NQDC-vs-402(b) – aka RAPS
An alternative to the US Tax Regulations that require NQDC plans (nonqualified deferred compensation plans) to be not formally funded ( The Total Return Swap Hedge requires 25 million annual contributions.)
The Alternative to Unfunded, Unhedged, or informally funded NQDC Plans:
We have a number of 402(b) Foreign Retirement Plan proposals that will provide you the ”reasons why” for the solutions we look to provide you from this side of the globe. Limits on qualified plans makes NQDC plans a more attractive savings tool.
Employer to Employee Contract:
The nonqualified deferred compensation trust in the USA is a contract between the Employer and the Employee. Therefore, isn’t it true that the tax treatment of contributions is always a huge question mark because the ingredient was mixed up by the attorney that wrote the contract between the employer and the employee and therefore it is a document of legal opinion rather than U.S. retirement plan law. This NQDC is nonqualified; uncertain until it is challenged by the IRS.
Section 83 and Section 409A:
Our 402(b) Foreign Retirement Plan from a US centric point of view would initially look like a category nonqualified deferred compensation trust; it is not a 401k, IRA or 403(b), and it is a contract which has a Trustee. However, this 402(b is not a contract between the employer and the employee. The employer, in fact , has no liability and is not a party to the contract. In other words, the treatment pretax or after tax of contributions is not determined by ERISA, an attorney opinion or by the employer. Which means that no attorney has been asked if this contract follows Section 83 and 409A because the employer is not involved.
The employee does not need to substantiate an employer’s having the right to a substantial risk of forfeiture because the employer is not a party to the contract.
Non-Vested by Law:
The 402(b) concept developed in Hong Kong permits that so long as the contributions, the accumulations of income and gains on the contributions,
together or separately, are never vested in the member, not by contract nor by US law, the result will be EET (Exempt Contribution, Exempt Growth,
Tax on withdrawal).
Therefore, contributions will lower the members current year taxable income and turbo-charge accumulation for their retirement. Because by Hong Kong law pensions are never part of the personal estate, they are never vested in the sense of the Employee Retirement Income Security Act of 1974 (ERISA), nor vested in the US tax sense. The assumption made under the IRS’s “substantial risk of forfeiture” rule is that there is vesting unless the rule between the employer and employee says no vesting. That is not a safe assumption to make on its own because the IRS can decide to override that employer-made rule. U.S. Legal advise says that the IRS will not override Hong Kong law because to do so would be to invent rather than interpret the law.
Employer has no Liability:
The employer is not a party to the contract in Hong Kong retirement law and has no law inside the retirement plan to determine if the Employer can expense the contribution immediately or at the time that it is vested in the employee…Which means that we make analysis of the Employer legal structure to determine the treatment of contributions in each case. Can the employer deduct it as an expense now or only later?
We do not need to make analysis of the members tax treatment of contributions because it is excluded and non vested until it is vested.
The fiduciary of this 402b foreign retirement plan is called a Trustee but the structure is a Foreign Retirement Plan and its legal basis is not Trust Law but rather Retirement Plan Law.
Therefore it is important to avoid mixing Trust/ Trust Law into the same kettle as a Foreign Retirement Plan/ Foreign Retirement Plan Law.
Foreign Retirement Plan Law is recognized in Common Law, Civil Law and Sharia Law Countries and Trust Law is recognized in Common Law Countries, Rarely ever in Civil Law Countries and Only under certain specified conditions in Sharia Law Countries.
Selecting the Foreign Retirement Plan Framework
Assets which will provide income for security now and retirement income later are the types of funds which require a view of 15-25 years out and longer. They are designed for your future and therefore you need to look out into the future of the law. The foundation of planning for the future requires that you need to break up the components of your retirement plan.
FIRST, we determine which is the best legal framework in the whole world and we do not assume that because you have a company registered in Hong Kong that it would be Hong Kong law applying to the retirement fund and why should we, because it is not logical to have the legal framework of your retirement plan coinciding with the place where the employer is registered, it sounds logical but actually in the future, modern world it is not. Because to chose the legal framework on the basis of your company registration would be constraining you and automatically the law on pensions and retirement plans is radically different than the law on corporations and trading, of course it is different and therefore we did not make that assumption when recommending Hong Kong.
SECOND, it is also imperative to look at where is the best place for your custodian. U.S. Centric people would make an assumption automatically, which explains how illogical some peoples thinking is, that if you have a foreign retirement plan in USD that naturally the custodian will be in New York.
The legal framework should be one thing, the custodian another. There is nothing wrong with having the custodian in New York but the point is that one needs to think about where one wants to have that custodian in the first place. And can that custodian do the best job?
The THIRD consideration is actually the whole point behind a foreign retirement plan which is to allow you to accumulate your deferred pay clear of taxation because it turbo-charges your retirement. Tax efficiency is the whole point and purpose of all retirement plans in perpetuity.
This structure is designed to last and therefore is the future of retirement law- where is best, who has the money and has turbo-charge it.
The “WHAT” is the Guarantee
By the way, I have heard people respond to our solution that ”this is too good to be true”,” why has my advisor never heard of it”, ”why have I never heard of it” and ”what about a guarantee”.
It’s been around since Reagan was in short pants; the only reason it has become relevant is because with FATCA and IRS 8938, the IRS has woken up to the fact that there is a big wide world out there. There are a lot of people who are involved with pensions plans these days that back in 1986 when the 402(b) became law, or indeed in 1974 when ERISA arrived, they just wouldn’t have dreamt of working outside of the USA…it was just not something that people did; but they do now.
The second question ”Why have my advisors never heard of it?” (it sounds a bit tricky) is that there is no reason for your advisor to have ever heard of it because by definition you don’t have to deal with foreign retirement plan law since a US advisor does not need to study this area of law at all. There are big firms around that have dealt with these laws for years and years. Finally, as to a guarantee, well it is all laid out for you in the law; you see by IRS Code, Rulings and Guidelines and also if you look at US Treasury commentary as well as the IRS and Treasury commentaries on FATCA and then read it in FATCA as it is specifically recognized – foreign retirement plans are exempt.
Foreign Retirement Plans are IRS recognized and mentioned in every U.S. Double Tax Agreement while Banks and Insurance Companies are not mentioned. This 402(b) is reported annually on ”Report of Foreign Bank and Financial Accounts” (FBAR) and is a Foreign retirement plan that is a Qualified Intermediary (not subject to withholding tax) by the Secretary of the U.S. Treasury and is not treated as a reporting Foreign Financial Institutions. The U.S. member reports his account annually on IRS Form 8938 as having Zero Value. Zero Value is reported because it is non-vested.
There are no U.S. Person Constraints
Foreign registered Retirement funds are not constrained by S.E.C. Securities law nor do they require an S.E.C. registered broker, dealer or advisor. The (PFIC) U.S. Passive Foreign Investment Company rule is irrelevant. Investments of a foreign regulated retirement plan are not subject to S.E.C regulations or to U.S. Person investment constraints or restrictions. There is no U.S. law that disallows a U.S. person from investing into a Foreign Retirement Fund that has a Government Regulated Fiduciary, is a registered foreign retirement plan and where the jurisdiction accommodates persons that do not live in that jurisdiction.
The law in Hong Kong automatically interfaces with the US and EU vis-à-vis exempting the Hong Kong plans from any reporting at all; they only need to report locally which means the whole cost structure is lowest.
The noise made by the State Department, that the rest of the world is bad or loving, has no bearing on the technical side of a 402b. If you want to have Americans in a Hong Kong plan with custodian in the USA that is also fine, it is exactly what these agreements are all about.
You can work out the benefits for yourself if you want to say, ”Don’t pay me, pay my retirement plan” then, that slice of your income simply doesn’t have tax paid on it for years and years and the compounding effect of that is huge.
The Deferred Tax Advantage of RAPS:
In our base case, a person making typical deferrals will have a payout at retirement that is approximately 52% larger after taxes than what he or she would have earned with personal after-tax investments. This scenario assumes taxes remain constant with the highest current effective marginal rate and an 8% growth rate.
Higher tax rates at the point of deferral increase the advantages of deferred compensation. Conversely, lower taxes decrease the advantages. Note that in an increasing tax rate scenario, results in a deferral advantage of 42%, while a decrease of 5% in the effective tax rate at retirement results in a 62% advantage for deferral.
The Regulatory Course
Over the last 10 years, governments have introduced a number of new initiatives to clamp down on tax enforcement. The Savings Tax Directive, Article 8 of the Administrative Cooperation and Mutual Assistance Directive of 2011 in the EU, for example, is to be enacted in 2014 and expanded in 2017. The impact of this legislation is to close down traditional offshore financial centers, or so-called “tax havens.”
In recent years, UK, France, Spain and Portugal have concluded hundreds of Tax Information Exchange Agreements (TIEAs) with traditional offshore financial centers. The UK has been significantly active, introducing information disclosure facilities with Lichtenstein, Switzerland, Channel Islands and Isle of Man. The US has introduced the Foreign Account Tax Compliance Act (FATCA) and the G5 is now preparing similar multilateral information sharing structures. There is no reason to believe that this approach will not become a global phenomenon.
In the global FATCA/G5 compliance environment the cost and risk of administrative compliance is both closing existing investment centers and making others prohibitively expensive for banks, brokerages, trust companies, life insurance companies, fiduciaries and their potential clients (e.g. Investment restrictions and constraints on Americans and anyone resident in the UK or US)
There are very few foreign financial institutions that know how to traverse this territory for their non-resident clients. Many have in fact left the field or significantly curtailed or fenced their operations within explicit national boundaries.
The foregoing analysis has been prepared to share the current landscape of asset protection as well as the current laws. While the analysis was not intended to be applied as a legal documentation of the laws it did provide guidance regarding the current trend and the opportunities available under regulatory, registered and recognized retirement plan law.
Related articles
Leave a Reply