Jump to content

Self Directions within a NonQualified deferred Comp plan


Guest dwitz

Recommended Posts

Guest dwitz

If you establish a "mirror 401k" plan i.e. nonqualified deferred compensation plan, that looks like a 401k using mutual funds and you provide employees with the ability to direct the investment of their account just like a 401k plan do you run afoul of an ERISA rules or regulations? if so, which ones and why? Thanks David Witz

Link to comment
Share on other sites

ERISA mandates that a covered pension benefit plan satisfy its trust, minimum benefit accrual, minimum vesting and a whole raft of reporting, disclosure and other requirements many of which are contrary to the principal goal of the plan in sheltering the executives from current taxation under the constructive receipt doctrine, codified in IRC Sec. 451 (with respect to taxable entities). Two types of plans are exempt from these ERISA requirements: "top hat" plans and "excess benefit" plans. A nonexempt plan cannot simultaneously satisfy ERISA's requirements and avoid the application of the constructive receipt doctrine. Thus, the pre-tax aspirations of the executives in a typical NQDC plan hinge on (1) the plan's exempt status under ERISA and (2) avoidance of the constructive receipt doctrine.

For different purposes and in different contexts the Code and ERISA Title I each require that the plan be "unfunded." Read Rev. Rul 92-64 for general background on the IRS view of the meaning of this term as it relates to the establishment of a rabbi trust. Generally, the trust must provide that the assets of the trust are at all times subject to the claims of the employer's general creditors. Of course, to the extent participant's can directly control the investment of trust assets, they may well be deemed in actual, if not constructive, receipt. So it's important to design the plan so that the participant's investment choices are used as tracking devices by which the plan determines the hypothetical rate of return applicable to the account.

When you consider allowing the plan to determine the hypothetical rate of return on a participant's account with the investment earnings/losses attributable to the participant's investment directions you are confronting the issue of "dominion and control." In the past, the IRS has not specifically said that the degree of the participant's "dominion and control" over the trust assets is a factor in determining whether or not the plan is "funded" for purposes of the constructive receipt doctrine. There is some old guidance from the Department of Labor that suggests it may consider this factor in analyzing whether a plan is "unfunded" for ERISA purposes. In light of this, it may be wise to consider designing the plan to impose administrative contraints on the ability of executives to execute investment transactions. One approach frequently used is to require that all investment directions be sent to the rabbi trustee, or other third party, for execution no more frequently than once a month.

Phil Koehler

Link to comment
Share on other sites

An unfunded plan ( i.e. where the assets are subject to the claims of the employers creditors ) is not subject to the fiduciary rules of ERISA or the rules for a 40(k) plan under the IRC. However, in an unfunded nqdc plan the employee cannot have the right to select investments without the consent of another person, e.g, plan administrator, because the employee would be deemed in constructive receipt of the assets held in the caacount for the employee. Investment selection is one of the rights that can be exercised only by the owner of the assets.

mjb

Link to comment
Share on other sites

  • 1 month later...
Guest LRR

Self-directed accounts in nonqualified plan designs can raise some serious ERISA funding questions (and in a neat "Catch 22"; therefore possible constructive receipt issues). Those plans with self-directed accounts that use "401k bookkeeping" (the plan is the fund is the plan) are the most at risk.

I recently authored an article that was published electronically on exactly your topic. Email me if you would like a copy of the article to review. Most of the material from this article also was included in an article by Richard Landsberg on the issues in self directed NQP's published in the Journal of Deferred Compensation, Vol. 6, Number 4 Summer, 2001.

Link to comment
Share on other sites

I disagree with the assertion that the ability to self-direct investments causes constructive receipt. That issue generated a lot of interest after the advent of Rabbi Trusts, and the IRS has agreed that there is no constructive receipt issue. See PLR 8804023.

Kirk Maldonado

Link to comment
Share on other sites

Guest LRR

Kirk:

The issue I've raised is not the TAX issue directly, but the ERISA issue that would cause the plan to be deemed "funded", and then hence the IRS would presumably take the position that if funded for ERISA purposes benefits would be currently taxable.

I agree with you on the bare constructive receipt tax issue. By the way, so does Tom Bresindine (ex IRS benefits head). At least as of the last time I discussed this with him. He did a fine article himself on that issue about a year ago that he shared with me.

If you're interested in the ERISA issue that would then draw the tax issue as well let me know and I'll send you a copy of the article I coauthored on this subtle largely undiscussed ERISA issue. Several people have asked for copies just yesterday and it might generate some additional useful discussion. By the way, the self-directed feature in a nonqualified plan really does put clear focus on this potential ERISA "funded" nonqualified plan issue.

Link to comment
Share on other sites

Thks. I wasnt aware of the PLR on Rabbi trusts I think the ERISA issue is moot now that the IRS has issued proposed reg 1.457-8(B) permitting employee direction of investments in NP plans. Otherwise there would be a circular result that permitting self direction for NP plans under 457 regs would result in the plans being deemed funded under DOL rules which would require the benefits to be taxed.

mjb

Link to comment
Share on other sites

  • 1 month later...

Is it clear that the 1.457-8(B)(2) regulations signal that participant directed investments in nqdc plan of for-profit employes are ok? Aren't 457 plans subject to substantial risk of forfeiture and doesn't that make them different with respect to this issue?

Link to comment
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
×
×
  • Create New...