Kirk Maldonado

TCWalker: It seems like your response contemplates that a future grant of a stock option. I interpreted the original posting as involving a situation where there is an existing (pre-2005) stock option that permits the gain to be transferred to a NQDC plan. sjb: Does such an arrangement really make sense any more? I see two major problems: 1. You are converting long-term capital gains (assuming that the person held the stock acquired upon the exercise of the stock option) into ordinary income (which is the way that all amounts distributed from NQDC plans are taxed); and, more importantly 2. The amounts deferred are subject to the claims of the employer's creditors until they are paid out. On the other hand, if the participant held the stock, then he or she could elect to sell the stock at any time. Accordingly, if the company becomes insolvent before the deferred compensation benefits are paid out, then the person has lost everything, whereas if the person held the stock, he or she could sell the stock as soon as the price started dropping. Admittedly, the second factor is present whenever a participant contributes to a deferred compensation plan. But those contributions are usually made because the person believes that they will actually pay less in taxes by contributing those amounts to the NQDC plan when they are in a high income tax bracket and withdrawing them when they are in a lower tax bracket. Given the loss of long-term capital gains treatment, it seems like it would be hard to prove that this arrangement will save taxes in most cases.

LeeNunn: At the last teleconference they said that those arrangements were dead in the water. This teleconference they backed off an awful lot. I interpreted their remarks as meaning that some arrangements do work, but they've not worked out exactly what the acceptable parameters are.

Yes, if employee money is being used to purchase employer stock, the sale of those shares must be registered with the SEC, unless there is an available exemption. The registration requirements impose extensive disclosure obligations, which overlap somewhat those required by ERISA.

What do you mean by partially self-funded?

DJW: Thanks for the kind words. The resurrection of a plan was very carefully considered in a deal I worked on a number of years ago. The eventual decision was that it was too aggressive after spending a fair amount of time analyzing the issue, but I don't recall why we reached that conclusion. It may have had something to do with the possible risk that the reinstatement might jeopardize the prior termination, but I just can't recall at this point in time.

mbozek: Thanks for clarifying that point.

Mbozek: The reason why is because the persons that would otherwise receive the benefit (if it didn't go to the ex-spouse) will sue, claiming that they are entitled to the benefit. Their argument is based on the fact that the divorce decree specified that each spouse is giving up any interest in the property of the other spouse. Thus, the beneficiaries are claim that, through the divorce decree the ex-spouse gave up any right to retirement plan benefits, even though the beneficiary designation wasn't revoked. Certainly, the plan has equally strong, if not stronger, arguments in favor of it being able to pay out the benefits in accordance with the beneficiary designation. I've had this issue come up twice in my career. My research (at that time) indicated that the answer wasn't crystal clear, and in both cases there was enough money at stake to make it worth while for the putative beneficiaries (typically the participant's children) to sue. The plan could file an interpleader action, but that can be very expensive. That's why I favor having the plan document say that the QDRO automatically revokes the beneficiary designation. In fact, if I get to review the QDRO (on behalf of the plan) I make them put it into the QDRO. It avoids this problem come up frequently, and I think that often participants fail to change their beneficiary designations after divorce.

401 Chaos: I think that your original posting could be submitted to the IRS, with some minor edits. They will accept informal comments. Just in case you don't know, they have an e-mail address that you can use to submit comments on this project, so you don't have to go through the hassle of putting it into letter format, mailing it, etc.

401 Chaos: I guess I wasn't as clear as I could have been. My point was that if you want the IRS to address your specific situation in the written guidance or even to mention it at the next teleconference, you should bring it to their attention. If they don't know about the issue and your concerns, it is unlikely that they will address them. Thus, if you really want official or semi-official guidance on your issue, your time will be better spent sending your comments to them, rather than posting them here on BenefitsLink. I don't mean to imply that you shouldn't raise the issues here (as well), but the odds of the IRS guidance addressing issues that are only raised on BenefitsLink isn't too good. They probably would think, "We have enough already that people want guidance on; we don't need to go searching for more issues." Also, they may feel that if the issue was that important to you, you would have brought it to their attention. Because you didn't, it must not be very important to you. Although I don't like to bring this up very often (I think I've only done it two or three times before), but I should point out to you that I spent a number of years at the IRS in Washington drafting regulations, etc. on retirement plan matters, so I understand how the process works from the inside.

If the statute and regs don't allow it, I don't see how you could do it. Otherwise, you could set up a classification that excludes everybody but the senior executives, which would completely get around the 105(h) rules.

I seem to recall that the PLRs made a distinction if the payment came from a separate fund, rather than from the plan; not allowing rollover if the payment came from the fund. Under that line of reasoning, the payment here wouldn't be eligible to be rolled over because it wasn't a payment from a qualified plan. I'm not sure how the IRS would come out if the plan no longer existed (so that it would be impossible for the payment to be made by the plan), but I wouldn't be optimistic.

401 Chaos: Submitting that comment to the IRS will be infinitely more productive than posting it here.

What do the statute and regs say?

401 Chaos: Why don't you bring this question to the attention of the IRS? That way we all might clarification of this issue in the future guidance under Section 409A.

Isn't there a serious question as to whether those laws are pre-empted by ERISA?

I had never seen the plan design that you mentioned, although I've seen several wrap-around plans with other design defects. I'm not aware of any legal precedent that has occurred since the PLRs that would approve such an arrangement (or anything that predates those PLRs). If anybody who implemented a plan without either (a) conferring with legal counsel or (b) adequately warning the client that this is an aggressive approach, they have should be concerned.

There are a number of PLRs addressing this issue. A little research will reveal the answer.

I'm surprised that anybody is saying that you can have the amounts in excess of what is permitted under 401(k) go to a nonqualified deferred compensation plan. That alternative came up about the time of the first PLR on a wrap-around plan, and Treasury representatives made public comments that were picked up in the benefits press that those arrangements don't work. (I agree with them on that point.) I agree with your comment in that I was myopic in assuming that when the speakers were referring to cash-back plans that their remarks included those of the type sanctioned by the PLRs. It could very well be (and I certainly hope) that they were focusing on some of the other variants. All of the wrap-around plans that I've drafted were designed along the lines of the PLRs. I hope that Treasury gets a lot of comments about why it should be possible to design wrap-around plans in a way that complies with Section 409A.

I disagree that there is a "distribution." How can there be a distribution when the amounts are not taxable to the individual? That is taking a very aggressive interpretation of the word "distribution."

One way of avoiding having to get a check from the participant would be for the plan to take out a loan against the CSV of the policy (thereby reducing its CSV to the desired level) before distributing the policy to the participant. If the participant purchases any portion of the policy, you need to make sure that the deal satisfies the conditions of the applicable prohibited transaction class exemption.

You should have received a document from the plan describing the tax treatment of distributions. You should contact them and ask them to send it to you. It will answer a lot of your questions.

While there is authority that has allowed recission, I'm not aware of anything that is even remotely like this. My guess is that the IRS would never approve such an arrangement. Remember that filing the 1099-R will make it exceedingly easy for the IRS to discover that she didn't pay the penalty tax. If the employee thinks that she is right, let her fight the IRS. Why should the employer and the plan get involved in this dispute? Why should the employer expend its time and energy to assist the employee in aggressive tax planning? That is a waste of corporate assets (assuming the employer is incorporated).

I agree with Jon's remarks. I think that because of their increased exposure to liability, the disparity between the fees charged by a discretionary trustee and those charged by a directed trustee will dimish. However, directed trustees don't have unlimited ability to raise their fees, because if the difference isn't that much, clients will choose a discretionary trustee to be able to shift more responsibility and potential liability to the trustee.

Katherine: I have basically the same question to you that I for DWK. Your posting contemplates an arrangement fundamentally different than that described in the PLRs and every such plan I've ever seen. I think that IRS problem may be because they have the same misapprehensions about how these plans as DWK and Katherine. I had assumed that everybody would do their homework to find out how these plans work before voicing their opinions in public, but I'm beginning to think that my assumption was wrong. I would be interested to see if you two still believe that it would be impossible to draft such a plan in a way that complies with section 409A, if you assumed the struture involved in those PLRs.

DMK: Could you explain how that problem you suggested could ever happen in a wrap-around plan? What you are suggesting is fundamentally inconsistent with the way every such plan I've seen was operated as well and the logical underpinnings of how they are designed. Are you sure that you are even talking about the same type of arrangement? Is your arrangement consistent with those discussed in the PLRS issued on such plans? Were you the person advising the IRS on this point? That would explain their position.