Go week: L19AALU_409A_wh
Go photo: None
Go graphic: Pull quote
With the full force of a new IRS regulation set to take effect on December 31st, companies will have to consider whether to amend, or entirely revamp, their non-qualified executive compensations plans. So noted three experts at the annual meeting of the Association for Advanced Life Underwriting, held here May 1-4, during a workshop on IRC rule 409A, an outgrowth of the America Jobs Creation Act of 2004.
“The new IRC rule is causing us to rethink designs for non-qualified executive compensation plans,” said Jim Clary, president and CEO of Mullin Consulting, Los Angeles, Calif. “We’re moving into a world where nonqualified plans look a lot like qualified plans in terms of the governing regulations.”
Prominent among 409A’s provisions are restrictions on elections and distributions. The rule stipulates, for example, that deferred compensation cannot be distributed earlier than the plan participant’s death, disability or the six-month period following the individual’s “separation from service” (e.g., termination).
Executives also must weigh the impact of compensation they elect to defer after December 31st, 2005. Two reasons: The election cannot take effect until 12 months after the election date; and the first payment must be deferred for not less than 5 years from the date such payment would otherwise have been made. What is more, 409A prohibits accelerated distributions.
Also to consider: All amounts previously deferred are immediately taxable unless subject to a substantial risk of forfeiture; executives pay an additional 20% tax on deferred compensation if they fail to comply with the rule; and they might not collect on the compensation because the 12-month/five-year rule magnifies their exposure to a change in company control, cash flow and bankruptcy risks.
The various restrictions might prompt some companies to opt for alternatives to traditional, non-qualified plans. William MacDonald, president & CEO of Retirement Capital Group, San Diego, Calif., suggested these could include a Section 162 bonus plan or secular trust.
The last, an irrevocable life insurance trust in which all benefits are funded and immediately vested in the executive, separates the deferred compensation from the employer’s assets. The contributions, though taxable to the executive, are tax-deductible for the employer. And contributions are not subject to claims of the employer’s creditors.
Another ILIT, the rabbi trust, can also prove valuable in protecting executives against the six-month delay following their separation from service, during which time the company (whether under old or new management) might think twice about making payments. The trust should be fully funded and managed by an independent trustee, said Clary.
“The rabbi trust will provide the executive with sufficient security so that, absent a legitimate reason in the plan document as to why the company shouldn’t pay, then the trustee will pay,” he said.