Can a participant’s governmental § 457(b) account be taken for restitution to the employer the participant stole from?

Imagine this situation: A government employee makes elective salary-reduction contributions under a § 457(b) plan. The plan receives only salary-reduction contributions. Later, the employee is found to have stolen from his employer. In the criminal case’s plea agreement (for a reduced sentence), the defendant agrees to pay restitution to his former employer.

Trying to get money for himself with no setoff or pay-over to his former employer, the participant asserts that the § 457(b) plan must not deny him his distribution because to do so would be contrary to the plan’s exclusive-benefit provision. (Assume the plan’s provision is no more than § 457(g)(1) requires for the plan to § 457(b)-eligible.)

Has anyone worked on or observed a situation like this?

How do you think the exclusive-benefit issue should sort out?

Did the defendant steal plan monies or other, unrelated employer property? What do the plan rules have to say about benefit forfeiture, or eligibility to participate, or disqualifying events? Has any of the benefit been assigned in a QDRO?

A naked exclusive-benefit rule does seem to weigh in favor of the defendant's argument, and a legal status as as a defendant agreeing to pay restitution for a wrongful act doesn't seem to change that. However, assuming a distribution made, the distribution then becomes an item in the defendant's attachable asset landscape -- because once distributed, that money is immediately subject to attachment. A creative prosecution can attach those funds when distributed faster than the defendant can blink. Even if the defendant doesn't survive his shame (snark caveat), his estate can be sued if enough money is at stake to make it worth the effort.

I had a client who was a former spouse under a FERS order make a claim sounding in equity several years ago when the employee lost his FERS benefit by operation of 5 U.S.C. § 8312. In that case, 5 years post-decree the employee was discovered having done some very bad things, for which he forfeited his pension, and my former client having moved by then, made a claim for her portion with counsel in another state, which was partially denied. I learned about it in a holiday greeting card last year from one of her children, who wrote to inform me she died of covid. Life has a way of not being fair.

blguest, thank you.

The participant stole money (not other property) from the employer that maintains the governmental § 457(b) plan.

The plan’s exclusive-benefit provision states: “The Plan is established for the exclusive benefit of Participants and their Beneficiaries.  All assets and income of the Plan must be held for the exclusive benefit of the Plan’s Participants and their Beneficiaries.  Any amount, property, or right held under the Plan will not be used for or diverted to any purpose other than for the exclusive benefit of Participants and Beneficiaries, except as otherwise permitted under IRC § 457(g)(1).”

Another provision, captioned Forfeiture, states: “To the extent not precluded by [the exclusive-benefit provision], if a Participant pleads guilty or is convicted of a crime or offense relating to his or her government office or government employment and an Order provides for restitution relating to such crime or offense, the Participant (or, after the Participant’s death, each Beneficiary)—if he or she has not paid promptly the restitution that the Order requires—forfeits his, her, or its Benefit and Deferred Compensation to the extent needed to meet the restitution not paid.”

The plan has no provision for making a surviving spouse a beneficiary other than as the participant designated. The plan has no provision for recognizing a domestic-relations order.

No distribution has yet been made or approved. If it were not for considering a potential forfeiture to pay the unpaid restitution, the participant would be entitled as he is severed from employment.

One reasoning urged is that paying restitution is for the participant’s benefit because it relieves him of an obligation.

IRS General Counsel Memorandum 39267 (March 21, 1984) (“The exclusive benefit rule of section 401(a)(2) by its terms is designed to prohibit the use of plan assets for the benefit of anyone other than the employees and their beneficiaries. In this case the amounts in question are assigned to pay debts of a retired employee. It would be difficult to argue that such payments were not for the benefit of that employee or that such payments prejudiced the benefits to be received by other beneficiaries.”), http://www.legalbitstream.com/scripts/isyswebext.dll?op=get&uri=/isysquery/irlb6a5/1/doc; IRS Letter Ruling 84-26-124 (March 30, 1984) (“The repayment of debts for an employee is for the economic benefit of an employee since it relieves him of a liability.”), http://www.legalbitstream.com/scripts/isyswebext.dll?op=get&uri=/isysquery/irlb6b1/1/doc

But a fact in that 1984 interpretation is that each debtor assented to a voluntary repayment plan under a chapter 13 bankruptcy. Some might reason that the plea agreement is voluntary. Others might reason that the plea agreement is somewhat less voluntary than the facts that persuaded the IRS in 1984.

Does anyone know about other IRS interpretations one might use to reason through what the exclusive-benefit rule allows or precludes?

This PLR discusses the exclusive benefit question under a writ of garnishment following a criminal conviction -- not exactly your situation, but close:

https://www.irs.gov/pub/irs-wd/0426027.pdf

Thank you for this nice help.

It confirms that in 2004 the IRS treated its 1984 interpretation as still good law.

It is closer to my situation than the 1984 ruling because the 2004 ruling’s case 3 is about an individual-account (defined-contribution) plan, and found that the plan could pay the creditor rather than the participant when the participant severs from employment or reaches age 59½.

And the 2004 ruling is a little stronger than the 1984 ruling because in 2004 the IRS allowed the payments to creditors despite the plan’s § 401(a)(13) anti-alienation provision. (A governmental § 457(b) plan need not state such a provision.)

Do any of our governmental-plans mavens have more experience to add?

Peter is the plan organized for a federal entity, or is the defendant charged under federal law? If so, would 18 USC 3613(c) help?

Peter, I've done a fair amount of research into exclusive benefit for governmental plans, although not in the area of garnishment. I don't think the IRS has opined a lot on the issue generally. The regs seem clear enough and don't come at the issue so much from the point of view of "you have to do everything you can to support the participant," but more from the technical angle that you simply can't spend plan assets on anything other than benefits and administration. I think that helps because arguably paying a debt of the participant is paying a benefit.

In the case of garnishment there's an interesting twist because 401(a)(13) does not apply to governmental plans so they are not required to have an anti-alienation provision, although some do and presumably those that do should be interpreted under state law. So your participant here is grasping at exclusive benefit where if he or she were in a private plan they would be pointing to anti-alienation.

As demonstrated by the PLR cited by Lois Baker, the IRS and courts have seemed to give broad leeway to MVRA where a federal crime is implicated. All the cases I recall have allowed the garnishment on the basis that MVRA is a federal law and shows a strong public policy for victims' restitution.

The last article in this issue of the NAPPA newsletter may help: https://www.reinhartlaw.com/wp-content/uploads/2019/05/Johnson_NAPPAReport_April-2019.pdf

I wrote my Wednesday and Thursday posts when I had only someone’s oral description of assumed facts, not yet the courts’ records.

The State’s criminal prosecution is scheduled for a trial.

The Federal criminal prosecution resulted in a plea agreement. That agreement recognizes restitution, debts, and other obligations the United States might collect under 18 U.S.C. §§ 3316, 3556, 3663, 3663A, including the Mandatory Victims Restitution Act of 1996; the Internal Revenue Code of 1986; and 28 U.S.C. §§ 3001-3308 (Federal Debt Collection Procedures Act of 1990).

As Lois Baker, blguest, and Luke Bailey point to, the IRS’s and some courts’ interpretations treat an involuntary transfer to meet those debts to the United States as for the participant’s benefit.

This situation is unlikely to reach the question of whether restitution ordered only under State law gets a similar tolerance in interpreting and applying the exclusive-benefit provision. (The participant’s debts under the Federal court’s order vastly exceed his § 457(b) balance.)

Luke Bailey, thank you for the NAPPA article.

Not sure any of this will be helpful, but I did come across a few cases where the parties tried to avoid criminal restitution by having a QDRO entered in order to transfer the retirement assets of the criminal defendant to his spouse.  See the attached Memo.  

See also attached DoL ESBA 1999 Advisory Opinion 13A. 

David

Advisory Opinion 1999-13A _ U.S. Department of Labor.pdf Restitution.pdf

Peter--I was involved as an expert witness in a regional case that achieved some notoriety several years ago that involved not only NQDC plans, but qualified plans as well.

Since then, we have been adding "bad boy" clauses to all of our 457(b) documents, and our Annual Incentive participant agreements also---

Turns out in the early 90s two different DC office clients' former employees had the chutzpah to steal from their employer, be fired , and then sue

for the bonus they felt they earned for the previous year. It's obviously hindsight here, but protection is the best measure.

fmsinc, thank you for the information about how some might assert a spouse’s rights to evade a restitution obligation.

This seems unlikely in the situation I described. The plan has no provision for recognizing a domestic-relations order. Further, even an attempt might be thwarted because an action for a divorce of the participant’s marriage or another domestic-relations order would be heard in the same court in which the State’s criminal case proceeds, and at least three subsets of the State’s attorneys general are tracking proceedings.

Bob the Swimmer, thank you for your observation about what one might accomplish with careful attention to the text of the plan’s governing document. This plan includes an express forfeiture provision. It’s a variation on clauses I’ve been using since the 1980s.

My question for this discussion arose because that provision—following how I revised it in 1996, when Congress added IRC § 457(g)—states an exception for a forfeiture that would contravene the plan’s exclusive-benefit provision, which follows IRC § 457(g)(1).

Thank you, everyone, for helping me on a question of law (the one I anticipated before I got the fuller facts) that has not seen as many published interpretations as other points we work on.

Peter:  I found it, at least some of it.  The case I mentioned was a 1999 case filed in the US District Court for the District of Maryland (Baltimore),  Bowersox v. Bell Atlantic, No. 99-cv-176-CCB.  The docket entries are attached.  I don't have access to Pacer so this is about as far as I can go.  

I realize the law may have changed in 23 years, but my recollection of the case is that the Plaintiff had either stolen or embezzled or maybe even negligent caused a loss and Bell Atlantic tried to access her 401(k) Plan as self help restitution.  My files from those days are long gone and I cannot identify a memo of points and authorities from the docket entries. 

Hopefully you have somebody who practices in the Federal system to can access Pacer.  Let me know if you find anything. 

David 

Bowersox Docket Entries.pdf

Peter:  Think I found what I was looking for.  See attached.  Bowersox v. Bell Atlantic.pdf

I have not had another case like it since 1999 so I cannot account for changes in the law in the past 23 years, but perhaps there is something there that can help you.   Bowersox v. Bell Atlantic.pdf

David

Thank you for the further information.