Elective deferrals subject to a substantial risk of forfeiture?

[ERISA guy]

Under a nonqualified 409A plan, must elective deferrals be 100% vested at all times - and only nonelective contributions may be subject to a vesting schedule? Or may elective deferrals also be made subject to a substantial risk of forfeiture? Some citation or authority one way or another would be much appreicated. 

[EBECatty]

The following is from 1.409A-1(d)(1). Note that salary deferrals can be made subject to vesting in certain circumstances where the ultimate payment will be materially greater than the salary deferred, e.g., an employee can defer base salary and receive an employer match on the deferral (25% minimum is a good rule of thumb), all of which can be made subject to a SROF. But just a straight salary deferral generally cannot be made subject to a SROF. 

Except as provided with respect to certain transaction-based compensation under §1.409A-3(i)(5)(iv), the addition of any risk of forfeiture after the legally binding right to the compensation arises, or any extension of a period during which compensation is subject to a risk of forfeiture, is disregarded for purposes of determining whether such compensation is subject to a substantial risk of forfeiture. An amount will not be 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 subject to a substantial risk of forfeiture (disregarding, in determining the present value, the 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. For this purpose, compensation that the service provider would receive for continuing to perform services regardless of whether the service provider elected to receive the amount that is subject to a substantial risk of forfeiture is not taken into account in determining whether the present value of the right to the amount subject to a substantial risk of forfeiture is materially greater than the amount the recipient otherwise could have elected to receive absent such risk of forfeiture. For example, a salary deferral generally may not be made subject to a substantial risk of forfeiture.

[Luke Bailey]

23 hours ago, EBECatty said:

For example, a salary deferral generally may not be made subject to a substantial risk of forfeiture.

EBECatty, you can take this statement at least two different ways. The first is as a legal prohibition against making deferred salary subject to forfeiture, at least "generally." The second way is as a statement that it's so unlikely for a variety of reasons that salary would be subject to a substantial risk of forfeiture that it won't pass muster under 409A. I would question the IRS's legal authority for the rule if the first interpretation is what they had in mind.. Seems like vesting outside the qualified plan realm is up to ERISA and DOL, and the absence of a requirement to vest elective deferrals 100% is a glaring omission from ERISA (not surprising since 401(k) plans weren't really a thing in 1974). Too bad ERISA probably preempts state wage and hour laws here.

I had a case 30 years ago in which a fairly substantial privately held company had a nonqualified plan with elective deferrals and did have a vesting schedule. We represented an aggrieved former employee and in the end they vested him, probably as part of a settlement involving other issues as well. But I think they had successfully applied the provision against other participants.

[EBECatty]

Fair point, Luke. I had assumed the question was asking whether a plain salary deferral could be made subject to a SROF for purposes of 409A.

I suppose deferred salary could, in the broader sense, actually be forfeited (in that the participant loses the right to receive payment altogether) but the SROF would not be recognized under 409A (or 457(f) or, I would think, 3121 by way of 83).  

[Luke Bailey]

EBECatty, completely agree with you on your first sentence. As to the second, it would be an interesting case. Presumably governed by ERISA, but ERISA's vesting rules wouldn't apply if a proper top-hat plan. I can think of some arguments that the participant could use, however, even if the employer/plan had good facts. And my guess is in a lot of cases the facts would be bad for the employer/plan.

[ERISA guy]

This is great information, and I follow. Thank you very much for the responses.