Nonqualified Deferred Compensation Rule Change
On October 11th, Senate and House approval of legislation for nonqualified deferred compensation was completed. The bill now awaits the President's signature. There was a great deal of effort from employers and industry organizations to end up with the language that recognizes the significant benefits of nonqualified deferred compensation and addresses the perceived abuses. We are pleased with the end result and believe that the legislation will require minimal administrative changes and minimal loss of benefit flexibility.
The basic changes to nonqualified deferred compensation plans include:
- Placing limits on the timing of distributions. Distributions may not be distributed any earlier than the occurrence of one of six specified events including: separation from service, the date the participant becomes disabled, death, a specified time (or fixed schedule) specified under the plan at the date of the deferral, a change in ownership or effective control of the corporation or the occurrence of an unforeseeable emergency.
- Placing limits on elections dealing with changes in time and form of distribution. If the plan permits a subsequent election to delay a payment or change the form of payment, new rules limit the amount of time necessary before the changes take effect.
- Prohibiting the acceleration of distributions. This provision would prevent the acceleration of distributions from the plan. Currently, participants can withdraw their money at a 10% early withdrawal penalty. This will no longer be permitted.
- Clarifying when the election to defer compensation should take place. Deferral elections for salary would have to be made before the start of the calendar year. For bonuses, deferral elections may be made as late as 6 months before the end of the period during which the bonus is "earned".
- Reporting nonqualified contributions on the participant's W-2. This would not impact the tax treatment of contributions. The reporting is for information purposes only.
- The elimination of aggressive security mechanisms such as Financial Triggers and Offshore Rabbi Trusts.
- The addition of significant penalties and interest for non-compliance.
The good news is that the proposed legislation does not affect any of the following:
- It does not limit the deferral amounts or the tax deferred growth of earnings.
- It does not limit investment options.
- It does not limit the use of domestic Rabbi Trusts.
- It does not repeal Section 132. This means that the IRS still has limited authority to issue regulations regarding nonqualified deferred compensation.
The proposed legislation would apply to deferrals made after December 31, 2004 and potentially to amounts deferred earlier if there was a material modification to the plan after October 3, 2004. Upon enactment, Congress has instructed the IRS to release regulations specific to the legislation within 60 days.
In light of some of the uncertain aspects of the new rules employers may want to consider a series of action steps in the immediate future. These steps might include:
- Determining what plans are subject to the new rules
- Determine how to proceed
- Communication to the employees
- Obtaining consent
Each of these steps are likely unique to your situation. In order to understand how you may be affected please do not hesitate to contact our office for a complete review of your organizations deferred compensation agreements.
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