There are many factors to consider when contemplating an accelerated payout from your deferred compensation plan, especially potential violations of IRC Section 409A. Short-term deferrals and separation pay plan payments are generally exempt from 409A and therefore not subject to 409A’s anti-acceleration rules. 409A failures may result in the plan benefits of affected participants becoming immediately taxable (for the current year and prior years) and trigger the assessment of substantial penalties and interest.
However, there is a limited exception to anti-acceleration in connection with permitted plan terminations. The termination of a deferred compensation plan involves both termination of employer and employee deferrals (unless otherwise already frozen) and the acceleration of the payment of accrued benefits. Such permitted plan terminations can only occur in one of three ways: in connection with the employer’s insolvency, change in control of the employer, or in accordance with the 409A general plan termination rules.
Absent insolvency or a change in control, an employer may terminate and liquidate a deferred compensation plan under the general plan termination rules if the following requirements are satisfied:
- termination and liquidation does not occur as result of a downturn in the employer’s financial health;
- employer terminates and liquidates all similar arrangements (applying the 409A plan aggregation rules);
- no payments are made for 12 months following the plan termination (unless otherwise payable without termination);
- all payments are made within 24 months of plan termination; and
- employer does not adopt a new plan, which would be aggregated with the terminated plan (applying the 409A plan aggregation rules), for a period of three years following the plan termination.
Further, under 409A, if a payment is made to an employee in “substitution” of the terminated deferred compensation plan benefit, such payment may be treated as an accelerated payment in violation of 409A. The IRS uses a facts and circumstances test to determine the existence of a substitution. For example, a payout will be considered a substitution if it reduces, may reduce, or offsets a payment of deferred compensation, either currently or in the future.
In short, you can accelerate payouts from your deferred compensation plan under certain circumstances. But, the rules in 409A are complex and there are serious consequences for failing to follow the rules. Caution is advised.