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Nonqualified plan with benefits reduced in case of future employment


Carol V. Calhoun
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I have a governmental client (not state or local, so 457 doesn't apply) that wants to implement a nonqualified plan for an official.  Without getting too far into the details, the plan would provide that the basic benefit is $X per year, but that a supplemental benefit of another $X a year is payable if the official doesn't engage in a paid activity (employment or self-employment) for as much as six months of the year.  Note that any paid activity (not just employment with the original employer) for six months would eliminate the supplemental benefit for that year.

Leaving aside for the moment the question of interpretation (e.g., how do you measure the number of months in the case of self-employment?), does this violate 409A?  In theory, the "form" of benefit could be modified by the participant's decision whether or not to accept paid activity.  (E.g., it would be a life annuity if the participant retired completely, but would be some sort of popup benefit if they continued to be employed elsewhere for several years.)  And the supplemental benefit would be payable on something other than one of the events named in 409A (the cessation of all paid activity, not separation from service with the original employer).  On the other hand, this doesn't seem to be what 409A was intended to get at, since the benefit would be forfeited entirely, not just deferred to some later date, if the individual engaged in paid activity.

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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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Without doing a deep dive, a few thoughts, for what they are worth:

  • Could the supplemental amount be analyzed similarly to a forfeiture for violating a non-compete (e.g., an agreement that says "you will not receive your annual payment for any year in which you violate your post-termination non-compete")? 
  • I think phrasing the benefit as the combined amount, then forfeiting the supplemental portion, frames the issue better. For example, "you will receive $200 as of December 31 of each year, but you will forfeit $100 per year if you work too much elsewhere during the year." As long as the forfeited amount is not deferred or otherwise paid later, and the basic benefit (the remaining $100) is unaffected, it seems like it's simply a forfeiture and not a change in form of payment or subsequent election. 
  • One potential sticking point may be the rules governing the determination of objectively determinable amounts paid pursuant to a fixed schedule in 1.409A-3(i), which won't comply if they are based on the occurrence of an "event" during the year. I'm not sure that performing services for another employer would be an "event" but there's not much guidance. 
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I agree, Carol, that this is not the kind of plan design that 409A was intended to regulate.  Generally, 409A cares only about the timing of payments and not the amount of the payments.  So I think that EBECatty's bullet point 2 is the better analysis.  His example assumes that you pay the benefit as an annual amount on 12/31 each year.  If the plan so provides, that seems workable within 409A.   Even if the payments are to be made "during the calendar year" without specifying a date within that year, I think that would meet the timing requirements of 409A. 

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I think there is an argument that the failure to engage in significant services is a vesting requirement for the additional payment, and, therefore, that portion of the payment is covered under the short term deferral rule.  I would absolutely suggest that it have the normal "separate identified payment" language to preserve this argument.

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41 minutes ago, LSB said:

I think there is an argument that the failure to engage in significant services is a vesting requirement for the additional payment, and, therefore, that portion of the payment is covered under the short term deferral rule.  I would absolutely suggest that it have the normal "separate identified payment" language to preserve this argument.

Wouldn't you still need a substantial risk of forfeiture as defined under 409A to delay vesting and use the short-term deferral rule? 

I would think the only vesting condition present (not performing substantial services elsewhere) would fall under the SROF rules governing non-competes that provide "[a]n amount is not subject to a substantial risk of forfeiture merely because the right to the amount is conditioned, directly or indirectly, upon the refraining from the performance of services." 

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On 8/23/2021 at 10:36 AM, EBECatty said:

Wouldn't you still need a substantial risk of forfeiture as defined under 409A to delay vesting and use the short-term deferral rule? 

Wouldn't the rusk of losing the benefit count as a substantial risk of forfeiture???

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