409A and 457(f) earnings

[Guest ecleverdon]

I am a bit confused about the effect of 409A on earnings on vested 457(f) amounts. These earnings are not considered "wages" for FICA tax purposes, which suggests that the amounts are not remuneration for services but are more like investment income. However, under 409A (and explicitly provided in the new preamble), these amounts are "deferred compensation" subject to 409A. Can anyone help me understand this disconnect?

Also, the provision in 1.409A-3(e) seems to indicate that if a 457(f) plan establishes an appropriate accounting procedure, it would be possible for the plan to distribute "principal" (i.e., vested deferrals, already taxed) and continue to defer post-vesting earnings until a later date. This appears contrary to 1.457-11(a)(4), which would tax distributions proportionately under the annuity rules.

Any thoughts?

[401 Chaos]

Not a reply to your specific question but I am a bit confused about the whole interplay between 409A and 457(f).

If a 457(f) plan is conservatively drafted to comply with the 409A substantial risk of forfeiture rules (which the IRS has signaled will be part of its new regulatory scheme for 457(f)), why would we ever need to worry about 409A. Given that the 457(f) amounts are taxed upon lapse of the substantial risk of forfeiture, won't it make sense for most 457(f) plans to be designed to distribute amounts immediately upon vesting such that the distribution would come within the short-term deferral exception to 409A?

I see some 457(f) plans that permit distributions in installments or by annuity but I don't see why a participant would elect that. What am I missing on the tax treatment of these 457(f) installment amounts?

[Guest fts]

Not a reply to your specific question but I am a bit confused about the whole interplay between 409A and 457(f).

If a 457(f) plan is conservatively drafted to comply with the 409A substantial risk of forfeiture rules (which the IRS has signaled will be part of its new regulatory scheme for 457(f)), why would we ever need to worry about 409A. Given that the 457(f) amounts are taxed upon lapse of the substantial risk of forfeiture, won't it make sense for most 457(f) plans to be designed to distribute amounts immediately upon vesting such that the distribution would come within the short-term deferral exception to 409A?

I see some 457(f) plans that permit distributions in installments or by annuity but I don't see why a participant would elect that. What am I missing on the tax treatment of these 457(f) installment amounts?

[Guest fts]

Not a reply to your specific question but I am a bit confused about the whole interplay between 409A and 457(f).

If a 457(f) plan is conservatively drafted to comply with the 409A substantial risk of forfeiture rules (which the IRS has signaled will be part of its new regulatory scheme for 457(f)), why would we ever need to worry about 409A. Given that the 457(f) amounts are taxed upon lapse of the substantial risk of forfeiture, won't it make sense for most 457(f) plans to be designed to distribute amounts immediately upon vesting such that the distribution would come within the short-term deferral exception to 409A?

I see some 457(f) plans that permit distributions in installments or by annuity but I don't see why a participant would elect that. What am I missing on the tax treatment of these 457(f) installment amounts?

I recall the 2.5 rule to be applicable to elective plans only, and which under 409A SRF defintion would be vested when they are contributed to the plan ; therefore the 2.5 month rule wouldnt apply in those situations. For nonelective plans, the 2.5 month rule does apply.

As for installments, I believe they dont' work anymore in these plans.

I will check this

[jpod]

Though unusual, there are reasons why a 457(f) might be written to defer payment after the vesting date. Typically, what will happen is that there will be a distribution of an amount that is estimated to be sufficient to pay the taxes due as a result of vesting, but no more than that. Then, the subsequent earnings are not subject to Federal income tax until paid, and then taxed under the Section 72 rules where there is a mixture of tax-free basis recovery and taxable earnings. Reasons why this might be done:

1. Thinking that this type of tax-deferral of the earnings is better than having the executive simply purchase an annuity loaded up with insurance company charges.

2. Depending upon the state involved, the state income tax on the amount deferred, as well as earnings, may be deferred until actual payment. Possibly a big tax savings for someone planning to retire to Florida or another no-tax or low-tax state.

3. Possible protection from the executive's creditors until payment is due.

[Locust]

1. All - This has been a very helpful post. Thanks for sharing your thoughts/expertise.

2. It's interesting the way you (fts) put the statement that the 2.5 rule doesn't apply to elective deferrals. At first I thought that's not right, but you are correct because elective deferrals will always be 100% vested - the IRS doesn't recognize vesting conditions on elective deferrals. With the upcoming round of guidance on 457, it seems likely that there will be no more elective 457(f) arrangements.

3. Mr. Kite - I don't see a conflict on the tax treatment of earnings between the 457 and 409A regulations, because Reg. ss 1.409A- 3(e) does not relate to the taxation of the payments, but only to the timing of payment elections. 1.457-11(a)(4) controls I think at least until we get new guidance under 457.

[Guest fts]

Yes, that's the end result, it appears the IRS is delivering a reality check

to the tax-exempt executives & planners: who would accept an SRF on electives? This is really a better framework to have though. In my view, split dollar - done the right way- is a better , easier way

to go. It's also consistent with the ownership philosophy of retirement planning. I've found a great way that's a winner for both the org and employee.

[Steelerfan]

2. It's interesting the way you (fts) put the statement that the 2.5 rule doesn't apply to elective deferrals. At first I thought that's not right, but you are correct because elective deferrals will always be 100% vested - the IRS doesn't recognize vesting conditions on elective deferrals. With the upcoming round of guidance on 457, it seems likely that there will be no more elective 457(f) arrangements.

Actually, the 2.5 rule can apply to immediately vested amounts because the rule uses the later of the attachment of a legally binding right or the lapse of a SRF. So, it's legally possible, but utterly ridiculious, to draft an elective deferal plan to require each year's deferrals to be distributed by 2.5 months after the end of the year in which the deferals were earned. That would obviously be ridiculous since the idea (presumably) is to defer the compensation more than one year.

Couldn't it be possible to still have elective deferrals if the employer is willing to give participant's a sufficient "kicker" in exchange for the attachemt of an SRF to the amounts earned?

[Guest fts]

Possible yes, do it with a match- but better to max out on 403b and 457- and be happy with

that- I wouldn't advise it- its the beginning of the end( or the end of the beginning?)