Luke Bailey

Contingent benefit rule

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K plan sponsor has bonus plan that says to execs: Every year, if you make more than $275k, I will give you a bonus equal to your Box 1 W-2, without any limit, times 6%, minus the 402(g) limit, and then all that multiplied by $.50. So if I make $400k, my bonus is $2,750, which is $24,000 (6% of $400k), minus $18,500, or $5,500, times $.50. The intent is basically to make up for the missed match based on the statutory limits, which it does not do perfectly, but anyway, that's what they do.

But then they also say that to get the bonus you have to have deferred into the plan, at least something. They do not penalize execs who defer less than the limit (e.g., defer $10,000), but they do exclude you if you deferred $0.

This violates the anti-conditioning rule of Treas. reg. 1.401(k)-1(e)(6)(ii), right? And the result would be the same if instead of only excluding those who did $0, they reduced the product of 6% times comp (e.g., the $24,000 in my example) by the sum of the 402(g) limit and the difference between the 402(g) limit and what the exec actually contributed (but not to where your bonus was negative, obviously), which would seem more rational than just basing it on whether the exec did or did not defer at all.

If this is a violation of the anticonditioning rule, what is the fix under EPCRS other than stopping it? Seems hard to believe the IRS would say you have to go back to all the folks you excluded and pay them the bonus they would have received if the employer had not conditioned payment of it on 401(k) participation, which is the only correction I can think of that would put folks in the position they would have been in but for the violation.

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The literal among us might argue that it is the plan that needs to be put in the same position as if no violation occurred, so they would not be at odds with the practical among us who would just stop the violation and run for luck.

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QDROphile, that was sort of my thinking as well as to the consequences, but you hit the nail on the head that EPCRS has rules for fixing qualified plans, not for fixing arrangements drawn into a qualified plan's orbit by the anti-conditioning (aka "contingent benefit") rule. Thanks.

Thought of another slightly interesting oddity of the regs. Suppose I amended the bonus arrangement the I described in my original post to say the more typical, "You get something under this bonus plan only if you max out what you can do under the K plan." If I had an nonqualified deferred comp plan, I would then fit exactly under the second sentence of 1.401(k)-1(e)(6)(iii), second sentence. But because this is a bonus payable within the 409A short-term deferral period, not deferred comp, it wouldn't fit exactly. However, I don't think it takes too much of a leap to conclude that the regulation did not intend the distinction.

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It has been a  while since I looked at this.  On the 401(k) side, this is clearly a violation of the contingent benefit rule.  I seem to recall that if the nonqualified plan contribution is contingent on the executive deferring the 402(g) max, that is one exception available for the contingent benefit rule.  I don't remember a cite for that.

As for the 409A regs, the preamble states the following: 

Commentators raised issues concerning other types of plans under which a service provider must participate in a qualified plan to receive nonqualified deferred compensation. Specifically, commentators asked whether a plan could comply with section 409A if it provided that an employee must defer the maximum amount permissible under a qualified plan in order to defer any amount under a nonqualified deferred compensation plan. Where the service provider can change the service provider’s election to defer the maximum amount permissible under the qualified plan during the taxable year, and thereby change or discontinue deferrals under a nonqualified deferred compensation plan, the service provider can effectively make a late election to defer (or not defer) amounts under the nonqualified plan. The final regulations generally do not provide any additional relief with respect to this type of plan. However, where the additional amounts deferred under the nonqualified deferred compensation plan reflect only matching contributions that would be available under the qualified plan absent the restrictions in the qualified plan intended to reflect limits on qualified plan contributions under sections 401(m) and 401(a)(17), the final regulations provide relief but solely with respect to the matching amount that could have been contributed to the qualified plan absent such limits.

I added the emphasis.  If I recall the issue, if the match is not a perfect match, and if the arrangement is subject to 409A, this also raises 409A issues because the participant can be said to have made a late election on the nonqualified deferral by changing the elective deferrals in the qualified plan.  

 

 

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Try looking at it this way:  any participant whose match is limited by 401(a)(17) will receive at least the missed match amount in cash.  Not limited by 401(a)(17)?  No bonus.  Didn't make a contribution? No match was missed, so no bonus.  Made a contribution and it was limited by 401(a)(17)? Get a cash bonus based on a formula, not based on the missed amount.

The argument is probably stronger if instead of using a flat formula to calculate the bonus that the amount of the missed match is actually calculated per individual, which still gives zero for those not making a contribution.

As an aside, since this is a cash bonus and not an NQ plan, I don't see 409A or 1.401(k)-1(e)(6)(iii)/(iv) applying, provided is it paid by March 15 of the following year.

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My apologies, but I may have missed it.  Is this "bonus" simply a bonus paid as compensation or is this made as an employer matching contribution?  Or other employer contribution? 

If it is not a contribution to the plan and it is simply a bonus that is added to compensation, I am not sure the anti-conditioning rule would apply.  Isn't this simply an action that is outside of the plan?  It affects the participants' compensation but does affect their contributions. 

Sorry if I missed this in the OP. 

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My take was that it was described as a cash bonus contingent upon whether or not an exec making over 275k participates.  Below is the reg (emphasis mine):

1.401(k)-1(e)(6)Other benefits not contingent upon elective contributions -

(i)General rule. A cash or deferred arrangement satisfies this paragraph (e) only if no other benefit is conditioned (directly or indirectly) upon the employee's electing to make or not to make elective contributions under the arrangement. The preceding sentence does not apply to -

(A) Any matching contribution (as defined in § 1.401(m)-1(a)(2)) made by reason of such an election;

(B) Any benefit, right or feature (such as a plan loan) that requires, or results in, an amount to be withheld from an employee's pay (e.g. to pay for the benefit or to repay the loan), to the extent the cash or deferred arrangement restricts elective contributions to amounts available after such withholding from the employee's pay (after deduction of all applicable income and employment taxes);

(C) Any reduction in the employer's top-heavy contributions under section 416(c)(2) because of matching contributions that resulted from the elective contributions; or

(D) Any benefit that is provided at the employee's election under a plan described in section 125(d) in lieu of an elective contribution under a qualified cash or deferred arrangement.

(ii)Definition of other benefits. For purposes of this paragraph (e)(6), other benefits include, but are not limited to, benefits under a defined benefit plan; nonelective contributions under a defined contribution plan; the availability, cost, or amount of health benefits; vacations or vacation pay; life insurance; dental plans; legal services plans; loans (including plan loans); financial planning services; subsidized retirement benefits; stock options; property subject to section 83; and dependent care assistance. Also, increases in salary, bonuses or other cash remuneration (other than the amount that would be contributed under the cash or deferred election) are benefits for purposes of this paragraph (e)(6). The ability to make after-tax employee contributions is a benefit, but that benefit is not contingent upon an employee's electing to make or not make elective contributions under the arrangement merely because the amount of elective contributions reduces dollar-for-dollar the amount of after-tax employee contributions that may be made. Additionally, benefits under any other plan or arrangement (whether or not qualified) are not contingent upon an employee's electing to make or not to make elective contributions under a cash or deferred arrangement merely because the elective contributions are or are not taken into account as compensation under the other plan or arrangement for purposes of determining benefits.

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