Section 409A of the Internal Revenue Code is a set of rules that govern Nonqualified Deferred Compensation Plans.
It includes rules that detail when the election to defer compensation must be made, but also how and when it is paid to the participant. Nonqualified plans are the bedrock of many companies’ executive compensation plans. A thorough understanding of Section 409A therefore plays a crucial part in the oversight of the plan by the plan sponsor.
Under Section 409A, there are a few key requirements which must be met by these types of plans: (I) strict timing of when an irrevocable deferral election must be made; (II) benefits may only be paid on the occurrence of a distinct set of permitted distribution events, which set the time and form of any pay out of benefits at the time of the deferral, (III) prohibitions on (a) accelerating payment of benefits and (b) limitations on delaying the payment of benefits once the time and/or form is elected; and (IV) documentary and definitional requirements.
Importantly, there is an exemption to this required compliance with 409A and the rules spelled out above. The so called “Short-Term Deferral Rule” provides this exemption. Under the exemption, if a NQDC plan meets the Short-Term Deferral Rule requirements, that plan will not then be required to follow the limitations and restrictions outlined above. Instead, these “Short-Term” plans will enjoy the freedom of integrating a variety of deferred compensation arrangements that would otherwise be prohibited.
One prominent example is the Short-Term Incentive Plan. This plan is setup to “vest” at the end of a specified performance cycle, if certain company targets are achieved. The payments are paid out in the year vesting occurs or within 2-1/2 months after the end of that year. For example, a four-year bonus plan with annual targets for performance, but the participant does not vest unless that employee is still with the organization at the end of the fourth year. As long as that deferral is paid out to the participant within 2-1/2 months after the end of the four-year period, the deferral of compensation will not be subject to Section 409A regulations. These arrangements often specify that the payment and vesting date be linked to a specific event or hurdle, i.e. the company reaches a specified level of corporate earnings or sales.
Navigating the complexities of Section 409A can be daunting. Making it important to have a partner you can trust to carefully design your Nonqualified Deferred Compensation Plan. The experts at Executive Benefits Network will guide you every step of the way to designing a plan which is beneficial to not only your employees but to your company as well.
Please contact Executive Benefits Network for more information.