414(h) - Contribute PTO bank at retirement?

[OldAsERISA]

A municipality wants to set up a DC plan under which retiring employees can defer their accumulated PTO bank when they retire.  The municipality has been told (not by me) that it can set up a 401(a) defined contribution plan for this purpose.  The leave bank will be the only source of contributions to the plan (no amounts other than the PTO bank contributed by the municipality or the employees).  Employees won't be required to contribute their leave bank, they will also have the option to receive a payout at retirement in a (taxable) lump sum.

I can't fit this situation under any of the PLR's, and am concerned this this is really an impermissible "cash or deferred election."  Any thoughts?  Has anyone seen this type of set-up before?  What if I drafted the plan so that employees were required to defer their leave bank at retirement (i.e., try to turn the leave bank into a "mandatory contribution")

I am aware that these amounts can be deferred under a 457(b) plan - but some employees have leave banks that are much larger than the annual limit under 457(b).

[Carol V. Calhoun]

The usual way this is done is to provide that at retirement, all unused leave goes into the plan; employees have no election to take it in cash. However, you then provide that the retired employee can take a lump sum distribution of the amount at any time. This has pretty much the same effect as allowing them an election unless they are so young they would face the 10% penalty for early distributions. 

[CuseFan]

Agreed, otherwise it is a CODA and you must comply with the 402(g) limits.

[Carol V. Calhoun]

It's not just the 402(g) limits.  A municipality is not permitted to have 401(k) plan at all, unless it (or an entity considered part of its control group) had a 401(k) plan before May 6, 1986.  So if the employee were given the option to take the amount in cash,  the entire amount would be taxable to the employee even if they elected to contribute it to the plan, and the 402(g) limits would be irrelevant.

[OldAsERISA]

Thanks to all for their insight here - very helpful!

[OldAsERISA]

Would it be permissible to draft the plan so that only employees who are age 55 are eligible to participate?  It would eliminate the possibility of a 10% early withdrawal penalty applying to employees taking an immediate distribution.