Deferrals Allowed After a Payment Event?

[kmhaab]

Elective deferral plan states that upon attainment of age 65 deferred amounts will be distributed in 120 monthly installments beginning the first of the following month. A new Director joined in May 2019, elected to defer his fees and turned 65 six months later (Nov. 2019). He has been allowed to continue deferring his fees and no distributions have been made to him yet.

I’m trying to identify exactly what the failure(s) are here and am looking for input/opinions related to the amounts deferred after he turned 65.  

Should he have been allowed to defer at all after age 65? If not, the entire amount deferred after age 65 must be paid out this year and the entire amount deferred in prior years is likely subject to penalties.

Or was he allowed to defer after age 65, but the distribution installments should have begun immediately following the deferral? For example, could he defer fees in May 2020, but distribution should have begun immediately since he was over age 65? Still on a 120 installment schedule? If this is the case, only the installment amounts that should have been distributed so far must be paid out this year and subject to penalties.

Thanks in advance for your input!

[EBECatty]

If the plan design/document will support it, maybe (1) start the distributions of all accrued amounts as of age 65 in their normal ten-year installments, and (2) for each year in which he defers after age 65, add that to his account balance and factor into his ongoing ten-year distribution?

For example, he has a $100,000 balance at age 65. Start ten annual distributions. In the beginning of year 1, distribute 1/10 of account balance ($10,000). He defers $5,000 more during year 1, bringing his balance back to $95,000 at the end of year 1. In the beginning of year 2, distribute 1/9 of account balance ($10,555). He defers $5,000 more during year 2, bringing his balance back to $89,445. And so on. 

I'm not sure how you would square a deferral election that sets a fixed payment date starting in a prior year, but given the seemingly difficult plan drafting this may be enough to get him to age 75. 

[Linda Wilkins]

Having reviewed the IRS correction Notice 2008-113 recently for a client, my recollection is that, if the participant is an "insider," then the amount that should have been distributed in a prior year (even if corrected in the very next year) will incur the 20% penalty tax (but not the premium tax, and the entire plan benefit is not deemed taxable when vested).  Also the amount that should have been distributed is taxable for the year in which it should have been distributed, not the year paid.  Part VII.D. of the Notice applies, I believe.  Please check me on this!

I think EBECatty's suggestion on how you calculate his payouts sounds like a reasonable reading of the plan provisions.