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My husband is now eligible for a 409A deferred compensation plan. How are Social Security and Medicare deductions handled? Are they against total current income (before 409A deductions) or against the distributions from the plan? If Social Security is against the distributions from the plan, then it would increase the total amount of Social Security deductions.

Debra
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Both are taken out based on his pre-tax income.

Calvin
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My husband is now eligible for a 409A deferred compensation plan. How are Social Security and Medicare deductions handled? Are they against total current income (before 409A deductions) or against the distributions from the plan?

409(a) plans are non-qualified deferred compensation plans, as opposed to qualified deferred compensation plans, like 401(k)s. However, the rules regarding Social Security/Medicare taxes are the same for both - the compensation, not the distribution, is subject to Social Security/Medicare taxation. So the taxes will be taken out of his paycheck now.

As a word of caution, taking an early distribution from a 409(a) plan can impose significantly more taxes and penalties than taking an early distribution from a 401(k) plan. With a disallowed distribution from a 409(a) plan, all the money in the plan can become immediately taxable, retroactive to the date of contribution. Interest and a 20% penalty are also charged. This compares to a 401(k) plan where only the money withdrawn is subject to taxes, as of the date of withdrawal, and a 10% penalty. So be really, really sure that the money won't need to be touched before it's put into the plan.

AJ
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As a word of caution, taking an early distribution from a 409(a) plan can impose significantly more taxes and penalties than taking an early distribution from a 401(k) plan. With a disallowed distribution from a 409(a) plan, all the money in the plan can become immediately taxable, retroactive to the date of contribution.

My understanding, which is shaky at this point, is that an advance selection of early withdrawl eliminiates the early withdrawl penalty.

Debra
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My understanding, which is shaky at this point, is that an advance selection of early withdrawl eliminiates the early withdrawl penalty.

"Advance" being at the point of decision to contribute. From http://www.fa-mag.com/past_issues.php?idArticle=1091&idPastIssue=103

- How does a nonqualified deferred compensation plan work? An executive must elect to defer compensation before the year in which the compensation will be earned. (For bonus compensation only, the executive can currently make a deferral election as late as six months into the performance year.) For example, Sally elected to defer her first $30,000 for ten years, until she attains the age of 55. She elected to defer her second $30,000 bonus for nine years, and so forth.
- Can a NQDC plan participant change his or her election? Yes, but only to extend the time period. Specifically, an election to delay or change the form of payment needs to be made at least a year in advance of when the new election is supposed to take effect. And the new distribution date must be at least five years after the old one.
- Can a participating executive have any access to, or secure an indirect benefit from, his or her deferrals prior to the election date? With a few exceptions listed below, no. Until the elected or specified distribution date, the plan funds must remain the company’s property. Thus, the plan is only “informally funded.” The executive cannot derive any benefits from the deferrals until the election date(s) come due.
- How does the employer fund the plan? The employer either pays the plan amounts out of current revenue, or more commonly, prefunds the plan out of periodic investments or corporate-owned life insurance. Obviously, an executive should only agree to participate in a plan if he or she is confident the money will be there when payments are due.
- Do the Section 409A rules permit early plan distributions for any reasons? Yes, the exceptions are:
• Separation from service
• Disability
• Death
• Change in ownership or control
• Unforeseeable emergency (as defined earlier)
• Miscellaneous (domestic relations order, conflict of interest divestiture requirements, de minimis cash-out payments)


In another part of the article, it indicates that the rules and penalties were put into place to prevent what occurred with the Enron NQDC plans where executives stripped the NQDC in the months/weeks prior to the bankruptcy.

AJ
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I new I didn't completely understand the rules and, therefore; the contribution is set low and the distribution choice for new contributions can be changed quarterly. The funds are placed in a separate account at Fidelity.

Okay, so the current contributions must be taken in the time frame specified which is over the three years following separation. Since this is only two years away, this is not extremely long term planning. The goal is a partial income bridge between his leaving employment and collecting social security. Given the risks involved with the plan, it will not be a major part of our retirement plan.

Debra
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