Terminating a 457(f)--409A Problems?

[Scott]

A school district established a 457(f) plan for an executive in August 2004. None of the deferred amounts are scheduled to vest until 2006. A consultant has come in and advised the district and executive that the executive would be better off if this were a 401(a) plan, so the proposal is to terminate the 457(f) plan and establish a new 401(a) plan.

I'm trying to figure out whether doing this would cause any 409A problems and if so, what? Since no amounts had vested under the plan as of 12/31/04, the plan is not grandfathered, so it's subject to 409A.

Q&A-20 provides that a plan can be amended to allow a participant to terminate participation with respect to amounts subject to 409A, without causing the plan to violate 409A, if the plan is amended before 12/31/05 and the amounts subject to the termination are includible in income in the year in which the amounts are earned and vested.

Under the proposal, the 457(f) plan will go away and be replaced with a plan that is exempt from 409A, and the participant will never receive any benefit under the 457(f) plan, so the amounts will never become "earned and vested" under that plan. But I'm wondering if Q&A-20 could somehow be interpreted to say that it doesn't matter that the plan is going away--whenever the amounts were scheduled to become earned and vested (in this case 2006), they still must be taken into income.

Any thoughts?

[mbozek]

Have you read the proposed 409A regs to see if there is an answer to this question in the 238 pages there?

[Scott]

The regs don't address it. The preamble merely states that the relief under Q&A-20 is not extended beyond 12/31/05.

[mbozek]

Isnt the issues resolved as follows:

409A merley added another layer of rules over the existing rules for NQDC under other sections of the code, e.g. IRC 83, 61, 457(f), etc. If the plan is terminated without any vested benefit being due to the participant under those sections then there can be no taxation under 409A. If the amount due the participant under the plan at termination is 0 then there is no tax under 409A. Under section 457(f) amounts deferred are not taxed until the employee ceases to perform substantial service for the employer. One implicit risk of participating in a 457(f) plan is is that the benefit can be cancelled before the employee acquires a vested right. If the benefit is forfeited there is no taxation under IRC 457(f) and no taxation under 409A because nothing is paid to the participant.

I think Q-20 was premised on the assumption that a benefit would be paid upon termination of the plan. If no benefit is paid there is no tax consequence under 409A.

[Scott]

That's the conclusion I originally came to, but because of the severe sanctions under 409A, I'm trying to be cautious. In the absence of anything clear to the contrary, I think this is at least a "good faith, reasonable interpretation" of the guidance. Thanks!

[E as in ERISA]

I think that the proposed regulations are generally intended to deter termination of plans. If you "terminate" you can't make distributions. So that technique can't be used to accelerate distributions. But if you terminate all plans of the same type then you can make distributions. So if this is the only plan, I would think that would work.