New Section 409A: Grandfathering pre-2005 deferrals

[Guest John Nelson]

I initially thought an employer could freeze their "old" Non-qualified Deferred Comp Plan, thereby preserving the participants' ability to make elections under the "old" Plan as to time and form of payment, then start a new Non-qualifed Deferred Comp Plan effective 1/1/2005 for post-2004 deferrals. And, that only deferrals under the new Plan would be subject to new Section 409A.

But, as I read Q-18 of Notice 2005-1, it says that a "new arrangement" after 10/3/2004 is presumed to be a material modification of the pre-2005 Plan.

I think this means that if the Employer wants to continue a non-qualified deferred comp plan for employees after 12/31/2004, the pre-2005 deferrals have to be brought under the new rules, i.e., the pre-2005 deferrals won't be grandfathered.

Is this correct?

[Guest LeeNunn]

I don't think that is correct. Consider this sentence from A-18(b):

Notwithstanding paragraph (a) and this paragraph (b), the grant of an additional benefit under an existing arrangement that consists solely of a deferral of additional compensation not otherwise provided under the plan as of October 3, 2004 will be treated as a material modification of the plan only as to the additional deferral of compensation, if the plan explicitly identifies the additional deferral of compensation and provides that the additional deferral of compensation is subject to § 409A.

[E as in ERISA]

What do you think is the "new arrangement" in your example?

If the choices about the time and form of payment are in accordance with the terms of the old plan as it existed on October 3, 2004, then the "exercise" is not a material modification. Q 18 says "it is not a material modification for a service recipient to exercise discretion over the time and manner of payment of a benefit to the extent such discretion is provided under the terms of the plan as of October 3, 2004"

If the plan previously didn't have installments and you added installments, that would be a material modification. But if the plan had installments and the participant used the rules of the old plan to choose that form, then you shouldn't have a material modification and un-grandfather the plan.

Of course the outstanding issue is whether on audit of the old plan the IRS will say that the timing of the election was allowable under the general constructive receipt rules. Even if 409A doesn't apply, that doesn't mean you're safe. 409A wouldn't have been passed if they didn't think that there weren't a lot of abuses out there....

[Guest John Nelson]

Katherine:

The "new arrangement" in my example is the new Non-Qualified Deferred Comp Plan that the Employer establishes effective 1/1/2005 for post-2004 deferrals.

Here is how I am reading Q&A 18(b): "It is presumed that the adoption of a new arrangement . . . after October 3, 2004 will constitute a material modification of a plan." If my reading is correct, could the term "new arrangement" include a whole new deferred comp plan?

As noted, my initial thoughts on dealing with 409A were the same as alot of others, i.e., freeze the old plan (thereby preserving old elections about time and form of payment), and start a new plan.

Is this thinking still valid?

Thanks.

[Guest John Nelson]

Lee: I think I see your point. I think this language says that if the existing Plan separately accounts for post-12/31/2004 deferrals and the Plan provides that only the post-12/31/2004 deferrals are to be subject to 409A, then the pre 1/1/2005 deferrals are grandfathered.

So, I guess that we really don't need the "new" Plan after all. Participants can continue to make deferrals under the "old" Plan, as long as we separately account for the post-12/31/2004 deferrals and earnings, and state that the new rules apply only to the post-12/31/2004 deferrals.

Thoughts?

Thanks.

[Alf]

Treasury has been clear all along that you won't need new arrangements to preserve grandfathering. Keep the old features running and gunning and move on with 409A provisions for 2005+ money.