CHICAGO - The new rules governing non-qualified deferred-compensation plans will be a boon for business, say financial planners working with top-paid executives.
"It is increasing the need for planning, because with more restrictions and complexity comes more need for financial advice," said J. Mark Joseph, president of Sentinel Wealth Management Inc. in Reston, Va. "I think it is a huge opportunity for planners."
The Department of the Treasury and the Internal Revenue Service issued about 240 pages of proposed regulations late last month that further clarified rules under Section 409A, the revenue code created a year ago that put major restrictions on deferred-comp plans.
"I would suggest that non-qualified plan participants need their financial planners and investment advisers even more after 409A than they needed them before," said Henry Smith, a partner in the Baltimore-based law firm of Smith and Downey PA. The firm specializes in executive compensation and employee benefits.
"It is critical that financial advisers and investment advisers jump into this process with both feet to help their executive clients replan around this new set of rules," he added.
Fortunately, the IRS is giving everyone plenty of time to adjust to the huge changes. One of the noteworthy aspects of the new guidance last month was that the deadline for plan amendments and some transition rules was extended through the end of 2006, rather than the original deadline of Dec. 31, 2005.
However, advisers and their clients need to be aware that some transition rules still will expire this year, experts said. One of them is a provision allowing participants to take their money out of the plan this year without any penalty, according to Liz Buchbinder, a partner in the Washington office of Ernst & Young LP of New York.
"So to the extent that employers want to allow their employees one last chance to take their money now, outside of the rules of 409A and without any penalties, this year is the only year you can do that," Ms. Buchbinder said. "I think that is an important year-end consideration for executives who have non-qualified deferred comp."
In addition, a transition rule that allows employers to choose to terminate a plan outright without any restrictions also expires this year, she noted.
Reaction to Enron
The new restrictions on deferred-comp plans were included in the American Jobs Creation Act of 2004, which became law last October.
With the Section 409A going into effect Jan. 1 this year, the IRS came out with interim guidance last December. But those involved with the plans said they have been eagerly awaiting more definitive guidance.
The new regulations are scheduled to take effect Jan. 1, 2007.
The original provisions were a reaction to the scandal at Enron Corp. of Houston.
Members of Congress thought certain Enron executives were able to withdraw money from their deferred-comp plans before the company's collapse, something that wasn't possible for the rank-and-file employees in the company's qualified retirement plan, according to Mr. Smith. He is the author of "The Non-Qualified Deferred Compensation Answer Book" (Aspen, 2005).
"Congress thought that the solution to that problem was to eliminate some of the planning flexibility for distributions in non-qualified plans, and they certainly did that," Mr. Smith said.
Under the old rules, some companies allowed their executives to withdraw their money whenever they wanted as long as they paid a 10% penalty, a so-called haircut provision.
"If you are walking through a maze and there is an exit door at every turn, you don't need someone to help you guide through that. I think people felt like the restrictions were kind of a wink before, where they could just get out of it if they needed to," Mr. Joseph said.
"Now there are not as many exit doors along the way."
Section 409A not only did away with the haircut provision but levies stiff penalties for inappropriate withdrawals as well as unlawful plan designs. The penalties for violating rules are immediate taxation on the deferred-comp balance, a 20% federal tax penalty, plus interest on the amount of money going back to the vesting date and an additional 1% interest penalty charge.
"When you add those up, sometimes the penalties exceed the account balance in the plan," Mr. Smith noted.
In the recent guidance, the IRS took some new positions that will affect executives and their employers, according to Rick Menson, partner in the Chicago office of McGuireWoods LLP, based in Richmond, Va.
In a departure from the interim guidance, the proposed regulations exempted all stock-appreciation rights from Section 409A, so long as the exercise price isn't less than the fair market value on the date the right is granted.
"That's a good thing that they did - good for the company and good for executives," Mr. Menson said. "If it was subject to 409A, it would have created a bunch of accounting and other problems."
Also, stock options, another form of executive compensation, might be subject to the new 409A rules, depending on how they are set up, he added.
One issue left unanswered is whether split-dollar insurance policies are subject to 409A. "Even though they haven't said anything in the regs, they leave that open," Mr. Menson said.