NQ Deferred Comp Question

[Guest cease]

I would like to know if there are any circumstances where a participant can limit the amount of reportable income to the amount that is paid as an installment. Example: NQ Plan is a 457(f) plan. Substantial risk of forfeiture is 10 years of future service. The funding vehicle is an annuity payable over the lifetime of the participant. The first payment commences at the first of the month following the 10th anniversary of future service.

Is a present value calculation of the annuity determined as of the 10th year of service (and the taxability determined), or can the reportable income be limited to the amount of installments received dueing the 1st tax year, then the 2nd tax year, etc.?

Thanks for any guidance.

[E as in ERISA]

Under 457(f), the taxability is based on time of vesting not cash payments.

[Guest cease]

Katherine,

Thanks for the response. In the case where an annuity has been purchased by the organization on behalf of the participant, then a present value calculation needs to be made regardless of the fact that the annuity is payable in installments? If a life insurance company were the issuer, would the insurance company make that calculation, or would the organization retain the services of an actuarial consultant/tax adviser?

[E as in ERISA]

The taxation is based on the terms of the plan and the application of Section 72, if necessary.

A simple example would be where the participant vests in a balance of $100,000 in year 10. The employer and participant may agree that the obligation will be satisfied with an annuity payment of $12,325 a year (over the following 10 years). But I don't think that any calcs would be necessary for tax purposes. The participant would be taxed on the $100,000 in year 10, because that is the stated amount in which he vests in year 10 under the terms of the plan. The timing and amount of cash payments aren't relevant for tax purposes.

Now I understand that you have a different situation -- where the participant may vest in year 10 but the cash will be received in installments. But the same logic applies. The timing and amount of the actual cash payments aren't determinative for tax purposes. You apply Section 72 to the terms of the plan.

I would typically see this done by an actuary or consultant. But whoever does it, just make sure they calculate the taxable amount under 457(f), based on the terms of the plan and the Section 72 rules...

[mbozek]

Under 457(f) the property is taxed to the employee at its FMV, e.g., the account balance of the annuity on the date there is no longer a substantial risk of forfeiture. Reg. 1.457-11(a)(1). You dont need an actuary to do a calculation. For distribution purposes the amount included for tax purposes become the basis and the installments are taxed under the annuity rules on the amount of any payments which represent interest or earnings.

[Kirk Maldonado]

mbozek:

How would you propose to determine the value of the annuity that the person is entitled to receive upon vesting without an actuary? Would you simply use the amount of the premium payment?

[mbozek]

Wouldn't the insurance co be able to compute cash value of the contract, since it is their product. I assume that the ins co will issue some form of 1099 to the employer. Otherwise the value would be the value of the account balance under the plan on the date the employee is vested.

[Kirk Maldonado]

Mbozek:

If you use the cash surrender value, won't that always be less than the premium paid? So if the premium payments was $100,000, but the cash surrender value is $95,000, are you saying that the participant is only taxed on $95,000?

(Of course, that assumes that the annuity contract can be cashed in.)

Your approach of using the value of the account balance presupposes that this is a defined contribution plan. Nothing in the original posting indicated that, although that is generally a safe assumption.

How would you determne the taxable amount if it were a defined benefit plan with the benefits to be paid directly from the plan? (Admittedly, that wold be an poor designed plan.)

[mbozek]

Why would the cash surrender value be less than premiums paid? I assumed that the contributions were invested in an annuity policy owned by the er which returned some positive rate although if premiums were invested in a VA then the FMV at the time of nonforfeiture could be less the the premiums. The policy was assigned to the employee at its FMV after terminaton.

Are u assuming that the plan took the amount deferred and purchased an annuity contract for the employee after the deferral became vested?

If this is a DB plan, the plan should have some formula, e.g. 50 % of pay and the interest rate and mortality table should be in the plan. The PV of the future benefit can be computed on a HP-12c from the factors, e.g, life expectancy can be the 401(a)(9) Life expectancy and interest can be the federal rate. Of course you can always pay an actuary to do the calculation.

[Kirk Maldonado]

I had assumed that the plan wouldn't invest in the contract until the participant vested. Thus, there would necessarily be some decrement, due to commissions, premium taxes, etc.

While it is true that tax-qualified retirement plans are required to set forth the actuarial assumptions, that does not apply to nonqualified plans.

Of course, you could always ask the plan's actuary for those numbers. However, you would probably need to ask ask for a copy of the mortality table that they used. (I don't know how readily available all of them are.)

While it probably could be done by a non-actuary, I don't imagine that it would cost that much to have the actuary do the computations for one individual. I'd rather not be personally on the hook, just to save a few dollars.