New Payment Elections under 2005-1, Q&A-19(c)

[401 Chaos]

IRS Notice 2005-1, Q&A-19© provides that "with respect to amounts subject to § 409A, the plan may be amended to provide for new payment elections with respect to amounts deferred prior to the election and the election will not be treated as a change in the form and timing of a payment under 409A(a)(4) provided that the plan is so amended and the participant makes the election on or before December 31, 2005."

I am curious if others interpret this provision as broadly as it appears on its face. I have seen little discussion of this particular provision but read it to give plans that must be amended for 409A broad flexibility in adding new payment distribution options governing prior deferrals. Take for example, a plan that previously paid out in 10-year installments but gave participants the option to elect a lump-sum distribution provided the lump sum election was made at least a year before the 10-year installment began. If this plan is amended for 409A to eliminate this subsequent payment election, could the plan be amended to allow participants to make a new election up front governing prior deferrals subject to 409A with a choice amoung: (i) a lump-sum distribution, (ii) installment payments over a 5 year period; or (iii) simply sticking with installment payments over the old 10-year period?

[E as in ERISA]

That is how I interpret it.

[Alf]

I agree. It only applies to a plan subject to 409A in 2005, so it is safe to assume that existing elections are noncompliant (or have impermissible discretion). Employees will have a chance to make new elections under the 409A regime and I don't see why your example won't work. Don't they also have the option of just deciding to take their money out? If that is true, then giving them the broad right to make new elections seems to make sense to me.

[KJohnson]

Just to be clear, the language cited by 401 Chaos was expanded in the correction of 2005-1. Under Chaos's example, you not only have a change in form and timing issue but potentially an acceleration issue because of the lump sum option. The revised 19© was clairified to provide that the new payment election in '05 would also not be considered an acceleration. the revised language is:

With respect to amounts subject to § 409A, the plan may be amended to provide for new payment elections with respect to amounts deferred prior to the election and the election will not be treated as a change in the form and timing of a payment under § 409A(a)(4) or an acceleration of a payment under § 409A(a)(3), provided that the plan is so amended and the participant makes the election on or before December 31, 2005.

The explanation of this change was:

Paragraph © of Q&A 19 in the December 20 version of the notice provides transition relief under which certain amendments and elections will not be treated as a change in the form or timing of a payment under section 409A(a)(4). The revisions to the paragraph make it clear that those amendments and elections also will not be treated as an acceleration of the payment under section 409A(a)(3).

[401 Chaos]

Thanks for everyone's thoughts and to KJohnson for posting the corrected Q&A-19 language--I keep mixing up my old (highlighted) copy of 2005-1 with the revised version.

[Guest Harry O]

Remember that merely offering new payment elections to grandfathered amounts will be a dreaded material modification that will cancel grandfathering treatment. This may be important if you have a "haircut" provision that employees view as a valuable "escape hatch" from the plan or you have other events triggering payment that are not permissible under 409A.

In addition, this Q&A does not protect against traditional constructive receipt attacks. For example, assume you give employees the choice between a lump sum and installments in December 2005, the employee chooses installments and then terminates and starts payment in January 2006. There is a significant risk that the employee constructively received the lump sum in January 2006 (since the installment vs. lump sum election was made one month before payment started).

[401 Chaos]

Harry O, thanks for your comments on the constructive receipt issues. The possibility for violations concerns me but I'm having a hard time imagining the IRS enforcing those concepts where an employer relies on the broad powers under Q&A-19 to offer new payment elections. But for the Q&A-19 guidance, the employer would not amend the plan to provide new payment elections. It is not always possible to know when a participant will terminate or a payout otherwise get triggered so the transition relief under Q&A-19 seems of limited value in many cases. I'm just not sure how to square the seemingly broad power in 409A with the risks of constructive receipt violations. Seems this is another area where you cannot act with certainty under the rules.

[Guest Harry O]

One way to perhaps deal with it is to simply say that payments can't begin until one year after the date the new election made under Q&A 19©. In the example above, this would mean that payments would start in January 2007 rather than January 2006.

[BeckyMiller]

What if the old distribution was compliant with 409A? Is it possible to add new distribution options now with respect to those old accruals? Say, prior plan provided for 10 installment distributions commencing at separation from service and that was the only distribution option? Could it be amended now to give additional choices, even if those choices serve to accelerate the timing of the distribution? I realize that this would be a material modification. I am just trying to pin down whether the community thinks the 19© relief is limited to noncompliant language or can be used to enhance options where the language was compliant.