Sponsors and participants must follow 409A true to form

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

While last month’s blog explored the permissible times NDCP distributions may occur under section 409A of the tax code, this month’s entry examines the rules surrounding the forms of payment that may be offered under these plans. Accelerations and deferrals can just as easily be effected with a choice of form (e.g., lump sum versus installment payments) as they can with timing elections. These two sets of rules are connected because they share a common purpose: proving some degree of flexibility while preventing the type of excessive control that 409A was enacted to eliminate. The following will examine how sponsors can ensure that their NDCP’s forms follow 409A function.

First step: grounding form flights of fancy
NDCP participants are used to the free-flowing flexibility of the qualified plan world in which they can typically wait right up until their benefit commencement date (BCD) before having to commit to the form of payment under which they wish to have their plan benefits distributed. A further false sense of flexibility may arise from pre-409A provisions, which permitted the linking of the form of payment from the NDCP to the form of payment elected by the participant under the qualified plan that the NDCP was intended to supplement. These were most prevalent in defined benefit (DB) style NDCPs but occasionally also appeared in some defined contribution (DC) ones. The 409A rules do allow grandfathering of prior amounts (see the “Honor thy 409A Grandfather” entry of this series for details); however, such linking is prohibited for benefits attributable to post-December 31, 2004, accruals or contributions.

Because the rules governing NDCP form elections for such amounts are much more rigid, NDCP sponsors must make sure they clearly communicate these differences to participants, develop the appropriate 409A compliant plan design for their executive group, and vigilantly administer their NDCP(s) in accordance with such designs. 409A generally requires that the participant’s form of payment under a NDCP be designated much earlier than would be the case under a qualified plan. For most NDCPs, the rule requires participants to elect their form of payment when they first become eligible for the NDCP. Accordingly, sponsors need to provide participants with sufficient notice and means to make this election prior to the expiration of their initial eligibility period (i.e., generally 30 days from the date they are first designated as eligible).

Exceptions to the rule
There are two exceptions to this rule requiring participants to make form elections to be made when first eligible:

(1) The “How do you meet a deadline you didn’t know existed?” exception
This applies for “non-elective excess benefit” NDCPs (i.e., plans that solely provide benefits beyond those permitted in qualified plans). Under these plans, a participant often automatically becomes eligible when benefits under the qualified plan become limited under the rules governing qualified plans. Because determining whether a participant is eligible requires calculations, both the participant and the NDCP sponsor may be unaware that the participant has become eligible in the plan for some time after actually first becoming eligible. 409A addresses this concern with a special rule giving participants in these plans a one-time opportunity to elect the form of distributions within 30 days after the end of the first year in which they accrue a benefit under the plan. No new elections are permitted if the participant subsequently accrues benefits under a different excess benefit plan of the same NDCP sponsor.

(2) The real life annuities of 409A
409A permits NDCPs to treat all “actuarially equivalent life annuities” as one form of payment. This treatment is extremely beneficial because it means such annuities are not only free from the previously discussed 409A rule regarding initial form elections but also from the dreaded “12-month/five-year” rules described later in this blog. As a result, participants who limit their election to only these annuities are free to initially elect and then switch back and forth between as many of such annuity option their NDCP offers right up until their BCD. So the key question is — which forms of payment have 409A deemed worth of casting in this role? The general definition under 409A makes it clear that the traditional single life annuity and joint and survivor annuities (e.g., joint and 50% survivor) qualify as long as they are payable not less frequently than annually and are actuarially equivalent applying reasonable actuarial methods and assumptions. While “actuarially equivalent” and “reasonable actuarial methods and assumptions” are not specifically defined, the rules do offer the following guidance:

(a) When determining whether two life annuities are actuarially equivalent, the same actuarial assumptions and methods must be used in valuing each life annuity.
(b) The above requirement applies over the entire term of the participant’s participation in the plan, such that the annuities must be actuarially equivalent at all times for the annuity options to be treated as one time and form of payment.
(c) As long as the actuarial methods and assumptions are reasonable, there is no requirement that consistent actuarial assumptions and methods be used over the term of the participant’s participation in the plan.
(d) The plan may change the actuarial assumptions and methods used to determine the life annuity payments provided that all of the actuarial assumptions and methods are reasonable.
(e) There is no requirement that the actuarial assumptions and methods used under a NDCP plan be the same as those used in a qualified plan sponsored by the NDCP sponsor.

In addition, the rules generally provide that certain specified features are ignored for purposes of determining whether a particular annuity is treated as a life annuity under the form of payment rules (but not for purposes of determining whether a life annuity with such a feature is actuarially equivalent to a life annuity without such a feature). These include:

• Term certain features (under which annuity payments continue for the longer of the life of the annuitant or a fixed period of time)
• Pop-up provisions (under which payments increase upon the death of the beneficiary or another event that eliminates the right to a survivor annuity)
• Cash refund features (under which payment is provided upon the death of the last annuitant in an amount that is not greater than the excess of the present value of the annuity at the annuity starting date over the total of payments before the death of the last annuitant)
• Social security or railroad retirement leveling features (including leveling features related to early retirement, survivor, or disability benefits)
• Features applying a permissible cost-of-living index

Accordingly, a life annuity with any of these specified features may be treated as a life annuity if the two life annuities are actuarially equivalent (taking into account the feature) and have the same initial payment date. With respect to subsidized joint and survivor annuities, such forms are treated as actuarially equivalent to a single life annuity provided that neither the annual lifetime annuity benefit nor the annual survivor benefit available under the joint and survivor annuity is greater than the annual lifetime annuity benefit available under the single life annuity. For example, a single life annuity providing $200 a month for the lifetime of the participant may be treated as actuarially equivalent to a joint and survivor annuity providing up to $200 a month for the lifetime of the participant and up to $200 a month to the surviving joint annuitant.

A life only sentence is not the only option
While limiting the NDCP form option to only life annuities options described in the previous section certainly provides the maximum flexibility permitted under 409A when it comes to the timing of the election, such enhanced flexibility may not be sufficient motivation for participants to eagerly eschew two of the more popular payments form under NDCPs: lump sums and installments payments. This is especially true in DC-style NDCPs where, as with their qualified plan counterparts, we see these options much more than with life annuities.

If the NDCP provides these popular options either along with or in lieu of the aforementioned life annuity options, then it must include and enforce the early form election procedures discussed earlier (i.e., participants must make the form election when first eligible to participate). Once the participant makes the initial form election, the ability to change such election in the future will then depend on which form is chosen. Assuming life annuities are offered and such annuities meet the criteria previously discussed, participants electing one of these alternatives will be able to switch back and forth between such annuities all the way up to their BCD. However, once a lump sum or installment option election is made (whether as an initial election or as a change from an initial life annuity election), the 409A subsequent deferral rules apply. These rules provide that a plan may permit a subsequent election to change the form of payment, provided that the new election meets three conditions (i.e., the “12-month/five-year rule”):

(1) Made not less than 12 months before the first date a payment scheduled for a specified time or based on a fixed schedule would otherwise have been paid
(2) Takes effect at least 12 months after the date the new election is made
(3) Defers payment for no less than five years from the date the first payment otherwise would have been made

The payment date cannot be accelerated under these rules. For example, if the original payment terms provided for a lump sum payment at age 60, the subsequent deferral election must be made before the employee becomes 59 and the payment date cannot be earlier than age 65.

Because the 409A rules described above apply both to participants and NDCP sponsors, a participant, a NDCP sponsor, or both a participant and a NDCP sponsor may have and exercise discretion to defer payment after the form of payment has been specified provided that such discretion is limited to changes that comply with the 12-month/five-year rule. This is important to note because it means that a NDCP sponsor is not able to avoid this requirement by amending the plan. However, the rules do not apply to changes in the form of payment under the terms of a domestic relations order to the extent the change in the form of payment applies to a payment that will be made to the alternate payee and not the participant. For example, a domestic relations order generally may provide for a new form of payment to a spouse or former spouse of the participant or provide such spouse or former spouse discretion to determine the form of payment to such spouse or former spouse.

If installment payments are in the election mix, the sponsor and participants need to also consider whether such installments are considered as a single or separate payment for purposes of applying the 12-month/five-year rule. The first step is to check the plan document to see if it indicates the applicable treatment. Under the 409A rules, if the plan is silent, installment payments are treated as a single payment. Any subsequent elections for installment payments treated as a single payment must be made at least 12 months before the installments were scheduled to begin and the payment of the first of the installments must be deferred at least five years from the original commencement date. Alternatively, installment payments may be treated as a separate payments. In this case, the 12-month/five-year rule applies to each separately identified payment. This approach enables participants to make subsequent elections after commencement has already begun. (i.e., the employer or participant could then subsequently elect to further defer a portion of the installment payments rather than all of them). The following two examples illustrate the difference between the single and separate approaches:

Single: Assume the participant is in a NDCP that provides for payment in a series of five equal annual amounts that are not designated as a series of five separate payments. The first amount is scheduled to be paid on January 1, 2020. Provided the participant makes the election on or before January 1, 2019, he or she may elect for the first payment scheduled to be deferred until January 1, 2025. Because the single payment rule is in effect, the remainder of the payments will automatically commence on January 1, 2026, and each January 1 thereafter.

Separate: Assume the same facts as above except that under its terms, the NDCP designates each payment as a separate payment. The first payment is scheduled to be made on January 1, 2020. Provided the participant makes the election on or before January 1, 2019, he or she may elect for the first payment scheduled to be made on January 1, 2020, to be deferred until January 1, 2025. If the participant makes that election but does not elect to defer the remaining payments, the remaining payments continue to be due upon January 1 of the four consecutive calendar years commencing on January 1, 2021.

Special consideration must be given if the employer or employee wishes to change the form of payment from installments to a lump-sum payment if the plan provides that each installment is treated as a separate payment. The lump-sum payment date must be at least five years after the final installment payment date. For example, consider a plan that provides for the payment of five equal annual amounts, each of which is designated as a separate payment. The first installment is scheduled for January 1, 2016, and the last is scheduled for January 1, 2020. The employee wishes to receive the payment in a lump sum. Provided the election is made on or before December 31, 2014, the earliest the employee may receive the lump-sum payment is January 1, 2025, which is five years after the last scheduled installment payment under the original election. If the plan did not provide that each installment payment was treated as a separate payment, the lump-sum payment could be made as early as January 1, 2021 (i.e., five years after the initial installment payment).

Sponsor’s choice
Form flexibility is a fine feature for participants but can add administrative complexity and thus corresponding cost to plan sponsors. The sponsor’s decision regarding which, if any, choices, it provides to participant may also be influenced by whether or not it wants to hold on to the assets for participants who separate from service. Consequently, some sponsors may opt for a more simplistic approach by designing the plan to only include a single form of payment with no choice for participants or only provide choices between forms that are not subject to the 12-month/five-year rule. For example, some DC NDCPs only permit lump-sum distributions while some DB NDCP may limit the participants to choosing between the previously discussed “actuarially equivalent” life annuities.

Another device available to sponsors to help simplify this process are default provisions which can be used to either mandate a certain form of payment if no timely participant election is made and/or to specify separate forms of payment for various distribution triggering events. In the case of the latter, the 409A rules require the following requirements be met regarding such default provisions:

• Must be objectively determinable when payment is triggered
• May vary by triggering event (e.g., lump sum upon death, 10 annual installments upon separation from service)
• Alternative payment schedule may apply if triggering event (other than fixed date) occurs on or before one (and only one) specified date (e.g., lump sum upon separation before age 55, life annuity upon separation thereafter)

The 409A rules also contain two separate mandatory cash-out provisions that NDCP sponsors may use to ease their administrative burdens by giving them the ability to eliminate ongoing tracking of and processing installment payments of amounts under certain dollar limits.

Cash-out option 1:
Under the first cash-out option, an NDCP may require (or include a provision granting the sponsor the discretion to require) a mandatory lump-sum payment of amounts deferred that do not exceed a specified amount provided that the payment (1) results in the termination of the employee’s entire interest in the plan (and all plans of the same type under the plan aggregation rules — so a sponsor may not use this rule to cash out an amount under one arrangement but not another arrangement where the two arrangements would be treated as one plan) and (2) does not exceed the limit on elective deferrals under Internal Revenue Code Section 402(g) for the calendar year of reference (e.g., $18,000 for 2016). In addition, any employer discretion must be evidenced in writing no later than the date of such payment. The rules do not require that a participant have separated from service for the sponsor to cash out the amount deferred.

Cash-out option 2:
The rules also offer another cash-out option, which provides that a plan under which amounts are to be paid in installments may permit the immediate payment of all remaining installments (without causing an impermissible acceleration) if the present value of the unpaid deferred Post 409A amount falls below a predetermined amount. Such a provision must specify the predetermined amount no later than the time and form of payment is otherwise required to be established. The immediate portion can be any amount as distinguished from cash-out option 1, which is tied to the Section 402(g) limit.

However, any immediate distribution in an installment series will result in an impermissible acceleration if it is paid at the discretion of the employer or the participant unless the payment does not exceed the 402(g) limit. Furthermore, any change in an immediate distribution provision, including a change in the predetermined amount, is treated as a change in the time and form of payment (i.e., subject to one-year/five-year rule).

Rounding into 409A form
The many 409A rules governing the permissible forms of payment can lead to a lot of confusion for participants and sponsors alike. Even worse, if they fail to make sure that their NDCP’s document and administration comply with these rules, participants are exposed to substantial penalties: 409A failures require participants to include all previously deferred amounts under the NDCP in gross income and pay on this amount income taxes, employment taxes, and a 20% penalty tax as well as interest and penalties on this amount at the underpayment rate plus 1% and underpayment penalties. Due to the complexity of these rules and the severe consequences of noncompliance, sponsors and participants cannot afford to be left in the dark watching 409A Form Here to Uncertainty. Accordingly, they should seek the assistance of their benefit consultants and ERISA counsel in order to stay true to 409A form.

Regulatory roundup

More retirement-related regulatory news for plan sponsors, including links to detailed information.

Final Rule lowering rates of penalty charged for late payment of pension premiums
The PBGC is lowering the rates of penalty charged for late payment of premiums by all pension plans, and providing a waiver of most of the penalty for plans with a demonstrated commitment to premium compliance.

The penalty for late payment of a premium is a percentage of the amount paid late multiplied by the number of full or partial months the amount is late, subject to a floor of $25 (or the amount of premium paid late, if less). There are two levels of penalty, which heretofore have been 1 percent per month (with a 50 percent cap) and 5 percent per month (capped at 100 percent). The lower rate applies to “self-correction” — that is, where the premium underpayment is corrected before PBGC gives notice that there is or may be an underpayment.

This final rule cuts the rates and caps in half (i.e., to ½ percent with a 25 percent cap and 2½ percent with a 50 percent cap, respectively) and eliminates the floor. The rulemaking also creates a new penalty waiver that applies to underpayments by plans with good compliance histories if corrected promptly after notice from PBGC. PBGC will waive 80 percent of the penalty assessed for such a plan.

For more information, click here.

Notice extends temporary nondiscrimination relief for closed defined benefit plans
The Internal Revenue Service (IRS) released Notice 2016-57, extending the temporary nondiscrimination relief for closed defined benefit plans provided in Notice 2014-5 and 2014-2, through 2017.

The temporary nondiscrimination relief for closed plans that is provided in Notice 2014-5 is hereby extended to plan years beginning before 2018 if the conditions of Notice 2014-5 are satisfied. This extension is provided in anticipation of the issuance of final amendments to the § 401(a)(4) regulations. Those regulations are expected to be effective for plan years beginning on or after January 1, 2018, and are expected to permit plan sponsors to apply the provisions of the regulations that apply specifically to closed plans for certain earlier plan years.

To read Notice 2016-57, click here.

To read and review Notice 2014-5, click here.

DoL Extends deadline for public comments on Form 5500 modernization proposal
The Department of Labor (DoL) announced a two-month extension of the comment period on the Form 5500 modernization proposals. A range of stakeholder groups asked for an extension of time to submit comments given the scope and significance of the proposed forms revisions and regulatory amendments. The DoL, IRS, and the Pension Benefit Guaranty Corporation (PBGC) decided to extend the public comment period on the proposed forms revisions and regulatory amendments from the original Oct. 4, 2016, deadline to the new Dec. 5, 2016, deadline.

For more information, click here.

Proposal to expand missing participant program
The PBGC administers a program to hold retirement benefits for missing participants and beneficiaries in terminated retirement plans and to help those participants and beneficiaries find and receive the benefits being held for them. The program is currently limited to single-employer defined benefit pension plans covered by the pension insurance system under title IV of the Employee Retirement Income Security Act of 1974 (ERISA).

The PBGC proposes to make changes to its existing program and, as authorized by the Pension Protection Act of 2006, to establish similar programs for multiemployer plans covered by title IV, certain defined benefit plans that are not covered by title IV, and most defined contribution plans. The proposed rule is needed to implement amendments to section 4050 of ERISA.

To read the proposed rule, click here.

For an overview of the proposed missing participants program for defined contribution and other terminated plans, click here.

Continue reading

Regulatory roundup

More retirement-related regulatory news for plan sponsors, including links to detailed information.

Actions to better address potential noncompliance for Roth individual retirement arrangement conversions
The Treasury Inspector General for Tax Administration (TIGTA) recently released “Actions can be taken to better address potential noncompliance for Roth individual retirement arrangement conversions.” The report notes that for tax year 2011, IRS records show that approximately 400,000 taxpayers converted more than $10 billion in assets from traditional to Roth Individual Retirement Arrangements (IRA). This TIGTA audit was initiated to assess whether the IRS has sufficient processes in place to address taxpayers who underreport taxes due when converting assets to Roth IRAs.

To read the entire report, click here.

DoL posts comments on agencies’ proposed rule – Form 5500
The Department of Labor (DoL) has made 23 comment letters received to date regarding the proposed rule that would amend Form 5500 and its schedules available on its website.

To access the comments, click here.

Improvements to claims process could help people make better informed decisions about retirement
The Government Accountability Office (GAO) released “Social Security – Improvements to claims process could help people make better informed decisions about retirement benefits” (GAO-16-786). Many eligible individuals claim Social Security retirement benefits at the earliest eligibility age, even though they would receive higher benefits if they waited until older ages. In order to make an informed decision about when to claim, people need to understand how various Social Security rules and other factors affect benefit amounts. GAO was asked to examine these issues.

To read the entire report, click here.

GASB 74/75: Impact on small government employers

The Alternative Measurement Method (AMM) allows small government employers to use a modified approach to calculate their postemployment benefits other than pensions liabilities. In this article, Milliman consultant Joanne Fontana reviews the AMM, which is used by small government employers in lieu of an actuarial valuation. It also discusses the important changes relevant to small government employers as GASB 74/75 takes effect.

It’s Your Move: The dash(board) to retirement

O'Brien-ShaneDonald Rumsfield, the former U.S. Secretary of Defense, once discussed “known unknowns,” referring to things that we are aware we don’t know. The idea can be applied to retirement plan participants as well. It is evident year after year that plan participants still lack a fundamental understanding of certain aspects of retirement planning, such as how to invest, how much to invest, and how to create a plan for retirement. These aspects remain widely misunderstood.

Enter the It’s Your Move dashboard on Milliman’s newly reimagined website. This dashboard aims to make participants aware of the tools at their disposal that can help them plan for retirement. The dashboard falls in line with other initiatives in the industry, all aimed toward improving employees’ preparations for retirement. I’ve previously discussed how the working population in the United States is massively unprepared for retirement and suggested that “gamification” was a possible solution. The SaveUp app was cited as an example of the effectiveness that gamification can have on retirement planning.

Now there is another newsmaker with a similar name—the Secure, Accessible, Valuable, Efficient Universal Pension Accounts (SAVE UPs) Act—grabbing a few headlines. SAVE UPs is a new piece of legislation that was introduced by Representative Joe Crowley (D-New York). The main objective is to provide all American workers with the opportunity to generate tax-advantaged assets. The legislation intends to help smaller employers subsidize the cost of contributing to IRAs in the form of a tax credit for the value of the contributions to 10 employee accounts. This bill, if enacted, could be following down a very controversial path similar to that of, I shudder to say, healthcare.gov. Since the full name of this new legislation threatens to exceed the character limit of any tweet commenting on it, I figured it would be easier to discuss on this platform since the overall objective appears to be to help provide opportunities for more people to prepare for retirement. The new Milliman Benefits dashboard was created with the same goals in mind and has a significantly lower chance of becoming part of the script for the next season of House of Cards.

The new It’s Your Move dashboard was designed to make participants aware of the various successful behaviors that will optimize their experience. With tools that help participants maximize company matches, diversify their investments, and utilize automatic increase and rebalance features, it could help to set new standards for best practices and increase participation rate in the plans that we manage.

PlanAhead - It's Your Move 2

Participant feedback has shown that a knowledge gap still exists in regards to retirement planning and investment decisions. A survey in March showed that 71% of participants were very likely or somewhat likely to seek advice from their plan providers and 69% were likely to seek advice from an independent advisor or financial services company. The advice they were seeking is on how to invest their money, what to do with their savings when they leave their employers, and what to do with the money when they retire. This shows that a majority of participants would like assistance in their retirement planning. The It’s Your Move dashboard helps to do just that. This readily accessible checklist of retirement behaviors is making participants aware of the tools available to them in an effort to improve their retirement outcomes. It can help employees feel more confident about retirement and offer some encouragement and useful information along the way.

Regulatory roundup

More retirement-related regulatory news for plan sponsors, including links to detailed information.

Study reveals accumulation potential of 401(K) by looking at consistent participants’ balances
The average 401(k) plan account balance of workers who participated consistently in one 401(k) plan increased significantly over the four-year period ending at year-end 2014, according to new data published today by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI).

The study, “What Does Consistent Participation in 401(k) Plans Generate? Changes in 401(k) Account Balances, 2010–2014,” examines the accounts of about 8.8 million “consistent participants” – those who remained active in the same 401(k) plan for the four-year period covering year-end 2010 through year-end 2014. It finds that average account balances increased during this period for consistent participants in all age cohorts.

To read the entire study, click here.

Modifications to minimum present value requirements for partial annuity distribution options
The IRS issued a final rule providing guidance relating to the minimum present value requirements applicable to certain defined benefit pension plans. The rule change the regulations regarding the minimum present value requirements for defined benefit plan distributions to permit plans to simplify the treatment of certain optional forms of benefit that are paid partly in the form of an annuity and partly in a single sum or other more accelerated form.

To read the entire final rule, click here.

GAO report explores 401(k) lifetime income options
The Government Accountability Office (GAO) released a report entitled “401(k) plans: DOL could improve use of lifetime income options” (GAO-16-433), presenting the results of a questionnaire the GAO sent to 401(k) plan record keepers. Among other issues, this report examines things, what is known about the adoption of lifetime income options in 401(k) plans, barriers that deter plan sponsors from offering such options, and the defaults that exist for participants who do not choose a lifetime income option.

GAO made seven recommendations to the Department of Labor (DoL), including that it clarify the criteria to be used by plan sponsors to select an annuity provider, consider providing limited liability relief for offering an appropriate mix of lifetime income options, issue guidance to encourage plan sponsors to select a record keeper that offers annuities from other providers, and consider providing RMD-based default lifetime income to retirees. DOL has described actions it would take to address the intent of the recommendations.

To read the entire report, click here.


August resembles July as record-low interest rates continue to drive the pension funding deficit

Wadia_ZorastMilliman today released the results of its latest Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans. In August, these pension plans experienced a $4 billion decrease in funded status due an increase in pension liabilities and flat asset returns. The funded status for these pensions inched downward from 75.8% to 75.7%.


Not much movement in pension funding last month. Assets didn’t budge in August, and the discount rate reached yet another record low with a modest step down. For the last three months, the funded ratio has barely moved in spite of continued funding by plan sponsors.

Looking forward, under an optimistic forecast with rising interest rates (reaching 3.52% by the end of 2016 and 4.12% by the end of 2017) and asset gains (11.2% annual returns), the funded ratio would climb to 79% by the end of 2016 and 91% by the end of 2017. Under a pessimistic forecast (3.12% discount rate at the end of 2016 and 2.52% by the end of 2017 and 3.2% annual returns), the funded ratio would decline to 73% by the end of 2016 and 67% by the end of 2017.

The NDCP dirty dozen: Timing is everything

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

While most nonqualified deferred compensation plan (NDCP) sponsors will be hard-pressed to find humor in 409A compliance, they may be willing to acknowledge that proper administration of NDCP distributions shares at least one common attribute with a winning comic performance: for the NDCP to successfully stand up in front of the most demanding critic—i.e., the Internal Revenue Service (IRS)—without facing any heckling, the plan must practice precision timing with its distributions to participants. Just as a comedian must work not to deliver a punch line too early or too late, an NDCP needs to avoid improper accelerations or delays of participant payments. A failure to do so can elicit a most unpleasant response in the form of a cacophony of catcalls and boos from participants, or an IRS audit discovery of 409A noncompliance, thereby triggering the resultant penalties.

This blog entry examines some of the toughest timing tests for the satisfactory operation and administration of NDCPs under section 409A of the tax code.

Activating the trigger
Section 409A severely restricts employer and/or executive discretion on the timing of distributions. It identifies six permissible NDCP distribution triggers, which generally must be established within 30 days of the date the executive first becomes eligible to participate in the plan:

1. A specified payment date (i.e., a future distribution date is designated either by the employer and/or executive upon the participant’s initial eligibility)
2. Separation from service
3. Disability
4. Death
5. Change in ownership or control of a corporation
6. Unforeseeable emergency

Except for death, each trigger has its own special 409A definition, along with complicated rules regarding how it may be applied. There is also a separate rule that permits the attachment of a “window” period to the applicable trigger. Under this rule, the participant may not designate the taxable year of payment; and such period must either both begin and end within one taxable year or must not be more than 90 days.

Recent IRS guidance expanded the permissible early payout alternatives to an NDCP participant’s beneficiaries in cases of death, disability, or unforeseeable emergencies. The guidance also clarifies that the NDCP may provide that the occurrence of death, disability, or an unforeseeable emergency may accelerate a schedule of payments that has already commenced prior to a participant’s or beneficiary’s death.

One of the most complex triggers happens to be one of the most commonly used: the “separation from service” distribution trigger. This trigger will not pose problems when the separation is clear-cut and final, such as a full retirement, resignation, or termination of employment. However, employment separations are often not so simple, such as where an executive’s duties are scaled back from his or her previous role (e.g., under a “phased retirement” scenario) or where a key employee “retires” but is then retained to consult as an independent contractor. Depending on the extent of the cutback and the terms of the NDCP, the plan may risk either prematurely commencing payment or impermissibly delaying a distribution that should commence. This may occur if the employer and/or the executive’s idea of what constitutes a separation does not align with the guidance under 409A. Although it basically is a facts-and-circumstances test, 409A considers a termination to have occurred if the employer and employee reasonably anticipate that either of these two conditions applies:

1. No future services will be performed after a certain date.
2. The rate of bona fide services to be performed after such date will not exceed 20% of the average rate of services performed over the preceding 36-month period (or the full period, if less than 36 months). (If the new rate of services is over 20% but less than 50%, such reduction may be treated as a separation from service under 409A, provided special rules are met.)

Continue reading

Regulatory roundup

More retirement-related regulatory news for plan sponsors, including links to detailed information.

DOL files final rule on savings arrangements established by states for nongovernmental employees
The U.S. Department of Labor (DoL) filed at the Federal Register a final rule entitled “Savings Arrangements Established by States for Non-Governmental Employees.” The final rule describes circumstances in which state payroll deduction savings programs with automatic enrollment would not give rise to the establishment of employee pension benefit plans under ERISA.

The final rule provides guidance for states in designing such programs so as to reduce the risk of ERISA preemption of the relevant state laws. The final rule also provides guidance to private-sector employers that may be covered by such state laws. This rule affects individuals and employers subject to such state laws.

The final rule is effective 60 days after publication in the Federal Register. It is scheduled for publication on August 30, 2016.

To read the entire final rule, click here.

Proposed rule on savings arrangements established by states for nongovernmental employees
The DoL filed a proposed rule entitled “Savings Arrangements Established by State Political Subdivisions for Non-Governmental Employees.” The proposed rule would amend a regulation that describes how states may design and operate payroll deduction savings programs, using automatic enrollment, for private-sector employees without causing the states or private-sector employers to establish employee pension benefit plans under ERISA. The proposed amendments would expand the current regulation beyond states to cover programs of qualified state political subdivisions that otherwise comply with the current regulation. This rule would affect individuals and employers subject to such programs.

Written comments should be received on or before 30 days after the date of publication in the Federal Register. Publication is scheduled for August 30, 2016.

To read the entire proposed rule, click here.

New procedure to help people making IRA and retirement plan rollovers
The Internal Revenue Service (IRS) provided a self-certification procedure designed to help recipients of retirement plan distributions who inadvertently miss the 60-day time limit for properly rolling these amounts into another retirement plan or IRA.

IRS Revenue Procedure 2016-47 explains how eligible taxpayers, encountering a variety of mitigating circumstances, can qualify for a waiver of the 60-day time limit and avoid possible early distribution taxes. In addition, the revenue procedure includes a sample self-certification letter that a taxpayer can use to notify the administrator or trustee of the retirement plan or IRA receiving the rollover that they qualify for the waiver.

To read the entire revenue procedure, click here.
For more information on rollovers and transfers, click here and here.

Guidance for one-participant plan sponsors
One of the most common reasons why a retirement plan becomes an orphan plan is because the plan sponsor no longer exists. The IRS has published some information offering sponsors guidance on how to prevent orphan plans.

For more information, click here.

SEC adopts rules to enhance information reported by investment advisers
The Securities and Exchange Commission (SEC) adopted amendments to several Investment Advisers Act rules and the investment adviser registration and reporting form to enhance the reporting and disclosure of information by investment advisers. The amendments will improve the quality of information that investment advisers provide to investors and the SEC.

For more information, click here.

Not-for-profit reduces payroll using voluntary early retirement program

In his article “Reducing payroll without involuntary terminations,” pension actuary Zorast Wadia discusses how Milliman helped a not-for-profit client reduce its payroll through a voluntary early retirement program (VERP).

Here is an excerpt:

The client considered a VERP that offered numerous types of incentives, including:

• Additional years of service and/or age credits
• Cash payment(s)—for example, one or two weeks of pay for each year of service
• Additional benefits, such as an extension of health coverage
• “Bridge” payments, where employees are paid an annuity from their termination date to a fixed date (such as age 62 or 65). …

…The window was offered to participants who were age 57 or older with early retirement benefits being calculated as if retiring participants were two years older with an additional two years of service. The additional years of service reward participants retiring early with higher benefits while the additional age criteria results in a lower reduction in benefit for most of the participants in the window group who would be retiring early. The client decided against offering an extension of health coverage because this option was deemed too costly.

The client also decided to amend the early retirement provisions in the retirement plan for future retirees. The early retirement eligibility was lowered from age 60 with 20 years of service to age 58 with 10 years of service going forward. The client felt that these changes would allow for a more orderly retirement of the work force and help facilitate work force transitions better in the future. Thus, not only was the client able to continue rewarding its employees with a strong retirement program, it was also able to redesign the retirement program to accomplish its human resource objectives.