absent an intervening event such as death, disability, or involuntary severance from employment).
  • The agreement subjecting the amount to a substantial risk of forfeiture must be made in writing before the beginning of the calendar year in which any services giving rise to the compensation are performed. Special rules apply to new employees (but not to employees who are newly eligible to participate in a plan).

Prop. Treas. Reg. § 1.457-12(e)(2).

Employee benefits legal resource site

The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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Proposed 457 regs. And yes, I'd agree that anything (match or earnings) that increases the value by more than 25%, and meets the other conditions, would work.

Employee benefits legal resource site

The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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Yep, sorry, I was referring to an old post, not old regulations. I've spent the last week mired in these regulations, and my brain is going. <_<

Employee benefits legal resource site

The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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