457(f) Plan + Constructive Receipt

Background: A non-profit operates a 457(f) plan for a select group of management. Only Non-Elective contributions are permitted. The plan uses a 5-year graded vested schedule and participants are fully vested at NRA (age 65). The Plan's substantial risk of forfeiture risk (SRF) such that participants who terminate for cause will forfeit 100% of their account balance, even if already fully vested. Plan allows payment upon the later of separation of service or attainment of NRA. 

Questions to clarify my understanding: 

1. As I read the regs, a participant is taxed when the SRF lapses. In this case, then, a participant who may be 100% vested in his account is not taxed on that amount until he terminates employment in good standing (since the SRF doesn't lapse until he terminates). 

2. If a participant terminates in good standing at age 65, the participant is taxed on their vested balance, since the SRF lapses. Based on the timing of the payment of benefits (later of separation of service or attainment of NRA), then, there really is no constructive receipt doctrine, in this example. 

3. If a participant terminates in good standing at age 55, the participant is taxed on their vested balance, since the SRF lapses. But, the participant cannot commence payment until attainment of NRA (age 65). In this case, the participant is taxed, without actually having taken a distribution (constructive receipt doctrine). 

Am I missing anything? 

You don't state your role, but I would strongly recommend getting connected with advisors who can guide your organization or your client on all of these issues (and preferably administer them). Most of your conclusions are based on the premise that a for-cause termination forfeiture provision will delay a substantial risk of forfeiture, when it generally will not.    

The plan design you describe will, in my opinion, be difficult to administer, tax, and report correctly without professional advice. There is a lot of nuance involved in getting these types of plans running smoothly (timing and amount of original income inclusion upon vesting; potential accelerated distributions to pay income taxes upon vesting; effect of earnings during vesting period; FICA reporting and taxation upon vesting; taxation of post-vesting earnings and eventual distributions; non-duplication of FICA; aligning payroll and W-2 reporting; etc.). 

18 hours ago, EBECatty said:

the premise that a for-cause termination forfeiture provision will delay a substantial risk of forfeiture, when it generally will not.    

I agree that it is very questionable that for-cause termination is considered a substantial risk of forfeiture. Such a provision appears to be primarily designed to defer taxation. I also agree with need for qualified professional counsel.

Agree with EBECatty and CuseFan that whether forfeitability on for cause termination is SRF is questionable and depends on facts and circumstances. The most important fact/circumstances would be whether has happened at this organization at this level, or does in future. It could get messy. And if termination for cause is a real possibility, it encourages executives to leave as soon as vested.

Regarding your point 3, and putting aside the SRF issue discussed in prior paragraph, right. One way to deal with this is to include a provision permitting distribution of the amount includable in income and for FICA, so executive has the cash to pay tax. The remainder then becomes, in effect, conventional NQDC. Income tax on earnings is deferred until payment, and there should be no more FICA. The principal (what was left after distribution to pay income and FICA) is recovered as payments are made under Section 72.