Consequences of 457(f) plan failing top hat criteria

[Christine Roberts]

Quasi-governmental employer establishes "ineligible" deferred compensation plan under 457(f) for a limited number of executives and department heads. Plan assets are to be held in a rabbi trust. If it turns out that the participants are too numerous to satisfy "top-hat" criteria, is the plan now a 457(B) plan subject to trust requirements ?

And would plan assets be subject to tax for lack of an adequate trust?

[QDROphile]

If the employer is a government or an instrumentality of a government, the plan is a governmental plan and the top-hat inquiry is inapplicable because it is solely an ERISA concern. You need to settle the question of plan status first. "Quasi-governmental" has no bearing except as a clue that you might have a governmental plan.

[Christine Roberts]

The employer entity is a creature of state statute but has some powers of self-governance; i.e. is an agency or instrumentality of the state. I used "quasi-governmental" intending it to be included within the definition of a governmental entity. Perhaps a poor choice of words.

[Carol V. Calhoun]

If it is an agency or instrumentality of the state, the "top hat" analysis doesn't apply. The "top hat" rules are used to determine whether a plan is subject to ERISA, and a governmental plan isn't subject to ERISA regardless of whether it is "top hat."

[Christine Roberts]

Then if I understand clearly, the practice of limiting participation in an ineligible 457 plan to a "top-hat" group, where the plan sponsor is a governmental entity, merely reflects a design choice on who to include in the plan, and does not have any other purpose (such as the ERISA exemption applicable for a private entity). I.e., the plan would be equally ERISA exempt if participation were not limited to a top-hat group.

[Carol V. Calhoun]

Christine, you are correct.

[Christine Roberts]

So is there anything stopping a governmental entity from establishing a trust that is tax-qualified under IRC 401(a), in connection with a deferred compensation plan limited to a "top-hat" group; i.e., the plan would not need to be extended to non-top-hat employees?

[Carol V. Calhoun]

Are you talking about a 457(B) plan for the top-hat group, plus a 401(a) for the rank and file employees, or about funding a 457(B) plan through a 401(a) trust?

You could definitely have a 457(B) plan limited to a top-hat group, plus a 401(a) plan for all employees, assuming that nothing in applicable state or local law prohibited it.

A governmental 457(B) plan can be funded through a trust, but it's typically a 457(g) trust, not a 401(a) trust. In theory, you could set up a group trust under Rev. Rul. 81-100 that would be a 401(a) trust, and that would in turn hold moneys of a 457(g) trust as permitted by Code section 401(a)(25). However, the second layer of trust is useful only in certain limited investment situations.

Finally, because 401(a) plan of a state or local government is not subject to nondiscrimination rules (see section 401(a)(5)(G)), you could in theory set up a 401(a) plan only for a top hat group, or that had special benefits for a top hat group. However, this is a very sensitive issue among governmental plans. Congress gave the 401(a)(5)(G) exemption because it was convinced that political pressures would make it unlikely that a governmental plan would in fact seriously discriminate in favor of the top paid employees. Many governmental plans are concerned that if 401(a) plans for top hat groups became wide-spread, Congress would repeal the exemption.

[Christine Roberts]

Thank you for the further input. Is there a Blue Book citation or other reference to the Congressional record addressing the intentions behind the 401(a)(5)(G) exemption?

[Carol V. Calhoun]

I think that there is discussion of this in the legislative history. However, I'm afraid I don't have an exact citation for you. Does anyone else?