Termination/Acceleration

[Randy Watson]

The final regs permit a service recipient to terminate and liquidate a 409A plan for any reason as long as certain requirements are met (1.409A-3(j)(4)(ix)©). One of those requirements prohibits the service recipient from terminating and liquidating if the termination is "proximate to a downturn in the financial health of the service recipient". Does anyone know of any guidance on what that phrase means? Just about every company is experiencing some financial downturn right now. I suspect that as long as the service recipient is able to meet its obligations under its other plans (e.g., adequately funding their defined benefit plan) that they can terminate and liquidate their NQDC, but I'd love to see some commentary supporting this. Thanks.

[Guest TooMuchFreeTime]

I'd love to see some guidance myself, but have not seen any, to date. If anybody has anything to point to, I'd greatly appreciate it. When trying to come up with an argument/analysis for your own case, consider the following...

Limitations on Accelerations on Terminations, Generally

The 2005 proposed 409A regs spent considerable time in the preamble spelling out some of Treasury's concerns in granting acceleration on termination/liquidation of the plan. They were ok with teh concept generally, but were afraid of the potential for abuse. As such, most of the limitations on a voluntary termination are desinged around ensuring that this termination is a REAL termination. They won't let you terminate it with respet to one participant while maintaining it for others; they won't let you terminate ti one day, and replace it with another plan the next. You get the idea. If it feels like a genuine termination of a plan, you'll be on more solid ground.

"Substantial Risk of Forfeiture"; It's Role in NQDC

Our entire non-qualified deferred compensation world revolves around this notion of "substantial risk of forfeiture." Past vesting and service requirements, this is typically maintained through the concept of creditor exposure. To see where Treasury and the Service have drawn the line, here, just look at Rabbi trusts and their springing cousins. Under a Rabbi trust, the money to pay plan benefits sits in trust; virtually untouchable, just as it would for a qualified plan. Normally, money in trust like this would trigger inclusion under the economic benefit doctrine or something related. However, the Rabbi trust contains one saving provision; its corpus is subject to the claims of the creditors. In other words, Treasury has decided that "substantial risk of forfeiture" includes the possiibililty that the company could go belly up, creditors raided the rest of the assets, and then cleaned out the trust; such that there would be no money to pay for the NQDC benefits. Bless them.

Eliminating the Risk while Maintaining the Risk

So, a crafty practitioner took the idea one step further. In addition to the general Rabbi provisions, they included a "spring trap." Here, under normal circumstances, the trust operated just as a Rabbi trust; untouchable by the employer, but subject to the claims of creditors. However, in the case where the company wasn't doing so hot and the possibility of door-knocking creditors became more real, the trust would "spring" shut; cutting off creditors and saving the cash for the NQDC participants. At this point, it was conceded that all risk of forfeiture had lapsed and the amounts would be includible, but that was just fine for the participant whose alternative was to risk losing it all to bill collectors. When setting up a Rabbi trust, including a spring might trigger accelerated taxation at some point, but it was still viewed as beneficial because it guaranteed benefits until... Crap. I said "guaranteed." With that, your substantial risk of forfeiture is gone, and any nonqualified tax deferral went with it.

In other words; everything hinges on the REAL likelihood that benefits may not be paid because the assets (whether sitting in a Rabbi trust or the employer's general assets) might someday get sucked up by creditors. So, you'll see other rules put into place to maintain this danger. Tightrope walking may require the same skill whether performed at 3 feet or 30 feet, but you'll only impress people with one them. Some plans tried making a financial downturn a trigger for distribution; basically putting the spring trap on the general assets instead of the specific trust. You won't be surprised to find out that this didn't fly.

Effect of a "Downturn" on the Risk

So, we have the prohibition on an acceleration on termination/liquidation in conjunction with a downturn in the financial health of the employer. The reason this is here is so that the generally permissible acceleration is not abused to achieve what has been shot down multiple times before; accelerated distribution for the purpose of protecting participant benefits rather than expose them to a substantial risk of forfeiture.

What Standard to Use?

Whether or not the employer has the assets to pay the plan benefits, as you suggest, is a lousy measure. If the company is deeply in the red and is looking to pay out the benefits while there's still time/money to do so, that's exactly the sort of situation we're trying to avoid here. Look at the plan and the employer and think about how likely it is in the near future that creditors will start pawing at the money needed to pay those benefits. If it's likely; you might have yourself a downturn. Also consider WHY they want to terminate/liquidate the plan. If it's because the executives fear the money to pay the benefits might soon be gone; you might have yourself a downturn. If they want to cut off the plan as a cost-savings measure, you might have yourself a downturn. Note, however, that the rules here are only applying to LIQUIDATIONS. If it's cost-savings the company's after, there's nothing preventing them from simply freezing the deferrals/accruals under the plan and allowing the benefits to be paid out under the normal terms of the plan.

At the end of the day, it's still unclear how bad is "too bad." I personally wouldn't expect the "downturn" prohibition to prevent a distribution in the face of ALL negative financial performance, no matter how slight; I would hope there's some threshhold of horribleness before the ability to terminate shuts down. However, without any authority to look to in support, you might be better off playing it safe.