Introduction to nonqualified deferred compensation plans

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1 The Advanced Consulting Group White paper Introduction to nonqualified deferred compensation plans Anne L. Meagher, JD, CLU, ChFC Director, Advanced Consulting Group Key highlights Why do employers establish NQDC plans? Comparing qualified and nonqualified plans Statutory framework Penalties for violating Code section 409A Basic requirements for NQDC arrangements Elective deferrals Nonelective deferrals Non-account balance plans Taxation Earnings Distributions Statutory funding rules Informal funding Choosing a funding vehicle Nonqualified deferred compensation (NQDC) plans have been around since at least the 1940s (and probably earlier) in the United States. Prior to 2004, these arrangements were largely governed by the constructive receipt doctrine as applied by the courts. This doctrine prohibits cash basis taxpayers from deliberately turning their backs upon income and selecting the year in which it will be reported as taxable income. The IRS issued a number of Revenue Rulings beginning in 1961 regarding NQDC plans, but there was still a great deal of flexibility, and employees, to a certain degree, we able to time the distribution and taxation of deferred amounts with relative ease. In 2004, motivated by the crash of Enron, World Com and others, in which executives were able to take enormous payouts from NQDC plans immediately preceding bankruptcy, Congress created a statutory framework intended to govern most types of deferred compensation arrangements. The new Internal Revenue Code (the Code) section 409A was signed into law as part of the American Jobs Creation Act of 2004 and final regulations became effective January 1, Some of the fundamental changes brought about by Code section 409A are the timing of deferral elections, changing distributions elections and the requirement that key employees 1 wait six months after separation from service to receive payments from a NQDC plan. The rules are extensive and touch on all aspects of deferred compensation plans. Scope This paper will limit its discussion to deferred compensation plans governed by Code section 409A (except governmental and church plans and Code section 457(f) plans for tax-exempt organizations). This paper will not cover tax-qualified plans, Code section 457(b) eligible deferred compensation plans and other bona fide vacation leave, sick leave, severance pay plan and disability and death benefit plans that are exempt from the provisions of Code section 409A. 2

2 Why do employers establish NQDC plans? NQDC arrangements are sponsored by employers to recruit, reward and retain the employees who are (or will be) keys to the success of the business. This type of plan allows pre-tax compensation to be deferred by an employee, thereby lowering his or her current taxable compensation and delaying payment to a later year (e.g., retirement). Plans can also be designed to have employer-paid benefits without the employee deferring his or her own compensation. This type of plan is frequently called a SERP a supplemental executive retirement plan. NQDC plans often supplement an employer s tax-qualified plan, particularly if highly paid employees are unable to defer the maximum allowed by law into a 401(k) plan due to nondiscrimination testing failures. Employers have a great deal of flexibility in the design of a NQDC plan and can tailor each agreement, if necessary, to meet the needs of a particular key employee. Here is an example of the potential impact a NQDC plan can have to a highly-paid employee s post-employment income. HCE (No NQDC) HCE (With NQDC) Annual compensation $100,000 $300,000 $300, (k) annual deferral* 18,000 18,000 18,000 Projected balance in 20 years** 700, , ,000 Estimated pre-tax annual payment for 20 years 56,000 56,000 56,000 Estimated annual Social Security benefit at age 66 (based on current law) Non- HCE 29,772 31,704 31,704 NQDC plan annual deferral ,000 NQDC projected balance in 20 years** 0 0 1,735,963 Estimated pre-tax annual payment for 20 years ,665 Total estimated pre-tax annual payment 87,704 85, ,379 Post-retirement income replacement ratio 85.80% 29.20% 73.40% *401(k) deferrals increase by 2% per year for 20 years **5% rate of return compounded annually Comparing qualified and nonqualified plans Many employers and employees are familiar with the main features and limits on qualified plans, particularly if they have sponsored or participated in one or more plans over their working lifetime. The following table highlights some of the main differences between a qualified and a nonqualified plan. Feature Tax-qualified plans NQDC plans Participation Must include all eligible employees Employer selects employees must be management / highly paid Vesting Statutory vesting schedules Employer can design vesting schedule no restrictions Funding Contributions/deferrals must be deposited into qualified plan trust in timely manner No assets/funds can be held in employees names, otherwise those amounts will be taxable income to employees 2

3 Feature Tax-qualified plans NQDC plans Creditor access to assets Amounts in the trust are not subject to claims of creditors of employer or employee Employer assets that are earmarked for NQDC plan are subject to claims of unsecured creditors, even if held by a rabbi trust Fiduciary Subject to ERISA fiduciary rules Not subject to ERISA fiduciary rules Reporting and disclosure Tax deduction for employer Contribution amount Employee recognition of taxable income Distributions Depending on the type of plan, may need to file annual report (form 5500) and provide summary plan description (SPD) to employees, funding disclosures and others Employer can deduct contributions (within limits) when made, including elective deferrals by employees Amount that can be credited to a participant s account is limited; benefit limited in defined benefit plan Employees recognize taxable income when amounts are paid or made available to them Depending on type of plan, employees may be able to take out loans, hardship distributions, and may elect when, after retirement, to begin distributions One-time notice to the U.S. Department of Labor of plan s existence; no SPD required Employer cannot deduct contributions (including employees elective deferrals) until they are paid out of the plan to employees No limit on amount that can be credited or paid to employees (subject to being reasonable compensation ) Employees recognize taxable income when amounts are paid or made available to them Distributions can only occur upon events defined in statute: separation from service, death, disability, unforeseeable emergency, change in control, fixed date or event Elective deferrals Rollovers Must begin distributions no later than age 70 ½, if no longer employed Employees may change, begin or stop deferrals to 401(k) plan at any time Employees may elect to rollover amounts to another qualified plan or IRA, thereby delaying the taxation of those amounts Employees must make irrevocable deferral election in the year before the year in which the amount is earned. May stop deferrals due to unforeseeable emergency or disability No rollovers allowed. Once an amount becomes payable, it is taxable to the employee Statutory framework ERISA In general, the Employee Retirement Income Security Act of 1974 (ERISA) was enacted to protect participants in employee benefit plans from unscrupulous employer practices that would deprive employees of anticipated benefits and to establish minimum standards for such plans to assure the equitable character of such plans and their financial soundness. 3 ERISA governs welfare benefit plans that provide, through the purchase of insurance, benefits in the event of sickness, accident, disability, death and unemployment, to name just a few. 4 ERISA also governs pension benefit plans that are established by an employer to provide retirement income to employees or results in a deferral of income by employees for periods extending to the termination of covered employment or beyond. 5 3

4 NQDC plans are pension benefit plans under ERISA; however, most of the substantive provisions of the law will not apply to a plan which is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. (This select group is often referred to as a top-hat group.) The ERISA provisions that will not apply to such a plan are: Participation and vesting; 6 Funding; 7 and Fiduciary responsibility. 8 On the other hand, ERISA s reporting and disclosure provisions 9 apply to NQDC plans, but the statute allows for an alternative method of compliance with these requirements through Department of Labor regulations. 10 In fact, the Department of Labor provides a simple method to comply with reporting and disclosure for unfunded top-hat plans. 11 An employer need only submit a notice to the Department that it has established a top-hat plan and make the plan document available upon request. Unfunded top-hat plans are not exempt from the administration and enforcement rules, including claims procedures. This means that the plan document must include the statutory claims procedures and must make participants aware of how a claim can be filed. Internal Revenue Code As already mentioned, Code section 409A became effective January 1, 2005 and governs most nonqualified deferred compensation arrangements. The Treasury Department, in the Preamble to the final regulations, makes it clear that Code section 409A does not replace the tax consequences that might ensue under Code sections 83 and 451, which codify the constructive receipt and economic benefit doctrines. These doctrines have been applied by courts for many years to prevent cash basis taxpayers from trying to delay the taxation of amounts that are otherwise currently available or irrevocably set aside for them. Penalties for violating Code section 409A If a NQDC plan fails to meet the requirements of Code section 409A, all compensation deferred under the plan for the taxable year and all preceding years will be included in the gross income of the employee along with late payment interest and an additional amount equal to 20% of the compensation which is required to be included in gross income. 12 In December, 2008, The IRS published proposed regulations outlining the method for calculating the amount includible in an employee s taxable income if an arrangement in which he or she participates fails to meet the requirements of Code section 409A. 13 The proposed regulations are long and complicated; suffice it to say that any Code section 409A violation may result in a substantial tax bill for an employee. Basic requirements for NQDC arrangements 1. The plan must be unfunded. This means that an employee cannot have a secured interest in any assets owned by the employer to receive benefits under a NQDC plan. Any assets earmarked or set aside to fund the plan s obligations must remain available to the unsecured general creditors of the employer in the event of the employer s insolvency or bankruptcy. Employees will be unsecured general creditors with respect to the benefits owed them in the event of the employer s insolvency or bankruptcy. 2. The plan must be for management and highly compensated employees - the top-hat group. Permitting rank-and-file employees to participate may cause the plan to be classified as a qualified plan and subject to all the ERISA requirements from which NQDC plans are exempt. 3. There must be a written agreement setting forth the substantive provisions of the plan. The Code section 409A regulations state that a plan is established on the latest of the date on which it is adopted, the date on which it is effective, and the date on which the material terms of the plan are set forth in writing The arrangement must comply with Code section 409A. Both the written agreement and the administration of the agreement must comply with Code section 409A. 15 Elective deferrals A plan that permits employees to elect to defer compensation that is otherwise payable immediately in cash is an elective deferral plan. The Code section 4

5 409A regulations make clear that a deferral election also means a distribution election. These elections must be made in the tax year prior to the tax year in which compensation subject to the election is earned. The deferral and distribution elections become irrevocable on the last day of the prior tax year. 16 Except under special circumstances, the election to defer cannot be changed once the deferral year begins; however, a new election can be made for each new tax year. For example, Mary elects on or before December 31, 2017 to defer 10% of her 2018 salary and 25% of the annual bonus she will earn in 2018 (that is paid in 2019). She further elects to receive those deferrals (plus earnings) at separation from service in five annual installments. The election to defer cannot be changed with respect to 2018 salary and bonus. Mary cannot change the time of the distribution (separation from service) with respect to 2018 compensation (unless she dies prior to separation from service). She may be permitted to change the form of payment, but only subject to certain rules which will be discussed later. There is an exception to the rule that a deferral election must be made in the tax year prior to the tax year in which the compensation is earned. If an employee has performance-based compensation the employee may make the deferral election no later than six-months before the end of the performance period. 17 Performance-based compensation means compensation that is contingent on the satisfaction of pre-established performance criteria relating to a period of at least 12 consecutive months. Organizational or individual performance criteria are considered performance criteria if established in writing no later than 90 days after the commencement of the period of service, provided the outcome is substantially uncertain at the time the criteria are established. 18 If, for example, the employer reserves the right to pay an annual bonus to any employees in spite of the fact that the performance criteria were not met, then that is not performance-based compensation, and the employees will need to make deferral elections in the year before any of the bonus is earned. Nonelective deferrals An arrangement in which employees do not elect to defer their own compensation is a nonelective deferral plan. The employer deferral to an employee s account may be matching or discretionary contributions or both. The benefit is based on the value of the account balance upon the distribution triggering date. Sometimes, an employer will mandate a form of benefit payment beginning upon a specified date or event; other times, the employee may be permitted to elect the form of payment from a list of options described in the plan document. Non-account balance plans Unlike the nonelective deferral plan described above, a non-account balance plan specifies the amount of the benefit that will be paid, usually beginning at a certain date or event and payable for a specified period of time. This type of plan is likened to a defined benefit pension plan. Typically, employees are not given a choice as to how benefits are paid out of these plans. Taxation It is important to remember that employees do not actually invest their money when it is deferred into a NQDC plan. The compensation an employee defers is accounted for by the employer as a liability that will be paid in the future. The employer will pay income tax on compensation that is deferred and can use the aftertax deferrals as it sees fit. Deferred compensation is subject to FICA and FUTA taxes when deferred, although an employee s taxable compensation will be reduced by the amount deferred. Nonelective employer deferrals are subject to FICA and FUTA when they vest. Failure to pay FICA and FUTA at the proper time will result in having to pay those taxes when benefits are paid out of the plan. The employer will be able to take an income tax deduction at the same time the employee recognizes such amount as taxable income. Earnings In general, NQDC arrangements provide for earnings, gains and losses to be credited to participants deferral accounts. Most plans (and best practice) is to allow participants to choose from a variety of investment options similar to what might be offered in a 401(k) plan. Although participants do not actually invest in those options, their accounts are credited and debited as though they had invested in them. In the past, many plans credited a stated rate that was pegged to an index such as 10-year Treasuries, the prime rate or Moody s Corporate Bond Yield Index. 5

6 Sometimes, a nonelective employer deferral may be credited with a stated rate, but elective employee deferrals are usually allocated by the employee among a variety of options selected by the employer. Distributions Under Code section 409A there are only six events that can trigger a distribution (so long as the document provides for it): 1. Death 2. Disability 3. Separation from service 4. Change in control 5. Unforeseeable emergency 6. Specified date/event 19 Not every plan provides for distributions on all of these events. In general, most account balance plans provide for distributions to commence upon separation from service, an unforeseeable emergency, death and on a specified date in the future. Most defined benefit plans provide for distributions upon separation from service on and after a stated age and upon death. Code section 409A regulations define disability, unforeseeable emergency, change in control and separation from service. Failure to meet the definition for an event could mean that Code section 409A has been violated if a distribution is made. Separation from service Employers need to be cautious when determining if an employee (or independent contractor) has had a separation from service. Failing to begin a distribution upon a separation or making payment before there is a separation from service are both Code section 409A violations. Whether there has been a separation from service (not due to death) is a facts and circumstances test, but the IRS will presume that an employee has a separation if the level of bona fide services the employee performs decreases to 20% or less of the average level of bona fide services performed over the immediately preceding 36 months. 20 The IRS will also presume that an employee has not separated from service where the level of bona fide services performed continues at a level that is 50% or more of the average over the immediately preceding 36 months. 21 These presumptions are rebuttable by showing that the employer and employee reasonably anticipated that, as of a certain date, the level of bona fide services would be reduced or would not be reduced -to the presumptive levels, but that business circumstances changed such that the anticipated reduction is not what happened in fact. In addition, services performed as an employee and as an independent contractor are all considered bona fide services; therefore, if an employee changes his or her status to independent contractor but continues to work at a level that is at least 50% of the average over the preceding 36 months, there is no separation from service. 22 However, there is an exception for an employee who is also a member of the board of directors of the employer, and where the employer maintains a plan for employees and a different plan for non-employee directors. In that case, the services provided as an employee are not considered in determining whether the employee has a separation from service as a director and vice versa. 23 Six-month delay in distribution Certain employees of publicly-traded companies must wait for six months after a separation from service to receive any payments from a NQDC plan. 24 This delay does not apply to distributions triggered by any other event. Employees who are key employees as defined in Code section 416(i)(1)(A) at any time during the 12-month period ending on an identification date (usually December 31) will be subject to this rule. 25 A key employee means: 6

7 An officer of the employer having annual compensation greater than $175,000 (2017 limit), but no more than 50 employees will be included in this group; A 5% owner of the employer; or A 1% owner having annual compensation from the employer of more than $150, This rule does not apply to privately-held companies, but the best practice is to include a provision in the document just in case the company is ever bought by a publicly-traded company. Changing a distribution election after it has become irrevocable If a plan permits a subsequent election that will delay a scheduled payment or change the form of payment, the plan must provide that: The election cannot take effect until at least 12 months after the election is made; If the election applies to (i) separation from service, (ii) a specified date or (iii) upon a change in control, the payment must be deferred for a period of not less than five years from the date the payment would otherwise have been made; and If the election applies to a distribution on a specified date, such election cannot be made less than 12 months prior to the date of the first scheduled payment. 27 For example, Bob elects in 2017 to defer 20% of his 2018 salary and further elects to receive those deferrals (plus earnings) on January 1, In July 2019, Bob wants to make a subsequent election to receive his 2018 account on a later date. Provided Bob makes the election no later than December 31, 2020 (12 months before the date of payment) and provided he elects to receive the account on January 1, 2027 or later, he can make this election. Note that it will not become effective until 12 months after he makes the election. In the above example, it s easy to see how the rules work with respect to specified date elections. In this next example, it s not quite as clear. Bob elects in 2017 to defer 20% of his 2018 salary and elects to receive that account in a lump sum upon separation from service. In 2019, Bob makes an election to receive his 2018 account in five annual installments when he separates from service. Bob separates from service on June 30, 2025 (so his subsequent election is now in effect). Bob will receive his first annual installment on July 1, 2030, which is five years after the date on which the distribution would otherwise have occurred when he separated in If a plan permits participants to make a separate election with respect to the form of distribution upon death or disability, the subsequent election will become effective 12 months after it is made, and there is no five-year delay in the distribution date. Acceleration of payments In general, a NQDC arrangement cannot permit the acceleration of the time or schedule of any payment under the plan except as provided in regulations. 28 The regulations permit a plan to accelerate the time or schedule of a payment under the following circumstances: Pursuant to a domestic relations order (defined in Code section 414(p)(1)(B)) provided the acceleration or payment is to someone other than the employee; 29 To comply with an ethics agreement that a federal officer or employee of the executive branch entered into with the federal government; 30 To avoid the violation of an applicable federal, state, local or foreign ethics law or conflicts of interest law; 31 To pay federal, state, local and foreign incomes taxes due upon a vesting event under a Code section 457(f) plan; 32 Where a plan has a mandatory lump sum payment or gives the employer the discretion to cash out a participant s balance when the payment will not exceed the Code section 402(g)(1)(B) deferral limit to a 401(k) plan and all the participant s balances under all nonqualified plans that are aggregated with the one being cashed out are all cashed out; 33 To pay employment taxes (FICA/Medicare/FUTA) on compensation deferred under the NQDC plan; 34 To pay the amount that was included in income due to a Code section 409A failure; 35 and Pursuant to the regulations that govern the termination and liquidation of a NQDC plan. 36 The plan may provide that an employee s deferral election is cancelled until the next annual enrollment date (or later) due to an unforeseeable emergency or 7

8 a hardship distribution. 37 This list is not exhaustive; if an employer or a participant is considering an acceleration of a benefit payment, it would be prudent to consult the regulations for other options. It is interesting to note that accelerating the vesting of benefits is not prohibited, so a plan could give the employer discretion to accelerate a participant s vesting without accelerating the date of a payment. Statutory funding rules Offshore trusts If any assets are set aside to pay deferred compensation under a NQDC plan for services performed in the United States, those assets will be treated as property transferred to the participants (and taxable to participants) if the assets are located or transferred outside of the United States. This is true even if the assets are subject to the claims of the employer s creditors. 38 Employer s financial health Code section 409A also addresses plans that try to restrict the disposition of assets to only pay plan benefits in the event of a downturn in the employer s financial health. There will be a transfer of property to participants on the earlier of (a) the date the plan first provides that assets will become restricted, or (2) the date on which assets are so restricted, whether such assets are available to satisfy claims of general creditors. 39 Other rules relating to funding Employers that sponsor a single-employer qualified defined benefit plan in addition to a NQDC plan will need to know that if the qualified defined benefit plan is in at-risk status meaning it is underfunded pursuant to Code section 430(i) then the employer should not deposit assets into a rabbi trust to fund nonqualified benefits of an applicable covered employee. 40 Any asset deposited into a rabbi trust when the qualified plan is at-risk will be treated as taxable compensation to the participants. Additionally, if the employer reimburses an affected individual for the taxes imposed, then the reimbursement itself is included in the amount subject to the penalty under Code section 409A and the employer is not permitted to deduct the reimbursement. 41 Informal funding To avoid current taxation of amounts deferred, employees cannot have an interest in any employer assets set aside to pay benefits; however, most employers choose to purchase or set aside assets to informally fund NQDC plans. Typically, an employer will purchase an asset with the employees deferrals and any employer nonelective deferrals. The asset will usually be either a taxable asset such as mutual funds or variable corporate-owned life insurance (COLI), and the notional investments offered to employees will be the actual investments of the employer. Other funding options are sometimes considered, but they are specialized (e.g., total return swap) or have other disadvantages (e.g., annuities). Considerations for choosing a funding vehicle There are three primary issues to consider when deciding how to informally fund a NQDC plan: The employer s liquidity needs; The taxation of the asset; and The assets impact to the employer s earnings. Considerations Taxable asset COLI Liquidity needs Ideal for short time horizon (i.e., benefits will be payable within three to five years from the plan). The ability to withdraw cash value can be limited in the early years of a policy if the employer wants to hold until death. 8

9 Considerations Taxable asset COLI Taxation Short- and long-term capital gains and dividends are taxable each year. Impact to earnings Gain on sale of asset is taxable. If the employer is paying taxes, the additional taxes generated may be more than the cost of COLI. Other Easy to understand No consent from employees needed Cash value gains are not taxable (unless the policy is surrendered). Cash value withdrawals and loans are not taxable. Death benefits are not taxable provided employees consent to be insured. 42 There is little advantage to COLI if the employer does not pay income taxes. Consent to be insured required from employees. Death benefits provide method to recover some or all the cost of the NQDC plan. In many cases a combination of taxable assets (for short-term needs) and COLI (for tax-deferred growth and taxfree death benefits) will be the best solution. Rabbi trusts Some employers choose to establish a grantor trust, referred to as a rabbi trust, to hold the assets that are earmarked to fund a NQDC plan. A rabbi trust is not a separate taxable entity; all accounting and taxation are recorded on the books of the employer (the trust s grantor). As mentioned earlier, an employee s benefit is not protected in the event of the employer s insolvency or bankruptcy, and a rabbi trust does not change that. A properly drafted and fully funded rabbi trust will, however, protect plan participants in the event of a change in control and a change of heart by the employer. Most large, publicly-traded companies have rabbi trusts, and some smaller companies do, too. There is an additional cost to having a rabbi trust, but some employers will establish them, particularly if the employer believes there will be a change in control (i.e., the owner is looking for a buyer) or if current management does not trust that future management will continue to pay benefits to them after retirement. Conclusion NQDC arrangements have been offered to key employees for many years by employers to help recruit, retain and reward those employees. These plans allow employees to reduce current taxable compensation and to receive those amounts in the future, normally after retirement. It also provides employers with a method for setting aside compensation for an employee and distributing it after retirement or some other event or date, as an incentive to continue working for that employer. Since 2005, there has been a statutory framework that prescribes a set of rules which must be followed to avoid current taxation of amounts deferred. The vast majority of employers that establish NQDC plans also choose to informally fund those plans with taxable assets, COLI or a combination of the two. Now that there are federal statutes governing the establishment and maintenance of both NQDC plans and COLI, there is a little more certainty about the stability of their future place among the tools an employer can use to recruit, reward and retain their key employees. 9

10 1 As defined in Code section 416(i) for top-heavy testing purposes under a qualified plan 2 Code Section 409A(d)(1) 3 ERISA section 2(a) 4 ERISA section 3(1) 5 ERISA section 3(2)(A) 6 ERISA section 201(2) 7 ERISA section 301(a)(3) 8 ERISA section 401(a)(1) 9 Title 1, Part 1 of ERISA 10 ERISA section DOL Reg. section Code Section 409A(a)(1) F.R (December 8, 2008) 14 Treas. Reg. section 1.409A-1(c)(3)(i) 15 IRS Nonqualified Deferred Compensation Audit Techniques Guide (June 2015) 16 Code section 409A(a)(4)(B)(i) 17 Code section 409A(a)(4)(B)(iii) 18 Treas. Reg. section 1.409A-1(e) 19 Treas. Reg. section 1.409A-3(a) 20 Treas. Reg. section 1.409A-1(h)(1)(ii) 21 Id. 22 Prop. Treas. Reg. section 1.409A-1(h)(5) 23 Treas. Reg. section 1.409A-1(c)(2)(ii) and Prop. Treas. Reg. section 1.409A-1(h)(5) 24 Code section 409A(a)(2)(B)(i) 25 Treas. Reg. section 1.409A-1(i)(1) 26 Code section 416(i)(1)(A) 27 Code section 409A(a)(4)(C) 28 Code section 409A(a)(3) 29 Treas. Reg. section 1.409A-3(j)(4)(ii) 30 Treas. Reg. section 1.409A-3(j)(4)(iii) 31 Treas. Reg. section 1.409A-3(j)(4)(iii)(B) 32 Treas. Reg. section 1.409A-3(j)(4)(iv) 33 Treas. Reg. section 1.409A-3(j)(4)(v) 34 Treas. Reg. section 1.409A-3(j)(4)(vi) 35 Treas. Reg. section 1.409A-(3)(j)(4)(vii) 36 Treas. Reg. section 1.409A-(3)(j)(4)(ix) 37 Treas. Reg. section 1.409A-(3)(j)(4)(viii) 38 Code section 409A(b)(1) 39 Code section 409A(b)(2) 40 Code section 409A(b)(3). The affected executives are generally the current and former chief executive officers and the four highest paid executive officers, as well as certain directors, officers, and shareholders covered by 16(a) of the Securities Exchange Act 41 Code section 409A(b)(3)(C) 42 Code section 101(j) outlines which employees can be insured for the benefit of an employer and the notice and consent requirements, which are beyond the scope of this paper. This material is not a recommendation to buy, sell, hold or rollover any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition, or particular needs of any specific person. Investors should work with their financial professional to discuss their specific situation. Federal income tax laws are complex and subject to change. The information in this memorandum is based on current interpretations of the law and is not guaranteed. Neither Nationwide, nor its employees, its agents, brokers or registered representatives gives legal or tax advice. You should consult an attorney or competent tax professional for answers to specific tax questions as they apply to your situation. Nationwide, the Nationwide N and Eagle and Nationwide is on your side are service marks of Nationwide Mutual Insurance Company Nationwide NFM-16756AO (08/17) 10