Salary Deferrals allowed in 457(f)?

[mariemonroe]

I know that salary deferrals are generally not subject to a substantial risk of forfeiture such that a 457(f) plan cannot provide for salary deferrals. However, what if the plan provides that the employer will make matching contributions on the salary deferrals? Does this sound like it will work?

[J Simmons]

As I understand it, for 457f to apply, the employee's rights to the compensation must be conditioned on the future performance of substantial services by the employee. IRC § 457(f)(3)(A).

Under state payroll laws, once compensation is earned and becomes payable, then it must be paid and not be so conditioned.

Ergo, you cannot have salary reductions under 457f.

However, matching contributions made by the employer could be conditioned on the future performance of substantial services by the employee if that condition is imposed before the salary reductions are elected.

[mariemonroe]

I am looking at Notice 2007-62 which states:

"The Service and Treasury anticipate that upcoming guidance under § 457(f) will generally adopt the rules relating to substantial risk of forfeiture that are contained in § 1.409A-1(d)...

Section 1.409A-1(d)(1) provides that an amount is not considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compensation, unless the present value of the amount made subject to a risk of forfeiture is materially greater than the present value of the amount the recipient otherwise could have elected to receive absent such risk of forfeiture. This is because, absent tax considerations, a rational participant normally would not agree to subject a right to amounts that may be earned and payable as current compensation, such as salary payments, to a condition that subjects the right to the same payments to a real possibility of forfeiture. Accordingly, in this situation, agreement to subject the amount to a substantial risk of forfeiture indicates that the recipient of the compensation is confident that there is not a real risk of forfeiture and is only subjecting the amount to the purported risk of forfeiture as a means of avoiding taxation. Thus, amounts that an individual could have elected to receive under a salary deferral election generally cannot be made subject to a substantial risk of forfeiture under the rules of § 409A beyond the date or time the salary would otherwise have been received."

If a participant defers salary and the employer provides a generous match, does anyone think that both the salary deferral and match could be subject to a substantial risk of forfeiture?

[J Simmons]

In your scenario, would the EE's right to the salary reduction be subjected to performing substantial future services? That would seem to yet be the test until the IRS in fact might infuse into 457f the 409A standard.

Even after that, are you saying that the promise of matching contributions would be sufficient to entice a rational EE to subject his immediate right to part of his salary to a substantial risk of non-payment in the future so that tax deferral is not the only motive and belying that the EE thinks there is a real risk of forfeiture?

What would be the risk you are thinking of imposing?

[Guest mjb]

As I understand it, for 457f to apply, the employee's rights to the compensation must be conditioned on the future performance of substantial services by the employee. IRC § 457(f)(3)(A).

Under state payroll laws, once compensation is earned and becomes payable, then it must be paid and not be so conditioned.

Ergo, you cannot have salary reductions under 457f.

That is not correct in all states. There is case law in NY and NJ (Rosen v. SmithBarney 2008WL 2521253 NJ) which permits forfeiture of employee contributions to a NQDC plan (IRC 83) without violating state labor laws.

While it permittted under state labor laws it makes no sense for an employee to put their own money at risk in a NQDC where the funds are subject to a substanial risk of forfeiture which can be determined by he employer.

That

[mariemonroe]

The salary deferrals and employer matching contributions would be subject to a SROF in the form of a vesting date - i.e. the participant would chose a distribution date and would have to be employed on that date in order to be entitled to receive distribution of his or her account. If participant's employment terminated before that date, the participant would forfeit his or her account.

[GBurns]

Assuming that your state labor laws allow forfeiture or earned wages etc, mjb's question still begs an answer. Why would an employee agree to have this done to them ?

And to that, I add, Why would an employer need to do this to its employees ?

[mariemonroe]

Assuming that your state labor laws allow forfeiture or earned wages etc, mjb's question still begs an answer. Why would an employee agree to have this done to them ?

And to that, I add, Why would an employer need to do this to its employees ?

An employee may agree to defer $10,000 of salary to a future year if the employer promised to match it 50 cents on the dollar. For instance, an employee would choose to take $10,000 now or take the chance that the employee will continue to work until some vesting date and receive $15,000 later.

An employer may want to provide this opportunity to its employees as a deferral opportunity in addition to 401(k) and 403(b) plans.

[GBurns]

I do not see any opportunity for the employee.

I cannot imagine any employee risking $10,000 or any substantial amount in this unnecessary manner. The deferral would be subject to forfeiture for any number of reasons entirely beyond his/her control.

The employer could fund a SERP or other NQDC plan without needing an employee contribution. The only purpose that I see, for an employer, is the hope of collecting the forfeitures by being able to terminate employment before the employee is vested enough.

Either I misunderstand or this really smells.

[TLGeer]

I agree that the structure you propose fits within the literal terms of the cited regulation. The last sentence of that subsection provides the model supporting imposing vesting on both the salary reduction and the match.

Whether the IRS would agree is more problematic, although they should do so. I would recommend an opinion of counsel or a PLR from the IRS, if the money is large enough, and avoiding the risk if the money involved is too small.