State deferred compensation plan qualifies under section 457(b)

Plain-English summary

A state agency established a nonqualified deferred compensation plan and trust that eligible state and local governmental employers could adopt for their employees. The plan allowed pre-tax and Roth deferrals, statutory catch-up contributions, eligible rollovers, emergency distributions, plan-to-plan transfers, and participant-directed investment of trust assets. The IRS ruled that the plan qualified as an eligible governmental deferred compensation plan under section 457(b). Deferred compensation and earnings would generally enter income when paid, while qualifying rollovers and qualified Roth distributions would receive their respective tax-favored treatment. The plan trust met section 457(g)(1) and was exempt from tax under section 501(a).

Ruling snapshot

• Question: Does the state-sponsored plan and trust meet the requirements for an eligible governmental deferred compensation plan under section 457(b)?
• Outcome: approved
• Key authorities: IRC §§ 401(a)(9), 402(c), 402A, 414, 415, 457, 501(a); Treas. Reg. §§ 1.401(a)(9)-1 through -9, 1.457-4, 1.457-5, 1.457-6, 1.457-10

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202017017                                              Third Party Communication: None
Release Date: 4/24/2020                                        Date of Communication: Not Applicable
Index Number: 457.00-00
                                                               Person To Contact:
------------------------------------------------------------   ----------------------------, ID No. --------------
----------                                                     -----------------
----------------------------------                             Telephone Number:
--------------------------------                               --------------------
------------------------------------------------------------   Refer Reply To:
----------                                                     CC:EEE:EB:QP4
                                                               PLR-117831-19
                                                               Date:
                                                               January 27, 2020




Legend

Plan                       = ---------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
State Agency               = ----------------------------------------------------------------
State A                    = -------------
Board B                    = -----------------------------------------------------------------------------

Dear ---------------:

This letter responds to your authorized representative’s letter dated -------------------, and
subsequent correspondence dated ----------------------------------------------------------------------
--------------------------, requesting a ruling concerning the Plan, which is intended to be an
eligible deferred compensation plan under section 457(b) of the Internal Revenue Code
and the regulations thereunder.

The following facts and representations have been submitted under penalties of perjury
in support of your request:

The Plan is a nonqualified deferred compensation plan and related trust established for
the benefit of employees of State A. The State Agency is authorized by State A to enter
into agreements with any eligible employer (including, but not limited to, any office of the
county superintendent of schools, school district, community college district, or city,
county, district, other local authority or public body) of State A for the eligible employer
to adopt the Plan and to make the Plan available to its employees. In order to offer the
Plan to its employees, the eligible employer of State A must enter into an agreement
adopting the terms of the Plan with respect to such employer and comply with the
applicable procedures adopted by Board B. It is represented that State A or any of its
political subdivisions are eligible employers within the meaning of section 457(e)(1)(A).

PLR-117831-19                                2

Under the Plan, an employee becomes a participant by executing a deferral agreement
to defer compensation into the Plan. The deferral agreement may include a designation
that all or a portion of the deferral elected by the participant shall be treated as Roth
contributions in accordance with section 402A. The election must be made prior to the
beginning of the month in which the employee’s compensation is paid or made
available. A new employee may defer compensation payable in the calendar month
during which the participant first becomes an employee if an agreement providing for
the deferral is entered into on or before the first day on which the participant becomes
an employee.

The Plan provides for a maximum amount that may be deferred by a participant in any
taxable year. It also provides for a catch-up contribution for amounts deferred for one or
more of the participant's last three taxable years ending before he or she attains normal
retirement age under the Plan. In addition, the Plan provides for age fifty-plus catch-up
contributions described in section 457(e)(18). The amounts that may be deferred under
the annual maximum limitation and the catch-up provisions are within the limitations of
section 457(c).

Upon separation from service, a participant may elect a form of distribution of benefits
from that participant’s account. Benefits under the Plan will commence no later than the
later of: April 1 of the year following the calendar year in which the participant attains
age 70 ½; or April 1 of the year following the calendar year in which the participant has
a separation from service. The Plan provides that the manner and time of benefit
payout must meet the distribution requirements of sections 401(a)(9) and 457(d).

Under the Plan, a participant (upon severance of employment) or beneficiary may elect
to have any portion of benefits deferred under the Plan that constitutes an eligible
rollover distribution described in section 402(c)(4) paid directly to another eligible
retirement plan described in section 402(c)(8)(B), such as an individual retirement
account (IRA) in a direct rollover, with nonspouse beneficiaries subject to certain
limitations set forth in section 402(c)(11). However, a direct rollover of an eligible
rollover distribution from a Roth contribution account may only be made to another
designated Roth account under an applicable retirement plan described in
section 402A(e)(1) or to a Roth IRA described in section 408A, and only to the extent
the rollover is permitted under section 402(c).

The Plan also provides for a distribution due to an unforeseeable emergency that is a
severe financial hardship resulting from extraordinary and unforeseeable circumstances
beyond the control of the participant under section 457(d)(1)(A)(iii) and § 1.457-6(c).

The Plan provides for acceptance of transfers of a participant’s account balance from
another eligible deferred compensation plan. The Plan provides for permissive plan-to-
plan transfers of all or a portion of a participant’s account to another eligible
governmental plan if the participant has terminated service and, in the case of a plan-to-
plan transfer, is a participant of the other eligible plan.

PLR-117831-19                                3


The Plan provides that amounts of compensation deferred under the Plan are to be
promptly remitted to and invested in a trust as described in section 457(g)(1) for the
exclusive benefit of the participants and their beneficiaries. Each participant may direct
the investment of his or benefit amount.

Section 457 provides rules for the deferral of compensation by an individual
participating in an eligible deferred compensation plan as defined in section 457(b).

Section 457(a)(1)(A) provides that in the case of a participant in an eligible
governmental deferred compensation plan, any amount of compensation deferred under
the plan and any income attributable to the amounts so deferred shall be includible in
gross income only for the taxable year in which such compensation or other income is
paid to the participant or beneficiary. Section 457(b) provides that the term “eligible
deferred compensation plan” means a plan established and maintained by an eligible
employer in which only individuals who perform service for the employer may be
participants and which meet the deferral limitations described in section 457(c); which
meets the distribution requirements described in section 457(d); which provides for
deferral elections described in section 457(b)(4); and, in the case of a governmental
plan, which requires the plan assets and income to be held in trust for the exclusive
benefit of participants and beneficiaries as described in section 457(g).

Section 457(e)(1) provides that the term “eligible employer” means a State, political
subdivision of a State, and any agency or instrumentality of a State or political
subdivision of a State, and any other organization (other than a governmental unit)
exempt from income tax.

Section 457(b)(4) provides that compensation will be deferred for any calendar month
only if an agreement providing for such deferral has been entered into before the
beginning of such month. An eligible plan may provide that if a participant enters into
an agreement providing for deferral by salary reduction under the plan, the agreement
will remain in effect until the participant revokes or alters the terms of the agreement.

Under section 402A(a), applicable retirement plans may include a qualified Roth
contribution program. Section 402A(e)(1) provides that eligible governmental deferred
compensation plans are applicable retirement plans. Section 402A(a)(1) provides that
elective deferrals of compensation which are designated Roth contributions under
qualified Roth contribution programs are not excluded from income in the year of
deferral. Section 402A(d)(1) provides that qualified distributions from designated Roth
accounts are not includible in gross income.

Section 457(b)(2) provides the basic limits on the amount of eligible annual deferrals.
However, a catch-up amount described in section 457(b)(3) may be added to this
amount for participants that are within three years of the normal retirement age or, for
participants age 50 or older, a catch-up amount may be added as described in

PLR-117831-19                                 4

section 457(e)(18). A participant eligible for both catch-up provisions is entitled to use
the higher limit of the two. The total annual eligible deferral amount is limited by
section 457(c). Coordination of the basic limits and the catch-up limits is described in
§ 1.457-4(c).

Section 1.457-4(c)(3)(v)(A) provides that a plan may define the normal retirement age
for purposes of the last-three-years catch-up provision as any age that is on or after the
earlier of age 65 or the age at which participants have the right to retire and receive,
under the basic defined benefit pension plan of the State or tax-exempt entity (or a
money purchase pension plan in which the participant also participates if the participant
is not eligible to participate in a defined benefit plan), immediate retirement benefits
without actuarial or similar reduction because of retirement before some later specified
age, and that is not later than age 70 ½. Alternatively, a plan may provide that a
participant is allowed to designate a normal retirement age within these ages. For
purposes of the last-three-years catch-up provision, an entity sponsoring more than one
eligible plan may not permit a participant to have more than one normal retirement age
under the eligible plans it sponsors. Section 1.457-4(c)(3)(v)(B) provides a special
exception for qualified police and firefighters to retire as early as age 40 for purposes of
the last-three-years catch-up provision.

Section 1.457-5 provides that the section 457(c) eligible deferral amount limitation is
applied to all eligible plans in which a participant participates in a tax year and is
determined on an aggregate basis. If a participant has annual deferrals under more
than one eligible plan and the applicable catch-up amount is not the same for each such
eligible plan for the taxable year, section 457(c) is applied using the catch-up amount
under whichever plan has the largest catch-up amount applicable to the participant. To
the extent that the combined annual deferral amount exceeds the maximum deferral
limitation, the amount is treated as an excess deferral under § 1.457-4(e). For purposes
of determining whether there is an excess deferral resulting from a failure of a plan to
apply the deferral limitations, all plans under which an individual participates by virtue of
his or her relationship with a single employer are treated as a single plan (without
regard to any differences in funding).

Section 457(d)(1)(A) provides that amounts distributed under an eligible plan will not be
made available to participants or beneficiaries earlier than (i) the calendar year in which
the participant attains age 70 ½, (ii) when the participant has a severance from
employment with the employer, or (iii) when the participant is faced with an
unforeseeable emergency.

Section 1.457-6(c)(2) provides the requirements for an unforeseeable emergency
distribution. An unforeseeable emergency must be defined in the plan as a severe
financial hardship of the participant or beneficiary resulting from an illness or accident of
the participant or beneficiary, the participant’s or beneficiary’s spouse, or the
participant’s or beneficiary’s dependent; loss of the participant’s or beneficiary’s
property due to casualty (including the need to rebuild a home following damage to a

PLR-117831-19                                   5

home not otherwise covered by homeowner’s insurance, e.g., as a result of a natural
disaster); or other similar extraordinary and unforeseeable circumstances arising as a
result of events beyond the control of the participant or the beneficiary. Whether a
participant or beneficiary is faced with an unforeseeable emergency is determined
based on the relevant facts and circumstances of each case. However, a distribution on
account of unforeseeable emergency may not be made to the extent that such
emergency is or may be relieved through reimbursement or compensation from
insurance or otherwise, by liquidation of the participant’s assets, to the extent the
liquidation of such assets would not itself cause severe financial hardship, or by
cessation of deferrals under the plan. Further, distributions because of an
unforeseeable emergency must be limited to the amount reasonably necessary to
satisfy the emergency need (which may include any amounts necessary to pay any
federal, state, or local income taxes or penalties reasonably anticipated to result from
the distribution).

Section 457(d)(2) requires a plan to meet the minimum distribution requirements of
section 401(a)(9). These requirements are described in §§ 1.401(a)(9)-1 through
1.401(a)(9)-9.

Section 457(e)(10) provides that a participant shall not be required to include in gross
income any portion of the entire amount payable to such participant solely by reason of
the transfer of such portion from one section 457(b) eligible deferred compensation plan
to another section 457(b) eligible deferred compensation plan. Section 1.457-10(b)(1)
provides that an eligible government plan may transfer amounts to, and receive
amounts from, an eligible government plan if certain conditions are met.

With regard to transfers from an eligible governmental plan to another eligible
governmental plan of the same employer, § 1.457-10(b)(4) provides that a transfer from
an eligible governmental plan to another eligible governmental plan is permitted if the
following conditions are met: (i) the transfer is from an eligible governmental plan to
another eligible governmental plan of the same employer; (ii) the transferor plan
provides for transfers; (iii) the receiving plan provides for the receipt of transfers; (iv) the
participant or beneficiary whose amounts deferred are being transferred will have an
amount deferred immediately after the transfer at least equal to the amount deferred
with respect to that participant or beneficiary immediately before the transfer; and (v) the
participant or beneficiary whose deferred amounts are being transferred is not eligible
for additional annual deferrals in the receiving plan unless the participant or beneficiary
is performing services for the entity maintaining the receiving plan.

Section 457(e)(16) provides that with respect to an eligible retirement plan established
and maintained by a governmental employer, if (i) any portion of the balance to the
credit of an employee in the plan is paid to him/her in an eligible rollover distribution
within the meaning of section 402(c)(4), (ii) the employee transfers any portion of the
property received in such distribution to an eligible retirement plan described in
section 402(c)(8)(B), and (iii) in the case of a distribution of property other than money,

PLR-117831-19                                 6

the amount so transferred consists of the property distributed, then such distribution (to
the extent so transferred) shall not be includible in gross income for the taxable year in
which paid. Section 402(c)(11) provides that nonspousal beneficiaries may elect to
have an eligible rollover distribution paid directly to an inherited IRA.

Under § 1.457-10(e), an eligible governmental plan that permits eligible rollover
distributions made from another eligible retirement plan to be paid into the eligible
governmental plan is required to provide that it will separately account for any eligible
rollover distributions it receives. Amounts contributed to an eligible governmental plan
as eligible rollover distributions are not taken into account for purposes of the annual
limit on annual deferrals by a participant but are otherwise treated in the same manner
as amounts deferred under the plan.

Consistent with section 414(p), § 1.457-10(c) provides for distributions made pursuant
to a qualified domestic relations order. If a distribution or payment is made from an
eligible plan to an alternate payee pursuant to a qualified domestic relations order, rules
similar to the rules of section 402(e)(1)(A) apply to the distribution. Section 414(p)(8)
provides that the term “alternate payee” means any spouse, former spouse, child or
other dependent of a participant who is recognized by a domestic relations order as
having a right to receive all, or a portion of, the benefits payable under a plan with
respect to such participant.

Section 457(e)(17) provides that no amount shall be includible in gross income by
reason of a direct trustee-to-trustee transfer to a defined benefit governmental plan (as
defined in section 414(d)) if such transfer is for the purchase of permissive service credit
(as defined in section 415(n)(3)(A)) under such plan or a repayment to which section
415(k)(3) does not apply. Section 1.457-10(b)(8)(i) clarifies that such a transfer may be
made before severance from employment.

Section 457(g) provides that a plan maintained by an eligible governmental employer
shall not be treated as an eligible deferred compensation plan unless all assets and
rights purchased with such deferred compensation amounts and all income attributable
to such amounts, property, or rights of the plan are held in trust for the exclusive benefit
of participants and their beneficiaries. Section 457(g)(2)(A) provides that a trust
described in section 457(g)(1) shall be treated as an organization exempt from tax
under section 501(a). Section 457(g)(3) provides that custodial accounts and contracts
described in section 401(f) will be treated as trusts under rules similar to the rules under
section 401(f).

Based upon the information submitted and the representations made, we conclude as
follows:

    1. The Plan is an eligible deferred compensation plan as defined in section 457(b)
      and the regulations thereunder.

PLR-117831-19                                7

    2. Amounts of compensation deferred in accordance with the Plan, including any
      income attributable to the deferred compensation, will be includible under
      section 457(a)(1)(A) in the recipient’s gross income for the taxable year or years
      in which amounts are paid to a participant or beneficiary in accordance with the
      terms of the Plan.

    3. Amounts distributed from the Plan in an eligible rollover distribution (within the
      meaning of section 402(c)(4)), will not be includible in gross income for the
      taxable year in which paid as provided in section 457(e)(16).

    4. The trust established as part of the Plan meets the requirements of section
      457(g)(1) and the trust is an organization exempt from tax under section 501(a).

    5. Amounts distributed from the qualified Roth contribution program maintained
      pursuant to the Plan’s provisions will not be includible in gross income under
      section 402A(d)(1).

Except as expressly provided herein, no opinion is expressed or implied concerning the
federal tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. If the Plan is significantly modified, the ruling will not
necessarily remain applicable.

This ruling does not address the validity of any Plan provisions under the laws of
State A.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party, as specified in Rev. Proc. 2020-1, 2020-1 I.R.B. 1, section
7.01(16)(b). This office has not verified any of the material submitted in support of the
request for ruling, and such material is subject to verification on examination. The
Associate office will revoke or modify a letter ruling and apply the revocation
retroactively if there has been a misstatement or omission of controlling facts; the facts
at the time of the transaction are materially different from the controlling facts on which
the ruling is based; or, in the case of a transaction involving continuing action or series
of actions, the controlling facts change during the course of the transaction. See
Rev. Proc. 2020-1, section 11.05.

PLR-117831-19                                  8

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.


                                           Sincerely,



                                           Cheryl Press
                                           Senior Counsel
                                           Qualified Plans Branch 4
                                           Office of Associate Chief Counsel
                                           (Employee Benefits, Exempt Organizations,
                                           and Employment Taxes)




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