Deferral Cancellation During 2005 - How Much is Distributed?

[Scott]

If an employee cancels his deferral elections by the end of 2005 under the 409A transition relief, how much should be distributed to him? Is it strictly the amount he deferred, or is it adjusted for earnings? For example, if an employee elected to defer $10,000 during 2005 into a new account-based plan, and his account, because of earnings, is now at $11,000, if he elects to cancel his deferrals, does he receive a distribution of $10,000 or $11,000? What if his account has decreased to $9,000?

[QDROphile]

There is no such thing as earnings.

[WDIK]

There is no such thing as earnings.

QDROphile:

Please excuse my inexperience with 409A, but how do you reconcile your statement with the reporting requirements for Form W-2, which indicate for Box 12, Code Y that "[a]ny earnings during the year on current year and prior year deferrals must also be reported here."

I've also hear that there are no such things as -

a free lunch (and yet I've eaten without paying),

bad publicity (and yet the court of public opinion is easily swayed), or

a stupid question (and yet I've probably just asked one).

[QDROphile]

If you cancel a deferral, that means there is no deferral and you get full compensation for 2005 -- not a raise or a pay cut. What the employer did with the money while not paying it to the employee in the meantime is irrelevant. If you accelerate payment under the terms of the plan (naughty!) then you might think about earnings credit (positive or negative) related to the deferral amount.

[WDIK]

Thank you for the kind and patient clarification.

[JDuns]

If you are cancelling deferrals - I agree that the employee receives the amount that would have been deferred as regular compensation (without adjustment).

However, if you were terminating participation and accelerating distributions, I would pay the deferrals net of investment gains/losses.

[Scott]

Thanks for all the input. If I understand correctly, there are two choices:

1. Treat this as a cancellation of a deferral, in which case under my example the employee would receive $10,000 and be taxed on $10,000.

2. Treat this as a termination of participation, in which case the employee would receive a distribution of his current account balance, and be taxed on that amount.

Is this correct?