NQ plan for a former employee

[Guest erepper]

I have a Not for profit that would like to set up a nonqualified plan for an executive who has recently terminated employment with the organization. They would like to provide him with a $3,000/month joint and 100% survivor annuity. Can this be done in the 401(9)(A) or 457(f) arena?

[QDROphile]

How do you deal with the risk of forfeiture requirement under section 457(f)?

[jpod]

As alluded to by QDRO, this can be done, but the tax results may not be to everyone's liking. Unfortunately, there's no flexibility here.

409A is not an obstacle; largely a non-issue.

In the absence of any guidance to the contrary from IRS (of which at this moment there is none), you should assume that the entire present value of the annuity will be subject to Federal income tax and FICA/Medicare tax on the day that the arrangement is established (and perhaps State income tax depending upon the State). Therefore, the only way to make this work, realistically, is to give the executive a lump sum cash payment equal to the taxes he will owe on that present value. Thereafter, the future monthly payments will reflect the annuity value of the present value minus the lump sum payment. The executive will have a tax basis in the annuity equal to the present value, and the Section 72 rules will provide the methodology for calculating the small taxable portion of each monthly payment. For example, if the present value of the $3,000 per month 100% J&S is $500,000, and if you assume a tax rate of 40%, you would give the executive $200,000 cash up front for him to pay his taxes on the $500,000. He and his spouse then will receive a monthly annuity of $1,800 per month.

Alternatively, the Executive can either fund the taxes himself or go to the bank and take out a loan for the $200,000 to pay the tax bill, and in either case he and his surviving spouse would receive the full $3,000 per month from the employer.