409A and Linked Elections Following 401(k) Hardship Suspension
Many tax-qualified Section 401(k) plans provide that a participant who takes a hardship distribution pursuant to Treasury Regulation Section 1.401(k)-1(d)(3) is suspended from participating in any qualified or nonqualified deferred compensation plans of the Company for a period of six months. After the suspension period elective deferrals under some plans automatically recommence without further action by the participant, whereas other plans require participants to make a new election to recommence their elective deferrals.
The second option may be problematic if the 401(k) plan election is linked to an election to a nonqualified plan (for deferrals exceeding the Section-402(g) limit) because an election under a nonqualified plan to recommence deferrals following a hardship suspension is subject to the rules governing initial deferral elections under the Section 409A regulations. An initial deferral election generally is timely if the election becomes irrevocable not later than the last day of the taxable year immediately preceding the year during which services are to be performed – an election cannot be modified once the service year has begun. However, an election is not considered revocable merely because the service provider may accelerate the time of payment (i.e., decrease the amount deferred) under a plan pursuant to a regulatory exception. One such exception, at Treasury Regulation Section 1.409A-3(j)(4)(viii), provides:
(viii) Cancellation of deferrals following an unforeseeable emergency or hardship distribution. A plan may provide for a cancellation of a service provider's deferral election, or such a cancellation may be made, due to an unforeseeable emergency or a hardship distribution pursuant to §1.401(k)-1(d)(3). The deferral election must be cancelled, not merely postponed or otherwise delayed. Accordingly, any later deferral election will be subject to the provisions governing initial deferral elections. See §1.409A-2(a).
If a new election is provided at the end of the six-month suspension period to recommence deferrals ("later deferral election"), it is treated as an initial deferral election. Any such later election would be too late if applied to compensation earned during the same service year and jeopardize the irrevocable status of the participant's existing deferral election. Giving an election to recommence nonqualified deferrals after a hardship suspension cannot be squared with the regulation. Alternatively, if the 401(k) plan/nonqualified plan election were cancelled for the year pursuant to a hardship distribution (or else automatically reinstated after the suspension without choice by the participant), both these designs should satisfy the 401(k) regulation and, because any existing deferral election would be unaffected, would not be problematic under Section 409A rule. A new election to defer under the nonqualified plan should be extended only as to the next year.