3558 / What elements of an unfunded arrangement met regulatory requirements before the enactment of Section 409A?

Prior to the enactment of Section 409A, the IRS generally would issue advance determination rulings concerning the tax consequences of an unfunded arrangement if the arrangement met the requirements outlined below. Some of the requirements parallel those now required in IRC Section 409A.¹ Currently, the IRS generally will not issue a letter ruling to a plan sponsor on the income tax consequences of a plan under Section 409A and does not plan to issue any prototype documents under Section 409A (there were no prototype documents prior to the enactment of Section 409A either).²

Any initial election to defer compensation generally had to be made before the beginning of the period of service for which the compensation was payable, regardless of the existence of forfeiture provisions. If any election other than the initial election to defer compensation could be made after the beginning of the period of service, the plan had to set forth substantial forfeiture provisions that had to remain in effect throughout the entire period of the deferral. The plan had to define the time and method for paying deferred compensation for each event (such as retirement) entitling a participant to benefits. The plan could specify the date of payment or provide that payments would begin within 30 days after a triggering event.

If the plan provided for the early payment of benefits in the case of an “unforeseeable emergency,” that term was defined as an unanticipated emergency caused by an event beyond the control of the participant or beneficiary that would cause severe financial hardship if early withdrawal were not permitted. The plan also had to provide that any early withdrawal would be limited to the amount necessary to meet the emergency. Language similar to that in Treasury Regulations Sections 1.457-2(h)(4) and 1.457-2(h)(5) could be used. The plan had to provide that participants had the status of general unsecured creditors of the employer and that the plan constituted a mere promise by the employer to pay benefits in the future. The plan also had to state that it was the intention of the parties that it be unfunded both for tax and ERISA purposes. The plan had to provide that a participant’s rights to benefits could not be anticipated, alienated, sold, transferred, assigned, pledged, encumbered, attached, or garnished by the participant’s or the participant’s beneficiary’s creditors.³