Plan Sponsor solvency as Substantial Risk of Forfeiture

[waid10]

Has anyone heard of an arrangement where the only risk of forfeiture is the plan sponsor's solvency/insolvency? Here is the scenario: executive enrolls in deferred comp plan with payout to occur three years out. The executive receives credits/deposits to his deferred comp account periodically throughout each year. If executive resigns before the three years, he receives whatever is in his account at that time. The only way he doesn't receive what is credited to his account is if the plan sponsor goes bankrupt.

I have never heard of this where the only risk of forfeiture is the solvency of the plan sponsor. To me, this doesn't seem like a "substantial" risk. Is anyone else familiar with this and whether it is permitted? By the way, the plan sponsor is a for-profit entity.

Thanks.

[jpod]

Your post suggests you think that a SRF is needed. If so, why?

[waid10]

Your post suggests you think that a SRF is needed. If so, why?

The plan appears to be subject to 409A. So I would think SRoF is required. Am I wrong?

[jpod]

The simple answer is "yes, you're wrong." SRF is a relevant concept if the intent is to structure a plan that is exempt from 409A, but you don't need one for a plan which by its terms is subject to 409A. And, for what it's worth you're right that employer insolvency is not a SRF for 409A purposes.

[My 2 cents]

I thought that the whole thing that made the magic of a Rabbi Trust work was that, by subjecting the trust assets to the claims of the sponsor's creditors, it was all treated as having a substantial risk of forfeiture, so mere vesting did not create any tax liability for the person covered. Is this not so?

[waid10]

These responses are helpful. I thought (apparently incorrectly) that the only way to avoid immediate taxation on deferred comp was for the assets to be subject to a SRoF. And I didn't realize that the mere solvency of the plan sponsor was "substantial" enough. I have always seen deferred comp plans with the following hook: if the executive voluntarily resigned before the payout date (here three years out), the executive forfeited his account.

[QDROphile]

A grantor trust (rabbi trust) addresses the requirement that a benefit be unfunded. Risk of forfeiture is another matter altogether and risk of insolvency is not generally a substantial risk under section 83, section 457, or or section 409A. If you are not very clear on the concept, then you should not be dabbling in nonqualified deferred compensation unless you believe that lack of enforcement with protect against shortcomings. The field is complex, the stakes are often high, and the cost of failure is substantial.

[XTitan]

The lack of a SRF would subject the contributions to FICA immediately as the amounts appear to be 100% vested.

[My 2 cents]

Is it not the case that a Rabbi Trust is funded with contributions for the sole benefit of the employee in question, which cannot ever be taken away from them due to change in ownership or falling out of favor, etc., but which (in the event of sponsor insolvency) IS subject to the claims of creditors? The key thing is that subjecting these otherwise absolutely earmarked and vested funds to the claims of the sponsor's creditors is a sufficient risk of forfeiture to make them not currently taxable in any way (not sure about FICA, though) to the intended beneficiary. Certainly no income taxes until actually paid to the person. Not so?

[QDROphile]

What you describe about the use of rabbi trusts is more or less correct. I am concerned with the less part for someone who is offering advice or information. The confusion in the terminology employed is a sign of a less than full technical understanding of the applicable principles and the law. If you are using the phrase "substantial risk of forfeiture" to explain anything about rabbi trusts, you are wrong. If you are serving up rabbi trusts to explain substantial risk of forfeiture, you are wrong.

[Louis Richey]

This is a really confusing area after 409A. Unsecured and unfunded deferred compensation plans historically avoided constructive receipt and current income taxation if they are subject to a "substantial limitation or restriction" under Reg. Sec. 1-451-2(a). A promise-to-pay plan subject to the claims of the employer's general creditors has such a limitation. In my experience, this limitation is often called a substantial risk of forfeiture by commentators and even some courts.

The question here is the plan also subject to 409A, which is additive law furthering defining the constructive receipt doctrine? To be a 409A-covered plan, it needs only to be a "nonqualified deferred compensation plan" that involves a "deferral of compensation" which in plain English is a binding promise in one year to pay compensation in a future year. This looks to be the case here.. The only way to avoid the application of 409A is if the plan is if is an exempted plan (like 457(b) plan) or can satisfy the 409A "Short-Term Deferral Exception." The plan requires a 409A substantial risk of forfeiture to claim this STD exception. 409A substantial risks are those we all tend to call "real" risks of forfeiture like those to be found in Section 83 governing funded plans, and does not include the risk of loss to general creditors as an adequate risk. Most plans do not place real of risks of forfeiture on vested compensation (salary and bonus amounts voluntarily deferred), and one is not present in the offered plan design. And 409A can cover a plan for a single person. Hence, looks like this plan is subject to 409A, which means that it also must satisfy the requirements of Section 409A which are both: 1) documentation compliance and 2) operational compliance.

FYI- with the addition in the June of proposed regs creating the separate definition of substantial risk of forfeiture under 457(f) governing tax exempt ineligible plans, there are now 7 different definitions of substantial risk of forfeiture in the Code for different purposes.