Carol V. Calhoun

We looked at this a few years ago, and it appeared that from a strict reading of the existing applicable statute and regulations, this probably worked for nongovernmental tax-exempt organizations if properly structured. However, the IRS obviously has concerns about such arrangement, so I would not be surprised to see changes or interpretations that would disallow them, at least for the future. The question then becomes how economically feasible it is to adopt an arrangement now that the organization may not be able to continue for very long in the future.

You'd have to check the legislation to see if it affects the decision. However, state law permitting, your best option would seem to be a direct transfer (not a rollover, since that cannot occur without a distributable event) of all account balances from the old plan to the new one. The events should not (barring contrary state law) require full vesting. Even for a 401(a) plan, that is required only on a termination of a plan (i.e., when the employees lose the right to have future vesting service applied), not just when contributions to the plan cease. On the other hand, if this is a 457(B) plan, it would be unusual to have anything less than full vesting in any event. Are there some employees who are only partially vested? How did this arise?

That would be prohibited.

Yes. The only caveat is that with limited exceptions, a state or local governmental employer may not maintain a SIMPLE plan in the form of a 401(k) plan.

In theory, you should have been taxed when you separated from service, if you did not make an election at that time and if you had the right to take the money out at that time. On the other hand, after 5 years the IRS may not be inclined to pursue this one. In general, the statute of limitations on innocent errors on your tax return is 3 years from the date of filing or the deadline, whichever comes last. Although there may be a longer statute of limitations on "substantial understatement of income," as a practical matter the IRS is unlikely to come after you after 5 years if they haven't done so already. So it's probably in the interest of the IRS just to let you pay the tax when the money is distributed.

There would be, in theory, two ways of complying with the equal protection clause of the VT constitution. The first would be to give early distribution rights to both married couples and parties to civil unions. The second would be to deny such rights to both. It is the Internal Revenue Code's qualification rules, combined with the Defense of Marriage Act, that make the first alternative risky, and therefore in effect mandate that a plan required to comply with the VT constitution must choose the second option if it is to avoid that risk. True. Given the current state of the law, that is the only risk-free option. But it means that a governmental plan in VT is in effect prohibited from allowing an early distribution option to married couples that other governmental and private plans are permitted to allow. Not only does it not require a state that permits civil unions to treat members of such unions to the same rights as married couples, it actually puts barriers (as described above) in the way of any state that on its own wants to treat members of such unions as having the same rights as married couples. Hmm, I thought I was arguing that equal protection should go both ways. I believe that the pensions of both husbands and wives should be divisible upon a divorce. I also believe that the pensions of parties to a civil union should be divisible upon a termination of the civil union. In what respect are my "comments about the impact of the Act to married couples ... similar to the outrage I heard from divorced women after REA was enacted because their ex husbands would be entitled to their pension benefits"?

Yes, the employee would be taxed on the income, unless the other party to the civil union was a dependent within the meaning of section 152. However, this at least is an issue that can often be worked out between the parties (e.g., by giving the alternate payee less in recognition of the fact that the employee will have to pay the tax). The question is whether you can ever get to that point, i.e., will plans be so concerned about potentially jeopardizing their own qualification that they simply will not allow a distribution to an alternate payee who is a party to a civil union until the employee has a distributable event? And in Vermont, which prohibits treating parties to civil unions differently than spouses, does this mean early distribution rights must be taken away from opposite-sex spouses because they cannot be given to parties to civil unions? (And does anyone but me find it ironic that a statute called the "Defense of Marriage Act" may have the effect of taking rights away from opposite-sex married couples?)

mbozek, You are correct that the Defense of Marriage Act permits Georgia, for example, to refuse to treat a Vermont civil union (or even a Dutch same-sex marriage) as not being a marriage, thereby precluding a Georgia court from even issuing a dro with respect to such relationship. However, the issue becomes what happens in, for example, a Vermont court, where state law prohibits treatment of parties to a civil union differently than spouses and thus a court could issue a dro in favor of a party to a same-sex union. Would compliance with such an order not only create unfavorable tax consequences to the employee and/or alternate payee, but risk disqualification of the plan? As you say, the IRS may have political reasons for not aggressively disqualifying state or local plans that comply with dros in favor of parties to a civil union. However, the politics goes both ways. State and local governments often do not want to get their names in the newspapers for doing something which, even in theory, could disqualify the plan. It is my understanding, for example, that the Vermont law establishing the statewide retirement system currently prohibits distributions pursuant to a dro earlier than when the participant has a distributable event, regardless of whether the alternate payee is an opposite-sex spouse or a party to a civil union. The reasoning was that treating a party to a civil union differently than an opposite-sex spouse would violate Vermont law, while allowing an early distribution to a party to a civil union could disqualify the plan. The solution was not to allow early distributions to anyone.

If the wages of an employee of a state or local government are exempt from the Social Security portion of OASDI, 414(h)(2) contributions will indeed be exempt from Social Security, also (although, as you correctly note, they will be subject to Medicare taxes). However, there are two major limitations on the application of the exemption in section 3121(B)(7): [*]Section 3121(B)(7)(E) excludes from that exemption Most states (although not Pennsylvania) have entered into such agreements with respect to all of their employees. For a list of those which have not, see Section 1014 of the Social Security Handbook. Even those states may have entered into Section 128 agreements with respect to some of their political subdivisions.[*]Section 3121(B)(7)(F) further excludes from that exemption Treas. Reg. § 31.3121(B)(7)-2 interprets this rule to impose a requirement that employees must be covered by a retirement system that meets various minimum requirements before they can be exempt from Social Security coverage.[/list=1]Thus, the only employees of state and local government to whom section 3121(B)(7) applies are those (a) whose employment is not covered by a Section 218 agreement, and (B) who are personally covered by a retirement system meeting minimum requirements. If the employee is either (a) subject to a Section 218 agreement, or (B) covered by a retirement plan that requires section 414(h)(2) contributions, but does not meet minimum requirements under the regulation, the 414(h)(2) contributions are subject to Social Security taxes to the extent they reduce the employee's salary.For more information on OASDI coverage of state and local government employees, see http://www.ssa.gov/slge/overview.htm.

It depends. If the 414(h)(2) contributions are taken out of the employee's salary, OASDI withholding (and payment of employer taxes) is required under section 3121(v). Otherwise, it is not. Of course, this is in large part a matter of semantics. In practical terms, there is really little difference between stating the employee's salary as $100x, but then having a "salary reduction" of $5x and a corresponding employer contribution of $5x, and stating the employee's salary as $95 with a non-salary-reduction contribution of $5x. Nevertheless, the semantics have a purpose. At least in social security states, the basis for the tax is the same as the basis for the ultimate social security benefits. The idea is to make sure that if the employer is reporting only $95x as social security wages at the time OASDI taxes are due, the employee should not later, when s/he claims benefits, be able to claim that the wages were $100x.

Out of curiousity, why is the union plan considered "private" if your governmental employer contributes to it? Does it cover workers in the private sector as well as public employees? If not, union involvement should not by itself make the plan "private."

My understanding from informal conversations with the relevant IRS people is that the reason they have not set a deadline for amending 403(B) plans is that 403(B), unlike 401(a), does not require a written plan document. Thus, they do not believe that they have the authority to require an amendment to a plan document by any particular time, but can only require that the plan be operated in accordance with 403(B). In the case of a 403(B) plan subject to ERISA, the Department of Labor requires a written plan document. However, this has traditionally been interpreted in a fairly loose manner--i.e., that no amendments are required until the summary plan description is due.

kkost and mbozek, Will I spoil the fun here if I agree with both of you? It is true that a state or local retirement system has no ERISA preemption, and therefore must comply with a valid domestic relations order. On the other hand, there may be a question is whether a valid domestic relations order can be issued. In the first place, state spendthrift trust law is as much a part of state law as state domestic relations law, so it is necessary to determine whether state spendthrift trust law may preclude a state domestic relations order from being issued with respect to the plan. In the second place, many state plans are embodied in state statutes, and many local plans are adopted pursuant to state enabling legislation. If such a statute provides that the plan is not required to comply with domestic relations orders, again it is necessary to try to reconcile the laws to determine whether a valid domestic relations order can even be issued. mbozek, I agree that "The fact that the state pension benefits are included as marital assets does not automatically mean that the spouse can receive a payout of the interest upon divorce. " All I was saying is that a state pension plan can provide for a payout to a spouse upon divorce, whereas it in many instances cannot provide for a payout to a participant at that time unless the participant has had some distributable event. Thus, although many would assume that protecting pension assets from a divorcing spouse is always in the interest of the participant, in fact there are many circumstances in which attempts to "protect" pension benefits creates inflexibility for the participant as well as the spouse.

mbozek, My experience has been somewhat different from yours with regard to state plans and domestic relations orders. Most of the ones I have seen have some provision (which in many cases resembles the qualified domestic relations rules imposed on nongovernmental plans by ERISA) for honoring domestic relations orders. See, e.g., SC Code §§ 9-18-10(9), § 9-18-20(B)&©. When advising governmental plans, I typically tell them that if a state's domestic relations law is going to treat the retirement plan assets as part of the marital estate for purposes of determining each spouse's share, it is in the interest of the participant as well as the spouse to allow domestic relations orders. This is because the alternatives impose less flexibility in planning for both parties. Having the participant receive the money, and then turn it over to the spouse, pursuant to a property settlement note requires contact between often hostile parties for many years in the future. Alternative methods (e.g., giving the spouse the marital home in exchange for the participant getting the full retirement benefit) may be impractical if the retirement plan is the largest asset, and may in any event leave the participant with a full retirement benefit but very limited assets to live on currently. Finally, the spouse's withdrawal rights may in many instances be more favorable than the participant's. (A defined benefit plan, for example, cannot pay a participant before normal retirement date or severance of employment, but it can--if state law permits--pay a spouse much earlier than that.) This gives the spouses flexibility at a time when immediate cash needs (for lawyers, and to set up two separate households) may be high.

Thanks for sharing this news!

An employee has no ability to force a 457(B) plan to make a transfer from one contract to another, at least until the employee has a distributable event. Whether a transfer is possible depends on applicable state and local law, the plan document, and any documents establishing the various investment options.

Probably, at least in the case of a "plan" within the meaning of the Department of Labor regulations. The regulation states as follows: Code section 414(i) defines a defined contribution plan as follows: Although it might be argued that section 414(i) should be considered to apply only to 401(a) plans, the fact that the regulation considered it necessary to exclude simplified employee pensions (which are not 401(a) plans) suggests that any defined contribution plan (including a 403(B) plan) would be treated as a successor plan.It might be possible to argue that a salary-reduction-only 403(B) arrangement that met the DOL standards for not being considered a "plan" could therefore not be a "successor plan." However, I have not seen anything on this, although I have not specifically researched the issue. And before you say anything, I realize that this rule does not really make sense with regard to a 403(B) plan. The whole idea was that a distribution could not be made upon plan termination if there were another plan to which the money could be transferred. Money cannot be transferred in-service from a 401(k) plan to a 403(B) plan. But I think that the statute by its terms would treat a 403(B) plan as a successor plan.

This has been one of the most common misconceptions about the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), the 2001 pension legislation. EGTRRA allows rollovers from 403(B) plans to 401(k) plans. However, a rollover requires a distributable event (e.g., severance of employment). EGTRRA allows transfers of amounts from a 403(B) plan to a 401(a) plan (a) only if the receiving plan is a defined benefit plan (i.e., a 401(k) plan would not be an acceptable receiving plan), and (B) only for the purchase of service credit (rather narrowly defined under the statute). Thus, EGTRRA does not, contrary to what many believe, allow for a 403(B) plan to simply be converted into a 401(k) plan.

The National Council on Teacher Retirement ("NCTR") surveyed state retirement systems that serve teachers and found that 36 out of 50 use a prudence rule that is modeled on the ERISA standard. However, I would suspect that the proportion of locally run 403(B) plans that are subject to the ERISA standard is much lower. Such plans often seem to fall into a gap between trust law (which does not apply to them, because they are not structured as trusts) and state pensions law (which may not cover plans of localities at all, or may cover localities only as to their 401(a) plans).

STLGiant, Although the fiduciary standards of ERISA are often "cut and pasted" into state statutes, the penalties for violating those standards are provided by state law, not ERISA. Thus, whether an employee-participant can sue the district in State court successfully would be determined under state law. In some instances, the answer would be yes. In others, the state law might provide different penalties, or might provide governmental immunity to the district. (But see the Walker case, in which governmental immunity was held not to apply to a collectively bargained governmental plan.)

Section 403(B)(12) is not empty. It provides the nondiscrimination rules for 403(B) plans, and includes the following language: Thus, state and local governmental plans have a statutory exemption from the nondiscrimination rules of Code section 403(B)(12)(i).Governmental plans other than state and local governmental plans do not currently have a statutory exemption from nondiscrimination rules. However, they have been provided with an administrative exemption under Notice 2001-46. The exemption states as follows: Thus, if no further action is taken, governmental plans other than state and local governmental plans will become subject to 403(B)(12)(i) upon the expiration of the period described in the notice.The one exception would be with respect to the nondiscriminatory coverage rules of section 410(B), as incorporated by reference in section 403(B)(12)(i). Under section 410©, all 401(a) governmental plans (not just state and local governmental plans) are exempt from section 410(B). To the extent that section 403(B) requires that 403(B) plans comply with it would appear that a governmental 403(B) plan (which would not be subject to 410(B) even if it were described in section 401(a)) should not be subject to 410©-type requirements.

State and local governments will still be exempt from nondiscrimination rules (other than the universal coverage rule for salary reduction 403(B) contributions) after 2003. Thus, this issue would apply only for purposes of other types of governmental plans (e.g., a school run by the federal government). And I suspect that before 2003, there will be technical corrections legislation that will eliminate the nondiscrimination rules for all governmental plans.

mjb, Actually, there is now one country (the Netherlands) that does not have a separate civil unions statute, but simply allows same-sex couples to marry. Nevertheless, under the Defense of Marriage Act, such marriages are not recognized for ERISA or Internal Revenue Code purposes. The Vermont statute is a hybrid. Although a Vermont civil union is not a marriage, the Vermont statute provides that Nevertheless, a same-sex spouse is not treated as a spouse for ERISA or Code purposes, due to the Defense of Marriage Act. Even if a state were to allow same-sex couples to marry, such persons would not be treated as married for ERISA or Code purposes.Also, a domestic relations order applicable to a governmental plan need not meet the requirements for being a QDRO in order to be treated as a QDRO for purposes of taxing the participant and the alternate payee. Any domestic relations order applicable to a governmental plan is treated as though it were a QDRO for this purpose. Code section 414(p). My concern is not just with regard to the tax effects on individuals. Because my clients are all either employers or plans, I am particularly concerned about the effect on plan qualification. For example, a pension plan is not allowed to distribute benefits until the earlier of retirement or separation from service. A QDRO (in the case of a private plan) or any domestic relations order (in the case of a governmental plan) is an exception to this rule. However, if an order in favor of a domestic partner is not even a domestic relations order, does an otherwise qualified governmental pension plan jeopardize its qualified status by distributing benefits in compliance with it before the participant attains normal retirement date or separates from service? Incidentally, health coverage to a domestic partner is not taxable if the domestic partner is a dependent of the employee. Similarly, an order in favor of a domestic partner is a domestic relations order, and may even be a QDRO, if the domestic partner is a dependent of the employee. However, the definition of dependency requires, among other things, that (a) the domestic partner is financially dependent on the employee, and (B) the relationship is not in violation of local law. It does not cover a situation in which the employee has not provided at least 50% of the domestic partner's support. This contrasts with health coverage of a spouse, which is nontaxable even if the spouse does not qualify as a dependent, or a domestic relations order in favor of a spouse, which is permissible even if the spouse does not qualify as a dependent.

Just a bit of background on the possible exemption of governmental plans other than plans of state and local governments. The provision that would have exempted all governmental plans was in both the House and Senate versions of EGTRRA. There was no meaningful opposition to it in either the House or Senate. The reason that it was dropped is that a technical objection was made that a revenue bill (which EGTRRA was) could not include provisions, such as this one, that did not affect revenues. However, given that the provision is considered noncontroversial, IRS and the Treasury Department have been delaying the effective date of nondiscrimination rules for all governmental plans. Informal statements by relevant employees have suggested that these delays are based on the belief that the issue may well be made moot by future legislation.

It depends on (a) applicable state or local law, and (B) the plan language. 457s may, but are not required to, offer such options under federal law.