Aging Sec. 457 Plan Regs. rejuvenated.

• Author: Pell, M. Howard
• Position: Deferred compensation plans - IRS proposed regulations

The IRS issued proposed regulations on Sec. 457 deferred compensation plans, under which state and local governments and tax-exempt entities must meet certain eligibility standards and limits not applicable to plans of taxable entities. For a deferred compensation plan established by a tax-exempt or government employer, which does not conform to Sec. 457 standards, an employee will be taxed currently on any amounts deferred, unless the right to plan benefits are subjected to a substantial forfeiture risk. For such an ineligible plan, compensation is included in a participant's or beneficiary's gross income for the first tax year in which there is no substantial risk of forfeiture of the right to such benefit (Sec. 83).The proposed regulations reflect 1986-2002 law changes and address and clarify other issues. They generally apply to tax years beginning in 2002.

General Provisions

Sec. 457 applies to tax-exempt employers and to state and local governments; it does not apply to a church, a qualified church-controlled organization or the Federal government. It pertains to both elective and other types of contributions (e.g., mandatory, nonelective employer and employer-matching contributions).

An eligible plan must be in writing, include all of the material terms for plan benefits and operate in compliance with the regulations.

All amounts deferred under an eligible governmental plan must be set aside in a trust, custodial account or annuity contract, for the exclusive benefit of participants and their beneficiaries. For a tax-exempt employer, they must be unfunded.

Deferrals, Limits and Agreements

Annual deferrals. Under the proposed regulations, an agreement to defer compensation will be valid if made before the first day of the month in which compensation is paid or made available. An agreement does not have to be entered into before services are performed. However, compensation payable in the first month of employment could be deferred if an agreement is entered into before a participant performs services.

Deferral limits. The proposed regulations explain the annual limits permitted under current law. Generally, the basic annual limit cannot exceed the lesser of (1) a specified dollar amount or (2) 100% of a participant's "includible compensation." The dollar amount is $11,000 for 2002; $12,000 for 2003; $13,000 for 2004; $14,000 for 2005 and $15,000 for 2006. After 2006, the $15,000 amount is adjusted for cost-of-living.

The plan may...