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Protection of 457(f) plan assets from employer's creditors?


Guest David999
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Guest David999

Is there a structure that would provide protection for 457(f) plan assets from the employer's creditors while at the same not removing the substantial risk of forfeiture that must exist for the plan participants to defer current taxation of contributions? And if such structure were available how would it differ in application with governmental entities vs. non-govt. tax-exempt entities?

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Guest PeterGulia

If the participant seeks to protect against a potential of the employer's dishonest refusal to pay deferred compensation, the usual protective device is a "rabbi trust".

If the participant seeks to protect against the employer's insolvency, several London and Bermuda insurers offer casualty insurance against this risk. The premium will vary with the insurer's credit evaluation of the employer. If the employer's credit is not "investment-grade", it may be difficult to get the insurance. For a reference to the IRS rulings on why the employee must buy this insurance without help (beyond furnishing information for the insurer's evaluation) from the employer, see Q 4:35 of Panel's 457 Answer Book.

It may be unnecessary to consider how these concepts vary with a government employer because in most States a local government employer does not have power to adopt a 457(f) ineligible deferred compensation plan. However, it may be appropriate to consider these concepts for a 415(m) excess benefit plan.

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  • 2 weeks later...
Guest David999

Thanks for the response, Peter. I the 457 answer book and will look that up.

When you say that local govt. employers don't have the power to adopt a 457(f) plan, I don't understand this point. It seems that if state law didn't specifically prohibit them from doing it they could.

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I spent a fair amount of time investigating an nsurance product that provides protection in this area, and I spoke with both the attorney that obtained the IRS PLR approving such an arrangement and the IRS attorney that issued the ruling. After reading the policy, I determined that it didn't make any sense to buy that product.

Kirk Maldonado

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Guest PeterGulia

After returning from some rough travel in California, your compliment made my day.

The most basic principle of local government law is that a municipality has no more power than the State provides it. If there isn't a state law that grants a power to a municipality, the municipality doesn't have that power. If you need to support this point, a hornbook on Local Government Law should point you in the right direction.

I can tell you from hard experience that it's ugly when a municipality "establishes" a plan that it had no authority to establish. The "plan" is void, and all transactions arising from the non-authorized act are subject to rescission. And then you get to re-do each employee's W-2.

Since most employee benefits practitioners don't have a desire to get involved in local government law, when in doubt it's best to get a written opinion from the municipality's solicitor.

About the insolvency insurance, Kirk is right that, quite apart from any tax treatment issues, the participant should carefully evaluate whether the insurance is worthwhile. The policy may have many specialized terms, conditions, and exclusions. Because the Bermuda and London markets do not regulate policy terms in the way that Americans are accustomed to, the participant will want his or her lawyer to explain the policy's provisions.

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Guest Gary Wyatt

It seems to me...

The "substantial risk of forfeiture" under 457(f) has only to do with a requirement for future service. Setaside of assets out of reach of the entity's creditors shouldn't make a difference as to whether a substantial risk of forfeiture exists as long as the creditor protection does not erase a requirement for future service.

Please let me know if I've missed something.

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Guest CVCalhoun

You make a good point, Gary. A plan which provided protection for plan assets from the employer's creditors would not technically be a 457(f) plan, as it would be covered under section 83 and therefore excluded from 457(f). However, on a practical basis, whether a governmental plan is a section 83 plan or a section 457(f) plan may not make a lot of difference, since the tax rules are pretty much identical.

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Employee benefits legal resource sitea

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Guest Gary Wyatt

I really wasn't making any distinction between 83 and 457(f). I am just pointing out that security devices such as rabbi trusts, executive compensation guarantees, etc. really aren't tax-relevant in a plan where taxation arises merely upon the occurrence of vesting (regardless of whether the benefit remains unfunded).

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  • 1 month later...
Guest Brent Rowell

I think there is a distinction.

If normal 457(f) (unfunded and subject to creditors of employer) only contributions become taxable when risk no longer exists ... not earnings.

IF 83 entire account is taxable

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Brent

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