3546 / When must a participant in a private nonqualified deferred compensation plan elect to defer compensation under IRC Section 409A?

IRC Section 409A imposes timing requirements for participants electing to defer compensation. The general rule is that participants now generally must make deferral elections prior to the end of the preceding taxable year (December 31 in most cases) in which the income is earned.¹ There are two major exceptions to the general rule, as follows:

1. In the first year of a plan, a participant can make a pro rata election on compensation, based upon the number of days remaining in the year.


2. In the case of any “performance-based compensation,” (PBC) as defined in the regulations to Section 409A, a participant must make an election to defer not later than six months before the end of the covered period (June 30 for a calendar year performance period) and performance period in the case of a fiscal year. The compensation must meet this unique Section 409A definition, which includes (among other important requirements) a 12-month performance period.²This rule also allows an election on fiscal year performance-based compensation to be made six months prior to the end of the fiscal year if that is the end of the performance period.³ This rule changes the common practice on bonus compensation under prior law, especially as to new plans, to make elections late in the performance period. Now it is essential to start and enroll a deferral plan prior to the six month deadline to maximize the deferral opportunity.

In the case of existing plans, participants need not make a final election on PBC until the six-month prior deadline, even if they make a preliminary election on it in the prior tax year.

Newly eligible participants must make an election within 30 days after the date of eligibility, but only with respect to services to be performed subsequent to the election. In addition, elections to defer on plans of the same Section 409A plan type (for example, all employee account balance plans) under the “aggregation rule,” if there is more than one, must occur at the same time.

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Planning Point: Employers with more than one plan of the same Section 409A type (e.g., employee account balance plans) only should allow enrollment in plans, including for newly eligible employees, during perhaps a mid-year and end-of calendar year enrollment window to comply with the requirement of a common enrollment period for similar Section 409A plans.

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Section 409A also requires a plan to specify whether any elected series of installment payments shall be treated as a single distribution or a series of individual distributions.

Subsequent Elections: Using this rule, Section 409A allows participants to elect to make a “subsequent election” to delay the timing of an existing elected distribution or change the form of that distribution from a plan so long as the plan provides for such subsequent election right. To make such a subsequent election, the plan document and the administration must require the subsequent election to be made at least 12 months in advance of the original distribution date, and the subsequent election must delay the timing of the distribution at least five years from the date of the original distribution (unless made on account of disability, death, or an unforeseeable emergency).

In addition, there is a 12-month waiting period requirement after the subsequent election during which the old election must be applied for an event-based separation from service. An election related to a scheduled series of installment payments made pursuant to a fixed schedule and treated as a single distribution must be made at least 12 months in advance of the first such scheduled installment payment.⁴ In general, it is usually preferable to create more flexibility for a participant in a plan by designating that a series of installment payments be treated as a series of individual distributions. However, it is necessary to have a plan administrator who can manage this complex flexibility and thereby comply with Section 409A to include it in a plan.

Current regulations generally also provide that a separately identified amount of an installment (either by percentage or fixed dollar amounts) that an employee is entitled to receive on a determinable date may be deferred subject to the subsequent election rules.⁵ In effect, a portion of an installment, if a series of installment payments are treated as a series of individual distributions, may be subsequently deferred.