In general, a participant must make a deferral election to a non-qualified deferred compensation plan before the beginning of the plan year and the election must remain in effect for the entire plan year. Participants made their deferral elections by December 31, 2019 to calendar year plans, before anyone knew how impactful the COVID-19 virus would be on businesses and individuals' incomes.
The regulations under Section 409A of the Internal Revenue Code (the “Code”) state that a plan may provide for the cancellation of a participant's deferral election, or such a cancellation may be made, due to an unforeseeable emergency or a hardship withdrawal, as defined in the 401(k) regulations. Both an unforeseeable emergency and a hardship withdrawal generally require the participant to have suffered a financial detriment, such as unreimbursed medical expenses, a casualty loss, or funeral expenses. As such, a decrease in income, standing alone, would not generally be sufficient to allow a participant to cancel his/her deferral election to a non-qualified plan.
IRS Notice 2020-50 (issued June 19, 2020) provides that if the participant is a qualified individual as defined in the CARES Act, and takes a coronavirus-related distribution (“CRD”) from an eligible retirement plan, that distribution will be deemed to be a hardship withdrawal for purposes of the Section 409A regulations, and the participant may be able to permissibly cancel his/her deferral election to the non-qualified plan.
The cancellation may be automatic under the terms of the non-qualified plan, or the participant may need to make an affirmative election to cancel the deferral election. Note that the deferral election must be actually cancelled, not merely postponed or delayed. Any subsequent deferral election would have to comply with the general timing rules under the non-qualified plan and Code Section 409A; therefore, if the deferral election is cancelled, the participant may need to wait until 2021 to make a new deferral election to the non-qualified plan.
The IRS interpretation in Notice 2020-50 is welcome relief by making it easier for participants who are experiencing adverse financial consequences as a result of the COVID-19 virus, such as those who are furloughed, laid off, or working on a reduced hour schedule with a related reduction in pay, to cancel their deferral elections to a non-qualified deferred compensation plan.
Originally published 29 June, 2020
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