Change Non-Account Balance to Account Balance

Say an employer has a deferred comp agreement in place that provides a retired employee a fixed amount per year for a defined period. Call it $100,000 per years for the next five years. The employer wants to add an earnings component by basically converting the payments to a $500,000 "account balance" and allowing the retired employee to select investments. The amounts would be paid out in five installments over the next five years (same time and form as the original terms) but instead of being a fixed $100,000 per year, it would be 1/5 of the account balance in the first year, 1/4 in the second year, and so on.

Would this be simply a change of "amount" (and not a change in time or form) such that they could amend during the payment period without violating 409A?

If not, could they add a new earnings component that says on the date of the last fixed payment, the employer will pay the employee an additional amount equal to the (positive) earnings accruing on the total remaining benefit amount as if it were invested in, say, the S&P 500 over that period (and that the employee would forfeit any negative earnings)?

It seems like adding only an earnings component would generally be acceptable, but I'm having a hard time squaring it with the existing nonaccount balance status. Would appreciate any thoughts.

There is a fine line between a non-elective account balance plan and a non-account balance that you've described above from the participant's view since mechanically it looks the same.  If you cast as a non-elective account balance plan, adding an interest component shouldn't be an issue.

Another way of looking at it is as a substitution of one benefit for another.  You note that you are keeping the time and form of payment the same so under a facts and circumstances test you should be able to argue you comply.

Side note - crediting interest based on the S&P with a floor could give you FICA issues as you aren't basing the earnings on a pre-determined investment or index; it would be treated as another employer contribution subject to FICA.

On 4/7/2021 at 1:40 PM, EBECatty said:

The amounts would be paid out in five installments over the next five years (same time and form as the original terms) but instead of being a fixed $100,000 per year, it would be 1/5 of the account balance in the first year, 1/4 in the second year, and so on.

EBECatty, I have not given this a lot of thought, but I think that your problem lies here, and you are right to be concerned with the shift from non-account balance to account balance. Right now, the person is getting $100k, fixed, per year. Now, if the investments are volatile, they could get, say, $150 year one (arguably an acceleration), $50,000 year two (arguably a deferral), etc. If you say that they will always get the lesser of $100k or the entire account balance in every year, and the entire account balance in the fifth year, then that probably solves the problem because they are simply getting a change in the amount (if > $100k), or experiencing a forfeiture (if < $100k).

Thank you both for your thoughts. They seem to confirm there's more than one way to approach.

I see both the position that the time and form arguably remain the same, so the amount does not matter, but also that the same fact pattern could be considered an impermissible acceleration/deferral from year to year. The definition of installment payment in 1.409A-2 specifically contemplates fluctuations for earnings and losses that would not cause each payment to be "substantially equal" but I'm not sure that directly addresses the issue of changing the formula mid-stream.

The definition of a fixed payment schedule in 1.409A-3(i)(1)(i) also requires an objective formula to be in place when the compensation is deferred, but again doesn't speak to the analysis if it's changed (maybe because it shouldn't be?). 

My secondary thought was to accrue gains and losses over the course of the five-year period based on the employer's informal funding account's rate of return. If the funding account's losses cause it to run out of money before paying all benefits, the employee would forfeit the remaining unpaid amounts, which on its own should be fine. If the gains cause an excess over the promised benefits, the excess would be paid on the date of the last payment, which is fixed. This keeps the time, form, and amount constant, with the only difference being an eventual forfeiture or an additional non-elective right to one new payment on a fixed date, which for earnings may be a different time/form than the underlying deferral.

Sounds like there will be uncertainty either way.

1 hour ago, EBECatty said:

My secondary thought was to accrue gains and losses over the course of the five-year period based on the employer's informal funding account's rate of return. If the funding account's losses cause it to run out of money before paying all benefits, the employee would forfeit the remaining unpaid amounts, which on its own should be fine. If the gains cause an excess over the promised benefits, the excess would be paid on the date of the last payment, which is fixed. This keeps the time, form, and amount constant, with the only difference being an eventual forfeiture or an additional non-elective right to one new payment on a fixed date, which for earnings may be a different time/form than the underlying deferral.

EBECatty, I agree. I think this is identical to the math I suggested, just a different way of expressing it in words.