Deferred Comp/Severance Pay

[Guest krijowri]

Does anyone have any thoughts on this? A client is considering an "exit incentive" for certain management-level employees over age 60. The incentive would be that if you are between 60-65 (i.e., not yet entitled to medicare), you can continue participating in the employer's self-funded health plan. If you are 65 or older, you will just get a lump sum severance payment. The employer is considering offering the option of the lump sum payment to the employees between 60-65. That type of option would have to be run through a cafeteria plan, obviously. My question is this: Is there a deferral of compensation there that would run afoul of the new proposed regulations? In other words, if a 60 year old employee pays $50 each month for their share of premiums, which the employer "contributes" for the employee on a pre-tax basis pursuant to the cafeteria plan election for the next five years, wasn't the inital choice between that benefit and the lump sum a deferral of compensation? The employee could have received a lump sum today, but instead you are essentially spreading it out over the next 5 years. Or is it not a problem since the employee may choose the health benefits this year, but may not choose them the next year? Or could the problem be avoided if you run the initial choice between the benefits and the lump sum through a cafeteria plan the first year, but then require the employees to pay premiums on an after-tax basis in subsequent years?

[Ron Snyder]

You are focused only on the Section 125 Regs, but a lump sum payment is deferred compensation and may not be provided under a cafeteria plan since it is not part of a 401(k) plan. It would have to be provided in compliance with IRC Section 409A and Regs thereunder.

[Guest krijowri]

You are focused only on the Section 125 Regs, but a lump sum payment is deferred compensation and may not be provided under a cafeteria plan since it is not part of a 401(k) plan. It would have to be provided in compliance with IRC Section 409A and Regs thereunder.

Sorry, I don't think that is correct. A lump sum is not deferred comp in this situation - and the lump sum is not the payment I'm worried about here. The issue/deferred comp would be the health plan premiums that are paid through the caf plan for several years in lieu of the lump sum paid in an earlier year. And the 401(k) issue is entirely irrelevant-I'm afraid I'm missing your point there. And while I'm intimately familiar with the 409A regs, they aren't my concern in this particular question - this was a more discrete, narrow issue specifically relating to the new proposed 125 regs, which is why, yes, I am focused on them...

[QDROphile]

Maybe the important question revolves around the choice at termination of employment between severanc in a lump sum or in five years of installments. The cafeteria plan comes in later and offers a choice between the cash severance payments or the health benefits. So (1) is the severance payment over five years deferred compensation, and (2) is the election to defer (choose the installments) timely?

[Guest krijowri]

Maybe the important question revolves around the choice at termination of employment between severanc in a lump sum or in five years of installments. The cafeteria plan comes in later and offers a choice between the cash severance payments or the health benefits. So (1) is the severance payment over five years deferred compensation, and (2) is the election to defer (choose the installments) timely?

Sort of...except the cash severance payments won't be made over time - they'll be made in a one-time lump sum. The health benefits would be the "deferred" part that can be spread over the next several years in lieu of the lump sum. I think I've gotten pretty comfortable with the idea that that arrangement would indeed constitute "deferred compensation" that cannot be run through a cafeteria plan because the option to forego the lump sum is essentially funding the health benefits on a pre-tax basis in future years in clear violation of the new proposed regs.

[Don Levit]

I am not familiar with the new cafe regs, but I do have something to offer here.

In addition, I am also interested in retiree medical benefits, and whether or not they are deferred compensation.

If you do not offer a lump-sum payment to those between 60-65, it appears that the medical benefits would not be deferred compensation.

In Rev. Rul.75-539, "an employee, upon retirement could choose either to receive a cash payment for accumulated sick leave or to have such payment applied to the cost of the insurance. The ruling holds that such payments for health insurance are includible in the employee's gross income."

"However, the ruling also holds that if the employer places the value of these accumulated credits in escrow solely for the payment of health insurance premiums, and that such credits may not be received in cash by the employee, such amounts are not constructively received by the employee."

Don Levit

[QDROphile]

You are correct. Lump sum "payment" for health benefits over a number of years won't work under a cafeteria plan. It will violate the rule against deferral of income.

[Steelerfan]

I can't tell whether the OP is saying 409A is inapplicable here, or that he has 409A under control. Depending on when the legally binding right to a payment comes into being, 409A is certainly a major concern with this type of arrangement regardless of whether there is merely a "lump sum" payment or a "deferral of compensation" under the 125 regs. The 409A regs have lot to say about payments of cash at severance and the right to receive welfare benefits after termination. Not saying I have the answers here, just giving a heads up.

[Guest krijowri]

I can't tell whether the OP is saying 409A is inapplicable here, or that he has 409A under control. Depending on when the legally binding right to a payment comes into being, 409A is certainly a major concern with this type of arrangement regardless of whether there is merely a "lump sum" payment or a "deferral of compensation" under the 125 regs. The 409A regs have lot to say about payments of cash at severance and the right to receive welfare benefits after termination. Not saying I have the answers here, just giving a heads up.

She is saying that 409A is under control. :-)