Reg-105885-99

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
the attendance list for the hearing,
please contact LaNita Van Dyke at (202)
622–7180 (not a toll-free number).
SUPPLEMENTARY INFORMATION:

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG–105885–99]
RIN 1545–AX52

Compensation Deferred Under Eligible
Deferred Compensation Plans
AGENCY: Internal Revenue Service (IRS),
Treasury.
ACTION: Notice of proposed rulemaking
and notice of public hearing.
SUMMARY: This document contains
proposed regulations that would
provide guidance on compensation
deferred under eligible section 457(b)
deferred compensation plans of state
and local governmental and tax-exempt
entities. The regulations reflect the
changes made to section 457 by the Tax
Reform Act of 1986, the Small Business
Job Protection Act of 1996, the Taxpayer
Relief Act of 1997, the Economic
Growth and Tax Relief Reconciliation
Act of 2001, the Job Creation and
Worker Assistance Act of 2002, and
other legislation. The regulations would
also make various technical changes and
clarifications to the existing final
regulations on many discrete issues.
These regulations provide the public
with guidance necessary to comply with
the law and will affect plan sponsors,
administrators, participants, and
beneficiaries. The document also
provides a notice of public hearing on
these proposed regulations.
DATES: Written and electronic comments
must be received by August 6, 2002.
Requests to speak and outlines of topics
to be discussed at the public hearing
scheduled for August 28, 2002, must be
received no later than August 7, 2002.
ADDRESSES: Send submissions to
CC:ITA:RU (REG–105885–99), room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand
delivered between the hours of 8 a.m.
and 5 p.m. to CC:ITA:RU (REG–105885–
99), Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue NW.,
Washington, DC. Alternatively,
taxpayers may submit comments
electronically directly to the IRS
Internet site at www.irs.gov/regs. The
public hearing will be held in the IRS
Auditorium, Internal Revenue Building,
1111 Constitution Avenue, NW.,
Washington, DC.
FOR FURTHER INFORMATION CONTACT:
Concerning the regulations, please
contact Cheryl Press, (202) 622–6060
(not a toll-free number). To be placed on

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Paperwork Reduction Act
The collection of information in this
notice of proposed rulemaking has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) under control number
1545–1580.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a valid control
number assigned by the Office of
Management and Budget.
Books or records relating to the
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
On September 23, 1982, final
regulations (TD 7836) under section 457
of the Internal Revenue Code of 1954
(Code) were published in the Federal
Register (47 FR 42335) (September 27,
1982) (final regulations). The final
regulations provide guidance for
complying with the changes to the
applicable tax law made by the Revenue
Act of 1978 (92 Stat. 2779) relating to
deferred compensation plans
maintained by state and local
governments and rural electric
cooperatives. These proposed
regulations would amend the final
regulations to conform them to the
many amendments made to section 457
by subsequent legislation, including
section 1107 of the Tax Reform Act of
1986 (TRA ’86) (100 Stat. 2494), section
1404 of the Small Business Job
Protection Act of 1996 (SBJPA) (110
Stat. 1755) (1996), section 1071 of the
Taxpayer Relief Act of 1997 (TRA ’97)
(111 Stat. 788) (1997), sections 615, 631,
632, 634, 635, 641, 647, 649, and other
sections of the Economic Growth and
Tax Relief Reconciliation Act of 2001
(EGTRRA) (115 Stat. 38) (2001), and
paragraphs (o)(8) and (p)(5) of section
411 of the Job Creation and Worker
Assistance Act of 2002 (116 Stat. 21)
(2002). These proposed regulations
would also amend the final regulations
to provide additional guidance on
section 457 issues raised since the final
regulations were published in 1982.
This document also incorporates the
guidance provided in Notice 98–8
(1998–1 C.B. 355), with respect to

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amendments made to section 457 by the
SBJPA and TRA ’97, including the
section 457(g) trust requirement for
eligible plans of state and local
governments (eligible governmental
plans).
Explanation of Provisions
Overview
The proposed regulations would
provide broad guidance regarding the
rules applicable to eligible deferred
compensation plans described in
section 457(b) (eligible plans) and, in
particular, provide clear standards for
the administration and operation of
eligible plans. The proposed regulations
would amend the existing final
regulations to update them for changes
in the law, including the many changes
made by EGTRRA, and respond to the
comments and inquiries received from
state and local governments and taxexempt employers that sponsor eligible
plans, from participants and
beneficiaries, and from service
providers and other advisors.
The proposed regulations at §§ 1.457–
1 through 1.457–3 include a general
overview of section 457, as applicable to
both eligible plans and ineligible plans
that are subject to section 457(f), and
general definitional provisions. Specific
rules applicable to eligible plans are
contained in proposed §§ 1.457–4
through 1.457–10, while rules
applicable to those deferred
compensation plans that fail to satisfy
the requirements applicable to eligible
plans (ineligible plans) are contained in
proposed § 1.457–11.
1. General Provisions and Establishment
of Eligible Plans
Section 457, as amended by TRA ’86,
applies to tax-exempt employers as well
as to state and local governments.
Eligible employers may maintain
eligible plans, which must satisfy the
requirements of section 457(b) in both
form and operation, or may maintain
ineligible plans. Benefits under eligible
plans are excludable from income of
plan participants until paid, in the case
of an eligible governmental plan, or, in
the case of an eligible plan of a taxexempt employer, until paid or made
available. Benefits under ineligible
plans are, under section 457(f),
includible in income when deferred or,
if later, when rights to the benefits are
not subject to a substantial risk of
forfeiture. Certain types of plans of state
and local government and tax-exempt
entities are not subject to section 457.
These types are listed in the definition
of plan in proposed § 1.457–2.

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
The proposed regulations make clear
that the requirements of section 457(b)
for eligible plans apply to both elective
contributions and to other types of
contributions, such as mandatory
contributions, nonelective employer
contributions, and employer matching
contributions. Thus, for example,
proposed § 1.457–2(b) defines annual
deferrals to include both elective salary
reduction contributions and nonelective
employer contributions. Annual
deferrals also include compensation
deferred under eligible plans that are
defined benefit plans.
An eligible plan must satisfy the
requirements of section 457(b) and
related provisions both in form and in
operation. Under the proposed
regulations, an eligible plan must be
established in writing, must include all
of the material terms for benefits under
the plan, and must be operated in
compliance with the requirements
reflected in the regulations. Of course,
plan sponsors retain flexibility in
determining whether to provide certain
design options permitted under section
457. For example, although these
proposed regulations permit certain inservice distributions of smaller account
balances in accordance with section
457(e)(9), an eligible plan is not
required to offer participants this
distribution option. However, any
optional features incorporated into an
eligible plan must meet the
requirements of section 457 and the
regulations in both form and operation.
All amounts deferred under an
eligible governmental plan are required
to be set aside in a trust, custodial
account, or annuity contract for the
exclusive benefit of participants and
their beneficiaries. However, under
section 457(b)(6), all amounts deferred
under an eligible plan of a tax-exempt
employer are required to be unfunded.
This requirement for an eligible plan of
a tax-exempt employer does not alter
any provision of Title I of the Employee
Retirement Income Security Act of 1974
(ERISA). Accordingly, an eligible plan
of a tax-exempt employer may be
subject to certain of the requirements of
Title I. In the case of an eligible plan of
a tax-exempt employer that is subject to
Title I of ERISA, compliance with the
exclusive purpose, trust, funding, and
certain other rules will cause the plan
to fail to satisfy section 457(b)(6). See
Q&A–25 of Notice 87–13 (1987–1 C.B.
432).
The proposed regulations include
certain basic rules regarding the taxation
of contributions and benefits under
ineligible plans, especially the
relationship between deferred
compensation under an ineligible plan

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and property transfers to which section
83 applies, but are not intended to
provide complete or comprehensive
guidance under section 457(f).
Similarly, the proposed regulations refer
to, but do not provide specific guidance
on, certain arrangements that are not
treated as plans providing deferred
compensation, such as bona fide
severance pay plans described in
section 457(e)(11).
2. Annual Deferrals, Deferral
Limitations, and Deferral Agreements
Under Eligible Plans
a. Annual Deferrals
Proposed § 1.457–4 sets forth rules
regarding deferrals under eligible plans
under section 457(b). The proposed
regulations would expand the rules
contained in the final regulations.
Examples have been included in order
to illustrate the application of the rules
to specific circumstances and to address
common questions and situations
encountered in the administration of
eligible plans.
The proposed regulations use the term
annual deferrals to describe all amounts
contributed or deferred under an
eligible plan, whether by voluntary
salary reduction contribution or by
other employer contribution, and all
earnings thereon. If, as is typical,
amounts contributed to the eligible plan
are fully vested, the total of amounts
contributed to the eligible plan during a
taxable year is the same as the total of
the annual deferrals for the taxable year.
The proposed regulations would also
clarify that the rules concerning
agreements for deferrals operate on a
cash basis. Thus, under proposed
§ 1.457–4(b), an agreement to defer
compensation is valid if it is made
before the first day of the month in
which compensation is paid or made
available. In general, there is no
requirement that the agreement be
entered into prior to the time the
services giving rise to the compensation
are performed. However, compensation
payable in the first month of
employment may be deferred only if an
agreement is entered into prior to the
time a participant performs services for
the employer. The proposed regulations
provide explicitly that nonelective
employer contributions are treated as
being made under a valid agreement. In
addition, Rev. Rul. 2000–33 (2000–2
C.B. 142), provides guidance concerning
automatic enrollment under eligible
plans. Contributions made under an
automatic enrollment arrangement
described in that Revenue Ruling may
be treated as made under a valid
agreement.

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b. Deferral Limitations
The proposed regulations under
§ 1.457–4 explain the annual limits that
apply to annual deferrals under eligible
plans. These contribution limits are
sometimes referred to as ‘‘plan
ceilings.’’ Generally, the basic annual
limit or plan ceiling for a year cannot
exceed a specified dollar amount for the
year or, if less, 100 percent of a
participant’s ‘‘includible
compensation.’’ Under EGTRRA, the
dollar amount is $11,000 for 2002;
$12,000 for 2003; $13,000 for 2004;
$14,000 for 2005; and $15,000 for 2006
and thereafter. After 2006, the $15,000
amount is adjusted for cost-of-living. As
a result of the enactment of the Job
Creation and Worker Assistance Act of
2002, Public Law 107–147 (116 Stat. 21)
on March 9, 2002, the calculation of
includible compensation is no longer
reduced by the exclusions from gross
income under sections 402(g), 125,
132(f), and 457. Thus, for years
beginning after December 31, 2001,
includible compensation is no longer
reduced by elective deferrals to an
eligible plan. If a participant’s
includible compensation is less than the
applicable dollar limit, the dollar
amount equal to 100 percent of
includible compensation is the basic
annual limit for the participant.
An eligible plan may also permit
certain ‘‘catch-up’’ contributions. First,
in accordance with section 414(v) as
added to the Code by EGTRRA, a plan
may allow a participant who attains age
50 by the end of the year to elect to have
an additional deferral for the year. The
additional amount permitted under this
age 50 catch-up is $1,000 for 2002,
$2,000 for 2003, $3,000 for 2004, $4,000
for 2005, and $5,000 for 2006. Proposed
regulations (REG–142490–01) under
section 414(v) were published in the
Federal Register on October 23, 2001
(66 FR 53555) as § 1.414(v)–1.
Second, an eligible plan may permit
a larger catch-up amount in the last
three years ending before the participant
attains normal retirement age. The
amount of this special section 457
catch-up is two times the basic annual
limit (e.g., an additional $15,000 for
2006), but only to the extent the
participant has not previously deferred
the maximum amount under an eligible
plan or similar tax-deferred retirement
plan (called the underutilized amount
or underutilized limitation in the
proposed regulations). Alternatively, the
age 50 catch-up is available in the last
three years ending before the participant
attains normal retirement age if the age
50 catch-up amount is larger than the
special section 457 catch-up amount.

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules

Under the proposed regulations, a
participant may not elect to have the
special section 457 catch-up apply more
than once, unless the participant is
covered by a plan of another employer.
If a participant also or later participates
in an eligible plan of a different
employer and otherwise meets the
requirements for limited catch-up, the
participant may elect under the new
plan to have the special section 457
catch-up apply.
For purposes of the special section
457 catch-up, the proposed regulations
provide that the plan must designate a
normal retirement age between the age
at which participants have the right to
receive immediate retirement benefits
under the basic pension plan of the state
or tax-exempt entity without actuarial or
similar reduction and age 701⁄2.
Alternatively, a plan may provide that a
participant is allowed to designate a
normal retirement age within these ages.
The proposed regulations provide a
special rule for defining normal
retirement age in eligible plans of
qualified police or firefighters as
defined under section 415(b)(2)(H)(ii)(I),
taking into account that these
participants are often eligible for
retirement at a younger age than other
workers.
The proposed regulations require an
eligible plan to set forth the plan’s
normal retirement age. However, as
discussed in this preamble under
Proposed Effective Date, plan
amendments to reflect this requirement
are not required to be adopted until
guidance is issued addressing when
plan amendments must be adopted.

entity, cannot exceed applicable section
457 plan limitations. Thus, these
limitations, including the basic
limitation, the age 50 catch-up
limitation, and the special section 457
catch-up limitation, apply not only on a
plan basis, but also on an individual
basis for cases in which an individual
participates in more than one eligible
plan during a taxable year. The
proposed regulations include rules for
how the applicable section 457
limitations apply on an individual basis.
The rules for applying catch-up limits
on an individual basis provide that the
special section 457 catch-up available in
the last three years prior to normal
retirement age is taken into account
only to the extent that an annual
deferral is made for a participant under
an eligible plan as a result of plan
provisions permitted under the special
section 457 catch-up and, if the
applicable catch-up amount is not the
same for each such eligible plan, the
individual limit is applied using the
catch-up amount under whichever plan
that has the largest catch-up amount
applicable to the participant. However,
as discussed above, a participant may
not elect to have the special section 457
catch-up apply more than once, unless
the participant is covered by a plan of
another employer.
The proposed regulations allow an
eligible governmental plan to pay out an
annual deferral to the extent the deferral
exceeds the individual limit or to
correct a deferral in excess of the plan’s
limit.

3. Individual Limitation for Combined
Annual Deferrals Under Eligible Plans
Before enactment of EGTRRA, a
coordination limitation applied under
which the basic annual limitation and
the special section 457 catch-up
limitation were reduced by amounts
excluded from a participant’s income
for any taxable year by reason of a salary
reduction or elective contribution under
a section 401(k) plan or a section 403(b)
contract. EGTRRA eliminated
coordination with section 401(k) plans
and section 403(b) contracts for 2002
and thereafter. However, coordination
with these types of arrangements is still
taken into account for purposes of
determining the underutilized amount
for years before 2002, so that these rules
continue to be reflected in the proposed
regulations for that sole purpose.
EGTRRA did not eliminate section
457(c) under which the maximum
amount excludable under all eligible
plans, including eligible governmental
plans and eligible plans of a tax-exempt

The proposed regulations would
permit an eligible plan to provide that
a participant may elect to defer
accumulated sick pay, accumulated
vacation pay, and back pay if certain
conditions are satisfied. In accordance
with section 457(b)(4), the plan must
provide that these amounts may be
deferred for any calendar month only if
an agreement providing for the deferral
is entered into before the beginning of
the month in which the amounts would
otherwise be paid or made available to
the participant. Thus, a participant is
not permitted to elect to receive the
value of accumulated sick and vacation
pay on or after the date on which the
employer makes that pay available to
the participant in cash. Any deferrals
under an eligible plan of sick and
vacation pay or back pay are subject to
the maximum deferral limitations of
section 457 in the year of deferral. Thus,
the total amount deferred for any year
cannot exceed the plan ceiling for the
year, taking into account the 100

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4. Sick and Vacation Pay Deferrals

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percent of includible compensation
limit.
5. Excess Deferrals
The proposed regulations address the
treatment of excess deferrals and the
effect of excess deferrals on plan
eligibility under section 457(b). The
proposed regulations also provide that
an eligible governmental plan may self
correct excess deferrals and will not fail
to satisfy the applicable requirements of
the proposed regulations (including the
distribution rules and the funding rules)
solely by reason of a distribution of
excess deferrals.
Under the proposed regulations, if an
excess deferral arises under the
maximum deferral limits of section
457(b) for a plan of a governmental
employer, an eligible governmental plan
is required to correct the failure by
distributing the excess deferral to the
participant, with allocable net income,
as soon as administratively practicable
after the plan determines that the
amount would be an excess deferral. If
excess deferrals of this type are not
distributed, the plan will be an
ineligible plan with respect to which
benefits are taxed according to the rules
of section 457(f). If an excess deferral
arises under the maximum deferral
limits of section 457(b) for a plan of a
tax-exempt employer, the plan is not an
eligible plan. For purposes of these
rules, all plans under which an
individual participates by virtue of his
or her relationship with a single
employer are treated as a single plan.
As stated previously, while EGTRRA
repealed the coordination limitation
under section 457(c), EGTRRA did not
eliminate the requirement that the
maximum amount excludable under all
eligible plans under section 457(c) as
revised by EGTRRA, including eligible
governmental plans and eligible plans of
a tax-exempt entity, cannot exceed the
applicable section 457(b) limitations.
Thus, an excess deferral that results
from the application of the new
individual limitation for multiple
eligible plans under section 457(c) may
also be, but is not required to be,
distributed to the participant. However,
consistent with the legislative history to
section 457(c), the proposed regulations
make clear that a plan will not lose its
status as an eligible plan by failing to
distribute those excess deferrals that
result from the application of this
requirement (although those amounts
are currently includible in the
participant’s income).
Comments are specifically requested
concerning record-keeping requirements
with respect to excess deferrals that are
not distributed and, in particular,

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
concerning the maintenance of records
adequate to keep track of any previously
taxed excess deferrals that remain in an
eligible plan. In addition, comments are
also requested as to the proper income
and payroll tax reporting of
distributions of excess deferrals.
6. Minimum Distribution Requirements
EGTRRA eliminated the special
minimum distribution rules that applied
to eligible plans. Thus, the proposed
regulations generally incorporate by
reference the requirements of section
401(a)(9) and the regulations thereunder
concerning minimum distributions to
participants and beneficiaries. Final and
temporary regulations (TD 8987) under
section 401(a)(9) were published in the
Federal Register on April 17, 2002 (67
FR 18988). These regulations provide
rules for defined benefit plans and
defined contribution plans. Generally,
the rules for defined contribution plans
apply to eligible deferred compensation
plans. Beginning in 2003, a simple
uniform table generally applies to all
employees to determine the minimum
distribution required during their
lifetime, including employees covered
by an eligible deferred compensation
plan.1 The one exception to this rule for
lifetime distributions is for an employee
with a spouse designated as the
employee’s sole beneficiary and the
spouse is more than 10 years younger
than the employee. In that case the
employee can use the employee and
spouse’s joint and last survivor
expectancy to determine the minimum
distribution required during the
employee’s lifetime.
7. Loans
Proposed § 1.457–6(f) sets forth rules
governing loans from eligible plans.
This proposal responds to the numerous
inquiries received concerning the
availability of loans from eligible plans
maintained by state and local
governments, the assets of which are
held in trust pursuant to section 457(g).
While section 457(g) does not directly
address the issue of whether, or under
what circumstances, loans may be made
available from trusteed eligible plans,
the legislative history to the SBJPA
indicates that the new statutory
provisions should be interpreted as
permitting participant loans from the
eligible plan trust under the rules
applicable to loans from qualified plans.
H.R. Rep. 104–737, at 251.
Commentators, some citing this
legislative history and some citing pre1 Employees

may use these new final regulations
for distributions for 2002 or may use regulations
proposed in 1987 or 2001.

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ERISA case law and rulings interpreting
the exclusive benefit requirement of
section 401(a), have urged the IRS to
issue formal guidance concerning loans
from eligible plans. These comments
take the position that the availability of
loans will make savings through eligible
plans more attractive to participants and
will decrease the disparity between
eligible plans and the other tax-favored
voluntary retirement savings plans.
The pre-ERISA requirements
applicable to loans from qualified plans
require a facts and circumstances
analysis of the availability of the loan
feature to all participants, the rate of
return, the overall prudence of the
investment of the trust corpus in the
note of an individual participant, and
the pattern of repayments. See, e.g.,
Central Motor Co. v. United States, 583
F. 2d 470, 488–491 (10th Cir. 1978);
Winger’s Department Store v.
Commissioner, 82 T.C. 869 (1982); MaTran Corp. v. Commissioner, 70 T.C.
158 (1978); and Feroleto Steel Co. v.
Commissioner, 69 T.C. 97 (1977). See
also Rev. Rul. 67–258 (1967–2 CB 68).
Under the proposed regulations, a
loan from an unfunded eligible plan of
a tax-exempt organization would be
treated as an impermissible distribution,
in violation of the requirements of
section 457. However, for loans from an
eligible governmental plan, the
proposed regulations include a facts and
circumstances general standard. This
general standard is intended to apply to
determine whether the loan is bona fide
and for the exclusive purpose of
benefitting participants and
beneficiaries under section 457(g), as
was required under pre-ERISA law for
qualified plans. Among the facts and
circumstances are whether the loan has
a fixed repayment schedule and a
reasonable interest rate, and whether
there are repayment safeguards to which
a prudent lender would adhere.2 The
proposed regulations require a loan to
bear a reasonable rate of interest in
order to satisfy the requirement that
assets and income of an eligible
governmental plan be held for the
exclusive benefit of participants and
their beneficiaries. The proposed
regulations would also clarify that
section 72(p) applies with respect to
loans made under an eligible
governmental plan. Regulations
interpreting section 72(p)(2) are at
§ 1.72(p)–1.
If the proposed regulations are
finalized in their current form, it is
2 See, for example, the standards in Rev. Rul. 69–
494 (1969–2 C.B. 88) for determining when plan
investments are primarily for the purpose of
benefitting employees or their beneficiaries.

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30829

anticipated that the IRS will modify its
current no-rule position regarding the
issuance of private letter rulings to
eligible plans that provide for loans.
8. Distributions From Eligible Plans
a. Eligible Governmental Plans
EGTRRA substantially altered the
taxation of distributions from an eligible
governmental plan by providing that
amounts held under such an eligible
plan are not included in a participant’s
or beneficiary’s gross income until
distributed. The proposed regulations
would interpret this EGTRRA change as
applying to all participants in an
eligible governmental plan. Thus, an
eligible governmental plan may permit
participants who are currently entitled
to be paid after 2001 to change their
previously irrevocable payment
elections.
Under EGTRRA, after 2001, the direct
rollover rules applicable to qualified
plans and section 403(b) contracts will
apply to distributions from an eligible
governmental plan. The direct rollover
rules for qualified plans and section
403(b) contracts are generally explained
at §§ 35.3405–1, 31.3405(c)–1,
1.401(a)(31)–1, 1.402(c)–2, and 1.402(f)–
1. These direct rollover regulations have
not been updated since EGTRRA to
reflect that rollovers are permitted for
distributions from eligible governmental
plans (nor do those regulations reflect
that amounts may be rolled over to
eligible governmental plans after 2001).
b. Eligible Plans of Tax-Exempt Entities
Amounts deferred under an eligible
plan of a tax-exempt entity continue to
be taxable when paid or made available.
The proposed regulations explain these
rules, including the exceptions for
amounts available in the event of
unforeseeable emergency and
distributions of smaller accounts (not in
excess of $5,000).
9. Plan terminations and plan-to-plan
transfers
The proposed regulations address the
topic of plan terminations and plan-toplan transfers. These topics have
become increasingly important in light
of the recent statutory changes that
impose a trust requirement on eligible
governmental plans. In particular,
questions have been raised with respect
to hospitals and other entities that
change from government to private
entities, whether or not tax-exempt. The
direct rollovers that will be permitted by
EGTRRA beginning in 2002 for eligible
governmental plans provide participants
affected by these types of events the
ability to retain their retirement savings
in a funded, tax-deferred savings vehicle

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules

by rollover to IRAs, qualified plan, or
section 403(b) contracts. The proposed
regulations provide a blueprint for the
different plan termination and plan-toplan transfer alternatives available to
sponsors of eligible plans in these
situations.
a. Plan Terminations
The proposed regulations would
allow a plan to have provisions
permitting plan termination whereupon
amounts could be distributed without
violating the distribution requirements
of section 457. Under the proposed
regulations, an eligible plan is
terminated only if all amounts deferred
under the plan are paid to participants
as soon as administratively practicable.
If the amounts deferred under the plan
are not distributed, the plan is treated as
a frozen plan and must continue to
comply with all of the applicable
statutory requirements necessary for
plan eligibility. The proposed
regulations generally follow the
approach of Rev. Rul. 89–87 (1982–2
C.B. 81), which provides guidance on
the termination of qualified plans. In
that revenue ruling, a qualified plan
under which benefit accruals have
ceased is not terminated if assets of the
plan remain in the plan’s related trust
rather than being distributed as soon as
administratively feasible.
The proposed regulations also
highlight the consequences to the plan
in the case of an employer that ceases
to be an eligible employer but fails to
terminate the plan or to transfer its
assets under the rules of the proposed
regulations described below.
b. Plan-to-plan Transfers
The proposed regulations would
clarify that transfers between certain
types of eligible plans do not violate the
requirements of section 457(b),
including the distribution requirements
of section 457(d), if certain conditions
are satisfied. Thus, an eligible
governmental plan may transfer its
assets to another eligible governmental
plan; likewise, an unfunded, tax-exempt
plan may transfer amounts deferred to
another unfunded, tax-exempt plan.
However, in the same manner that
rollovers are not permitted between
unfunded plans of tax-exempt
employers and funded governmental
plans (and because of potential
violations of the exclusive benefit rule
applicable to eligible governmental
plans), amounts cannot be transferred
from an eligible plan of a tax-exempt
employer to an eligible governmental
plan or from an eligible governmental
plan to an eligible plan of a tax-exempt
employer.

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Plan-to-plan transfers within similar
types of eligible plans are permitted in
two kinds of circumstances. First, it is
contemplated that transfers may occur
when a participant in the transferor plan
terminates employment with the
transferor employer and is employed by
the transferee employer. Transfers with
respect to individual participants are
permitted if both plans agree to the
transfer, the participant has terminated
employment with the transferor, and the
participant whose amounts deferred are
being transferred will have an amount
deferred immediately after the transfer
at least equal to the amount deferred
immediately before the transfer.
Second, the proposed regulations also
contemplate certain asset transfers of all
amounts deferred under the plan in the
event an activity of a state or local
government is privatized or otherwise
ceases to be performed by a
governmental entity. Thus, as an
alternative to plan termination or a
plan-to-plan transfer, the proposed
regulations provide that a government
employer that loses its eligible status
may transfer the eligible plan to another
eligible government employer within
the same state. For example, a county
hospital that maintains an eligible plan
and that ceases to be a governmental
entity could transfer the plan to the
county for continued administration.
The proposed regulations also address
transfers between eligible governmental
plans and qualified defined benefit
plans with respect to past service credit.
Because the proposed regulations
specifically state that a transfer for past
service credit is not treated as a
distribution for purposes of section 457,
such a transfer could be made while the
participant is still working.
10. Qualified Domestic Relations Orders
The proposed regulations address the
issue of qualified domestic relations
orders (QDROs). The administration of
QDROs has created difficulties for
eligible employers and section 457 plan
administrators and participants, and
numerous inquiries and private letter
ruling requests involving the
application of judicial domestic
relations orders to participants’
accounts in eligible section 457(b)
deferred compensation plans have been
received. The proposed regulations
provide that an eligible plan may honor
the terms of a QDRO without
jeopardizing its eligible status.
Under the proposed regulations, as
provided under section 457 as amended
by EGTRRA, an eligible plan does not
become an ineligible plan described in
section 457(f) solely because its
administrator or sponsor complies with

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a QDRO described in section 414(p)
(taking into account the special rule
section 414(p)(11) for governmental and
church plans), including a QDRO
requiring the distribution of the benefits
of a participant to an alternate payee in
advance of the general rules for eligible
plan distributions under § 1.457–6. In
the case of an eligible governmental
plan, amounts paid to the alternate
payee who is the spouse or former
spouse of a participant under the QDRO
are taxable to the alternate payee when
they are paid.
In the case of an eligible plan of a taxexempt entity, amounts payable to the
alternate payee who is the spouse or
former spouse of a participant under the
QDRO are taxable to the alternate payee
when they are paid or made available to
the alternate payee. In addition,
amounts deferred under an eligible plan
of a tax-exempt entity that are
attributable to the alternate payee are
treated as made available on the date the
alternate payee is first able to receive a
distribution.
11. Rollovers to Eligible Plans
EGTRRA now allows rollovers
contributions to be accepted by an
eligible governmental plan, but only if
the receiving eligible governmental plan
maintains the rollover amount in a
separate account. The proposed
regulations include such rollovers as
part of the amount deferred under the
receiving plan, but a rollover
contribution is not taken into account as
an annual deferral under the plan for
purposes of the plan ceiling limit on
annual deferrals. While EGTRRA does
not require a separate account for each
type of rollover contributions (e.g, an
account for rollovers from qualified
plans which is separate from rollovers
from section 403(b) contracts),
comments are requested on whether
there are any special characteristics
applicable to qualified plans, section
403(b) contracts, or individual
retirement arrangements (IRAs) under
section 72(t) (imposing an additional
income tax on early distributions from
such plans, contracts, or arrangements)
which could be lost if multiple types of
separate accounts are not maintained.
12. Correction Program for Section
457(b) Eligible Deferred Compensation
Plans
Employee Plans, within the office of
the Commissioner, Tax Exempt and
Government Entities (TE/GE), has
comprehensive correction programs for
sponsors of retirement plans (qualified
retirement plans, 403(b) plans, and
Simplified Employee Pensions). These
programs, including the Employee Plans

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
Compliance Resolution System
(EPCRS), Rev. Proc. 2001–17 (2001–7
I.R.B. 589), permit plan sponsors to
correct plan defects and thereby
continue to provide their employees
retirement benefits on a tax-favored
basis. Employee Plans intends to
expand the provisions of EPCRS to
include appropriate correction
procedures for certain failures arising
under eligible deferred compensation
plans. The public is invited to submit
comments to assist in the development
of these procedures. Comments should
be sent to: Internal Revenue Service,
Attention: T:EP:RA:VC, 1111
Constitution Avenue NW, Washington,
DC 20224.
Pending the update of EPCRS,
submissions related to section 457 (b)
eligible deferred compensation plan
failures will be accepted by Employee
Plans on a provisional basis outside of
EPCRS.
13. Ineligible Plans
The proposed regulations include
guidance regarding ineligible plans
under section 457(f). Section 457(f) was
in section 457 when it was added to the
Code in 1978 for governmental
employees, and extended to employees
of tax-exempt organizations (other than
churches or certain church-controlled
organizations) in 1986, because
unfunded amounts held by a tax-exempt
entity compound tax free like an eligible
plan, a qualified plan, or a section
403(b) contract. Section 457(f) was
viewed as essential in order to provide
an incentive for employers that are not
subject to income taxes to adopt an
eligible plan, a qualified plan, or a
section 403(b) contract. 3 Section 457(f)
generally provides that, in the case of an
agreement or arrangement for the
deferral of compensation, the deferred
compensation is included in gross
income when deferred or, if later, when
the rights to payment of the deferred
compensation cease to be subject to a
substantial risk of forfeiture. Section
457(f) does not apply to an eligible plan,
a qualified plan, a section 403(b)
contract, a section 403(c) contract, a
transfer of property described in section
83, a trust to which section 402(b)
applies, or a qualified governmental
excess benefit arrangement described in
section 415(m).
The proposed regulations reflect the
statutory changes in section 457(f) that
have been made since 1982—which is
3 See generally the Report to the Congress on the
Tax Treatment of Deferred Compensation under
Section 457, Department of the Treasury, January
1992 (available from the Office of Tax Policy, Room
5315, Treasury Department, 1500 Pennsylvania
Avenue, NW., Washington DC 20220).

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when the current outstanding
regulations were issued—and clarify the
interaction between sections 457(f) and
83 (relating to the transfer of property in
connection with the performance of
services). Under the proposed
regulations, section 457(f) does not
apply to a transfer of property if section
83 applies to the transfer. Further,
section 457(f) does not apply if the date
on which there is no substantial risk of
forfeiture with respect to the
compensation is on or after the date on
which there is a transfer of property to
which section 83 applies. However,
section 457(f) applies if the date on
which there is no substantial risk of
forfeiture with respect to the
compensation deferred precedes the
date on which there is a transfer of
property to which section 83 applies.
The proposed regulations include
several examples, including an example
illustrating that section 457(f) does not
fail to apply merely because benefits are
subsequently paid by a transfer of
property. Comments are requested on
the coordination of section 457(f) and
section 83 under these proposed
regulations.
In 2000, the IRS issued
Announcement 2000–1 (2000–2 I.R.B.
294), in which it provided interim
guidance on certain broad-based,
nonelective plans of a state or local
government that were in existence
before 1999. Comments are requested on
whether similar guidance should be
included in the final regulations, and, if
so, how the guidance should apply to
arrangements, such as those maintained
by certain state or local governmental
educational institutions, under which
supplemental compensation is payable
as an incentive to terminate
employment, or as an incentive to retain
retirement-eligible employees, to ensure
an appropriate workforce during periods
in which a temporary surplus or deficit
in workforce is anticipated.
Proposed Effective Date
It is proposed that these regulations
apply generally for taxable years
beginning after December 31, 2001. This
is the general applicability date of the
changes made in section 457 by
EGTRRA. Special effective date
provisions apply to provisions relating
to coordination of sections 457(f) and 83
and for qualified domestic relations
orders. Plan amendments to reflect
EGTRRA, and any other requirement
under these regulations, are not required
to be adopted until the later of when
guidance is issued addressing when
plan amendments must be adopted or
the date final regulations are issued.
However, employers may rely on these

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30831

proposed regulations in taxable years
beginning after August 20, 1996 (which
is the earliest applicability date for
requirements applicable to eligible
plans under the SBJPA). Comments are
requested on whether an applicability
date later than taxable years beginning
after December 31, 2001 should apply
when the regulations are issued in final
form.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a
significant regulatory action as defined
in Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations, and because the
regulations do not impose a collection
of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue
Code, these proposed regulations will be
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on its
impact on small business
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations,
consideration will be given to any
written or electronic comments (a
signed original and eight (8) copies) that
are submitted timely to the IRS. The IRS
and Treasury specifically request
comments on the clarity of the proposed
regulations and how they may be made
easier to understand. All comments will
be available for public inspection and
copying.
A public hearing has been scheduled
for August 28, 2002, beginning at 10
a.m. in the IRS Auditorium of the
Internal Revenue Building, 1111
Constitution Avenue, NW., Washington,
DC. All visitors must present photo
identification to enter the building.
Because of access restrictions, visitors
will not be admitted beyond the
immediate entrance more than 30
minutes before the hearing starts. For
information about having your name
placed on the building access list to
attend the hearing, see the FOR FURTHER
INFORMATION CONTACT section of this
preamble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish
to present oral comments at the hearing
must submit written comments and an
outline of the topics to be discussed and
the time to be devoted to each topic
(signed original and eight (8) copies) by
August 7, 2002. A period of 10 minutes

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will be allotted to each person for
making comments. An agenda showing
the schedule of speakers will be
prepared after the deadline for receiving
outlines has passed. Copies of the
agenda will be available free of charge
at the hearing.
Drafting Information
The principal author of these
regulations is Cheryl Press, Office of
Division Counsel/ Associate Chief
Counsel (Tax Exempt and Government
Entities), IRS. However, other personnel
from the IRS and Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
proposed to be amended as follows.
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *

Par. 2. Sections 1.457–1, 1.457–2,
1.457–3 and 1.457–4 are revised to read
as follows:
§ 1.457–1

General overview of section 457.

Section 457 provides rules for
nonqualified deferred compensation
plans established by eligible employers
as defined under § 1.457–2(d). Eligible
employers can establish either deferred
compensation plans that are eligible
plans and that meet the requirements of
section 457(b) and §§ 1.457–3 through
1.457–10, or deferred compensation
plans or arrangements that do not meet
the requirements of section 457(b) and
§§ 1.457–3 through 1.457–10 and that
are subject to tax treatment under
section 457(f) and § 1.457–11.
§ 1.457–2

Definitions.

This section sets forth the definitions
that are used under §§ 1.457–1 through
1.457–11.
(a) Amount(s) deferred. Amount(s)
deferred means the total annual
deferrals under an eligible plan in the
current and prior years, adjusted for
gain or loss. Except as otherwise
specifically indicated, amount(s)
deferred includes any rollover amount
held by an eligible plan as provided
under § 1.457–10(e).
(b) Annual deferral(s)—(1) Annual
deferral(s) means, with respect to a
taxable year, the amount of
compensation deferred under an eligible
plan, whether by salary reduction or by

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nonelective employer contribution. The
amount of compensation deferred under
an eligible plan is taken into account as
an annual deferral in the taxable year of
the participant in which deferred, or, if
later, the year in which the amount of
compensation deferred is no longer
subject to a substantial risk of forfeiture.
(2) If the amount of compensation
deferred under the plan during a taxable
year is not subject to a substantial risk
of forfeiture, the amount taken into
account as an annual deferral is not
adjusted to reflect gain or loss allocable
to the compensation deferred. If,
however, the amount of compensation
deferred under the plan during the
taxable year is subject to a substantial
risk of forfeiture, the amount of
compensation deferred that is taken into
account as an annual deferral in the
taxable year in which the substantial
risk of forfeiture lapses must be adjusted
to reflect gain or loss allocable to the
compensation deferred until the
substantial risk of forfeiture lapses.
(3) If the eligible plan is a defined
benefit plan within the meaning of
section 414(j), the annual deferral for a
taxable year is the present value of the
increase during the taxable year of the
participant’s accrued benefit that is not
subject to a substantial risk of forfeiture
(disregarding any such increase
attributable to prior annual deferrals).
For this purpose, present value must be
determined using actuarial assumptions
and methods that are reasonable (both
individually and in the aggregate), as
determined by the Commissioner.
(c) Beneficiary. Beneficiary means a
beneficiary of a participant, a
participant’s estate, or any other person
whose interest in the plan is derived
from the participant, including an
alternate payee as described in § 1.457–
10(c).
(d) Catch-up. Catch-up amount or
catch-up limitation for a participant for
a taxable year means the annual deferral
permitted under section 414(v) (as
described in § 1.457–4(c)(2)) or section
457(b)(3) (as described in § 1.457–
4(c)(3)) to the extent the amount of the
annual deferral for the participant for
the taxable year is permitted to exceed
the plan ceiling applicable under
section 457(b)(2) (as described in
§ 1.457–4(c)(1)).
(e) Eligible employer. Eligible
employer means an entity that is a state
as defined in paragraph (l) of this
section that establishes a plan or a taxexempt entity as defined in paragraph
(m) of this section that establishes a
plan. The performance of services as an
independent contractor for a state or
local government or a tax-exempt entity
is treated as the performance of services

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for an eligible employer. The term
eligible employer does not include a
church as defined in section
3121(w)(3)(A), a qualified churchcontrolled organization as defined in
section 3121(w)(3)(B), or the Federal
government or any agency or
instrumentality thereof.
(f) Eligible plan. An eligible plan is a
plan that meets the requirements of
§§ 1.457–3 through 1.457–10 that is
established and maintained by an
eligible employer. An eligible
governmental plan is an eligible plan
that is established and maintained by an
eligible employer as defined in
paragraph (l) of this section. An
arrangement does not fail to constitute
a single eligible governmental plan
merely because the arrangement is
funded through more than one trustee,
custodian, or insurance carrier. An
eligible plan of a tax-exempt entity is an
eligible plan that is established and
maintained by an eligible employer as
defined in paragraph (m) of this section.
(g) Includible compensation.
Includible compensation of a
participant means, with respect to a
taxable year, the participant’s
compensation, as defined in section
415(c)(3), for services performed for the
eligible employer. The amount of
includible compensation is determined
without regard to any community
property laws.
(h) Ineligible plan. Ineligible plan
means a plan established and
maintained by an eligible employer that
is not maintained in accordance with
§§ 1.457–3 through 1.457–10. A plan
that is not established by an eligible
employer as defined in paragraph (e) of
this section is neither an eligible nor an
ineligible plan.
(i) Nonelective employer contribution.
A nonelective employer contribution is
a contribution made by an eligible
employer for the participant with
respect to which the participant does
not have the choice to receive the
contribution in cash or property. Solely
for purposes of section 457 and
§§ 1.457–2 through 1.457–11, the term
nonelective employer contribution
includes employer contributions that
would be described in section 401(m) if
they were contributions to a qualified
plan.
(j) Participant. Participant in an
eligible plan means an individual who
is currently deferring compensation, or
who has previously deferred
compensation under the plan by salary
reduction or by nonelective employer
contribution and who has not received
a distribution of his or her entire benefit
under the eligible plan. Only
individuals who perform services for

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
the eligible employer, either as an
employee or as an independent
contractor, may defer compensation
under the eligible plan.
(k) Plan. Plan includes any agreement
or arrangement between an eligible
employer and a participant or
participants under which the payment
of compensation is deferred (whether by
salary reduction or by nonelective
employer contribution). The following
types of plan are not treated as
agreements or arrangement under which
compensation is deferred: a bona fide
vacation leave, sick leave, compensatory
time, severance pay, disability pay, or
death benefit plan described in section
457(e)(11)(A)(i) and any plan paying
length of service awards to bona fide
volunteers (and their beneficiaries) on
account of qualified services performed
by such volunteers as described in
section 457(e)(11)(A)(ii). Further, the
term plan does not include any of the
following (and section 457 and
§§ 1.457–2 through 1.457–11 do not
apply to any of the following)—
(1) Any nonelective deferred
compensation under which all
individuals (other than those who have
not satisfied any applicable initial
service requirement) with the same
relationship with the eligible employer
are covered under the same plan with
no individual variations or options
under the plan as described in section
457(e)(12), but only to the extent the
compensation is attributable to services
performed as an independent
contractor;
(2) An agreement or arrangement
described in § 1.457–11(b);
(3) Any plan satisfying the conditions
in section 1107(c)(4) of the Tax Reform
Act of 1986 (TRA ‘86) (relating to
certain plans for state judges); and
(4) Any of the following plans or
arrangements (to which specific
transitional statutory exclusions
apply)—
(i) A plan or arrangement of a taxexempt entity in existence prior to
January 1, 1987, if the conditions of
section 1107(c)(3)(B) of the TRA ‘86, as
amended by section 1011(e)(6) of
Technical and Miscellaneous Revenue
Act of 1988 (TAMRA), are satisfied;
(ii) A collectively bargained
nonelective deferred compensation plan
in effect on December 31, 1987, if the
conditions of section 6064(d)(2) of
TAMRA are satisfied;
(iii) Amounts described in section
6064(d)(3) of TAMRA (relating to
certain nonelective deferred
compensation arrangements in effect
before 1989); and
(iv) Any plan satisfying the conditions
in section 1107(c)(4) or (5) of TRA ‘86

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(relating to certain plans for certain
individuals with respect to which the
Service issued guidance before 1977).
(l) State. State includes the 50 States
of the United States, the District of
Columbia, a political subdivision of a
state or the District of Columbia, or any
agency or instrumentality of a state or
the District of Columbia.
(m) Tax-exempt entity. Tax-exempt
entity includes any organization (other
than a governmental unit) exempt from
tax under subtitle A of the Internal
Revenue Code.
(n) Trust. Trust means a trust
described under section 457(g) and
§ 1.457–8. Custodial accounts and
contracts described in section 401(f) are
treated as trusts under the rules
described in § 1.457–8(a)(2).
§ 1.457–3
plans.

General introduction to eligible

(a) Compliance in form and operation.
An eligible plan is a written plan
established and maintained by an
eligible employer that is maintained, in
both form and operation, in accordance
with the requirements of §§ 1.457–4
through 1.457–10. An eligible plan must
contain all the material terms and
conditions for benefits under the plan.
An eligible plan may contain certain
optional features not required for plan
eligibility under section 457(b), such as
distributions for unforeseeable
emergencies, loans, plan-to-plan
transfers, additional deferral elections,
acceptance of rollovers to the plan, and
distributions of smaller accounts to
eligible participants. However, except as
otherwise specifically provided in
§§ 1.457–4 through 1.457–10, if an
eligible plan contains any optional
provisions, the optional provisions must
meet, in both form and operation, the
relevant requirements under section 457
and §§ 1.457–2 through 1.457–10.
(b) Treatment as single plan. In any
case in which multiple plans are used
to avoid or evade the requirements of
§§ 1.457–4 through 1.457–10, the
Commissioner may apply the rules
under §§ 1.457–4 through 1.457–10 as if
the plans were a single plan.
§ 1.457–4 Annual deferrals, deferral
limitations, and deferral agreements under
eligible plans.

(a) Taxation of annual deferrals.
Annual deferrals that satisfy the
requirements of paragraphs (b) and (c) of
this section are excluded from the gross
income of a participant in the year
deferred or contributed and are not
includible in gross income until paid to
the participant in the case of an eligible
governmental plan, or until paid or
otherwise made available to the

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30833

participant in the case of an eligible
plan of a tax-exempt entity. See § 1.457–
7.
(b) Agreement for deferral. In order to
be an eligible plan, the plan must
provide that compensation may be
deferred for any calendar month by
salary reduction only if an agreement
providing for the deferral has been
entered into before the first day of the
month in which the compensation is
paid or made available. A new
employee may defer compensation
payable in the calendar month during
which the participant first becomes an
employee if an agreement providing for
the deferral is entered into on or before
the first day on which the participant
performs services for the eligible
employer. An eligible plan may provide
that if a participant enters into an
agreement providing for deferral by
salary reduction under the plan, the
agreement will remain in effect until the
participant revokes or alters the terms of
the agreement. Nonelective employer
contributions are treated as being made
under an agreement entered into before
the first day of the calendar month.
(c) Maximum deferral limitations—(1)
Basic annual limitation. (i) Except as
described in paragraphs (c)(2) and (3) of
this section, in order to be an eligible
plan, the plan must provide that the
annual deferral amount for a taxable
year (the plan ceiling) may not exceed
the lesser of—
(A) The applicable annual dollar
amount specified in section 457(e)(15):
$11,000 for 2002; $12,000 for 2003;
$13,000 for 2004; $14,000 for 2005; and
$15,000 for 2006 and thereafter. After
2006, the $15,000 amount is adjusted for
cost-of-living in the manner described
in paragraph (c)(4) of this section; or
(B) 100 percent of the participant’s
includible compensation for the taxable
year.
(ii) The amount of annual deferrals
permitted by the 100 percent of
includible compensation limitation
under paragraph (c)(1)(i)(B) of this
section is determined under section
457(e)(5) and § 1.457–2(g).
(iii) For purposes of determining the
plan ceiling under this paragraph (c),
the annual deferral amount does not
include any rollover amounts received
by the eligible plan under § 1.457–10(e).
(iv) The provisions of this paragraph
(c)(1) are illustrated by the following
examples:
Example 1. (i) Facts. Participant A, who
earns $14,000 a year, enters into a salary
reduction agreement in 2006 with A’s eligible
employer and elects to defer $13,000 of A’s
compensation for that year. Participant A is
not eligible for the catch-up described in
paragraph (c)(2) or (3) of this section,

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participates in no other retirement plan, and
has no other income exclusions taken into
account in computing includible
compensation.
(ii) Conclusion. The annual deferral limit
for A in 2006 is the lesser of $15,000 or 100
percent of includible compensation, $14,000.
A’s annual deferral of $13,000 is permitted
under the plan because it is not in excess of
$14,000 and thus does not exceed 100
percent of A’s includible compensation.
Example 2. (i) Facts. Assume the same
facts as in Example 1, except that A’s eligible
employer provides an immediately vested,
matching employer contribution under the
plan for participants who make salary
reduction deferrals under A’s eligible plan.
The matching contribution is equal to 100
percent of elective contributions, but not in
excess of 10 percent of compensation (in A’s
case, $1,400).
(ii) Conclusion. Participant A’s annual
deferral exceeds the limitations of this
paragraph (c)(1). A’s maximum deferral
limitation in 2006 is $14,000. A’s salary
reduction deferral of $13,000 combined with
A’s eligible employer’s nonelective employer
contribution of $1,400 exceeds the basic
annual limitation of this paragraph (c)(1)
because A’s annual deferrals total $14,400. A
has an excess deferral for the taxable year of
$400, the amount exceeding A’s permitted
annual deferral limitation. The $400 excess
deferral is treated as described in paragraph
(e) of this section.
Example 3. (i) Facts. Beginning in year
2002, Eligible Employer X contributes $3,000
per year for five years to Participant B’s
eligible plan account. B’s interest in the
account vests in 2006. B has annual
compensation of $50,000 in each of the five
years 2002 through 2006. Participant B is 41
years old. B is not eligible for the catch-up
described in paragraph (c)(2) or (3) of this
section, participates in no other retirement
plan, and has no other income exclusions
taken into account in computing includible
compensation. Adjusted for gain or loss, the
value of B’s benefit when B’s interest in the
account vests in 2006 is $17,000.
(ii) Conclusion. Under this vesting
schedule, $17,000 is taken into account as an
annual deferral in 2006. B’s annual deferrals
under the plan are limited to a maximum of
$15,000 in 2006. Thus, the aggregate of the
amounts deferred, $17,000, is in excess of the
B’s maximum deferral limitation by $2,000.
The $2,000 is treated as an excess deferral
described in paragraph (e) of this section.

(2) Age 50 catch-up—(i) In general. In
accordance with section 414(v) and the
regulations thereunder, an eligible
governmental plan may provide for
catch-up contributions for a participant
who is age 50 by the end of the year,
provided that such age 50 catch-up
contributions do not exceed the catchup limit under section 414(v)(2) for the
taxable year. The maximum amount of
age 50 catch-up contributions for a
taxable year under section 414(v) is as
follows: $1,000 for 2002; $2,000 for
2003; $3,000 for 2004; $4,000 for 2005;
and $5,000 for 2006 and thereafter. After

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2006, the $5,000 amount is adjusted for
cost-of-living. For additional guidance,
see regulations under section 414(v).
(ii) Coordination with special section
457 catch-up. In accordance with
sections 414(v)(6)(C) and 457(e)(18), the
age 50 catch-up described in this
paragraph (c)(2) does not apply for any
taxable year for which a higher
limitation applies under the special
section 457 catch-up under paragraph
(c)(3) of this section. Thus, for purposes
of this paragraph (c)(2)(ii) and paragraph
(c)(3) of this section, the special section
457 catch-up under paragraph (c)(3) of
this section applies for any taxable year
if and only if the plan ceiling taking into
account paragraphs (c)(1) and (3) of this
section (and disregarding the age 50
catch-up described in this paragraph
(c)(2)) is larger than the plan ceiling
taking into account paragraph (c)(1) of
this section and the age 50 catch-up
described in this paragraph (c)(2) (and
disregarding paragraph (c)(3) of this
section). Thus, a participant who is
eligible for the age 50 catch-up for a year
and for whom the year is also one of the
participant’s last three taxable years
ending before the participant attains
normal retirement age is entitled to the
larger of—
(A) The plan ceiling under paragraph
(c)(1) of this section and the age 50
catch-up described in this paragraph
(c)(2) (and disregarding paragraph (c)(3)
of this section) or
(B) The plan ceiling under paragraphs
(c)(1) and (3) of this section (and
disregarding the age 50 catch-up
described in this paragraph (c)(2)).
(iii) Examples. The provisions of this
paragraph (c)(2) are illustrated by the
following examples:
Example 1. (i) Facts. Participant C, who is
55, is eligible to participate in an eligible
governmental plan in 2006. The plan
provides a normal retirement age of 65. The
plan provides limitations on annual deferrals
up to the maximum permitted under
paragraphs (c)(1) and (3) of this section and
the age 50 catch-up described in this
paragraph (c)(2). For 2006, C will receive
compensation of $40,000 from the eligible
employer. C desires to defer the maximum
amount possible in 2006. The applicable
basic dollar limit of paragraph (c)(1)(i)(A) of
this section is $15,000 for 2006 and the
additional dollar amount permitted under the
age 50 catch-up is $5,000 for 2006.
(ii) Conclusion. C is eligible for the age 50
catch-up in 2006 because C is 55 in 2006.
However, C is not eligible for the special
section 457 catch-up under paragraph (c)(3)
of this section in 2006 because 2006 is not
one of the last three taxable years ending
before C attains normal retirement age.
Accordingly, the maximum that C may defer
for 2006 is $20,000.
Example 2. (i) Facts. The facts are the same
as in Example 1, except that, in 2006, C will

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attain age 62. The maximum amount that C
can elect under the special section 457 catchup under paragraph (c)(3) of this section is
$2,000 for 2006.
(ii) Conclusion. The maximum that C may
defer for 2006 is $20,000. This is the sum of
the basic plan ceiling under paragraph (c)(1)
of this section equal to $15,000 and the age
50 catch-up equal to $5,000. The special
section 457 catch-up under paragraph (c)(3)
of this section is not applicable since it
provides a smaller plan ceiling.
Example 3. (i) Facts. The facts are the same
as in Example 2, except that the maximum
additional amount that C can elect under the
special section 457 catch-up under paragraph
(c)(3) of this section is $7,000 for 2006.
(ii) Conclusion. The maximum that C may
defer for 2006 is $22,000. This is the sum of
the basic plan ceiling under paragraph (c)(1)
of this section equal to $15,000, plus the
additional special section 457 catch-up under
paragraph (c)(3) of this section equal to
$7,000. The additional dollar amount
permitted under the age 50 catch-up is not
applicable to C for 2006 because it provides
a smaller plan ceiling.

(3) Special section 457 catch-up—(i)
In general. Except as provided in
paragraph (c)(2)(ii) of this section, an
eligible plan may provide that, for one
or more of the participant’s last three
taxable years ending before the
participant attains ‘‘normal retirement
age,’’ the plan ceiling is an amount not
in excess of the lesser of—
(A) Twice the dollar amount in effect
under paragraph (c)(1)(i)(A) of this
section; or
(B) The underutilized limitation
determined under paragraph (c)(3)(ii) of
this section.
(ii) Underutilized limitation. The
underutilized amount determined under
this paragraph (c)(3)(ii) is the sum of—
(A) The plan ceiling established under
paragraph (c)(1) of this section for the
taxable year; plus
(B) The plan ceiling established under
paragraph (c)(1) of this section (or under
section 457(b)(2) for any year before the
applicability date of this section) for any
prior taxable year or years, less the
amount of annual deferrals under the
plan for such prior taxable year or years
(disregarding any annual deferrals
under the plan permitted under the age
50 catch-up under paragraph (c)(2) of
this section).
(iii) Determining underutilized
limitation under paragraph (c)(3)(ii)(B)
of this section. In determining the
includible compensation of a
participant under § 1.457–2(g) for
purposes of calculating the amount
described in paragraph (c)(3)(ii)(A) of
this section, includible compensation is
not reduced by contributions of
amounts described in paragraph
(c)(3)(ii)(B) of this section. In addition,
a prior taxable year is taken into account

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
under paragraph (c)(3)(ii)(B) of this
section only if it is a year beginning
after December 31, 1978, in which the
participant was eligible to participate in
the plan, and in which compensation
deferred (if any) under the plan during
the year was subject to a plan ceiling
established under paragraph (c)(1) of
this section.
(iv) Special rules concerning
application of the coordination limit for
years prior to 2002 for purposes of
determining the underutilized
limitation—(A) General rule. For
purposes of determining the
underutilized limitation for years prior
to 2002, participants remain subject to
the rules in effect prior to the repeal of
the coordination limitation under
section 457(c)(2). Thus, the applicable
basic annual limitation under paragraph
(c)(1) of this section and the special
section 457 catch-up under this
paragraph (c)(3) for years in effect prior
to 2002 are reduced, for purposes of
determining a participant’s
underutilized amount under a plan, by
amounts excluded from the participant’s
income for any prior taxable year by
reason of a salary reduction or elective
contribution under any other eligible
section 457(b) plan, section 401(k)
qualified cash or deferred arrangement,
section 402(h)(1)(B) simplified
employee pension (SARSEP), section
403(b) annuity contract, and section
408(p) simple retirement account, or
under any plan for which a deduction
is allowed because of a contribution to
an organization described in section
501(c)(18) (pre-2002 coordination
plans). Similarly, in applying the
section 457(b)(2)(B) limitation for
includible compensation for years prior
to 2002, the limitation is 331⁄3 percent
of the participant’s compensation
includible in gross income.
(B) Coordination limitation applied to
participant. For purposes of
determining the underutilized
limitation for years prior to 2002, the
coordination limitation applies to pre2002 coordination plans of all
employers for whom a participant has
performed services, not only to those of
the eligible employer. Thus, for
purposes of determining the amount
excluded from a participant’s gross
income in any prior taxable year under
paragraph (c)(3)(ii)(B) of this section, the
participant’s annual deferral under an
eligible plan, and salary reduction or
elective deferrals under all other pre2002 coordination plans, must be
determined on an aggregate basis. To the
extent that the combined deferral for
years prior to 2002 exceeded the
maximum deferral limitations, the
amount is treated as an excess deferral

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under paragraph (e) of this section for
those prior years.
(C) Special rule where no annual
deferrals under the eligible plan. A
participant who, although eligible, did
not defer any compensation under the
eligible plan in any given year before
2002 is not subject to the coordinated
deferral limit, even though the
participant may have deferred
compensation under one of the other
pre-2002 coordination plans. An
individual is treated as not having
deferred compensation under an eligible
plan for a prior taxable year if all annual
deferrals under the plan are distributed
in accordance with paragraph (e) of this
section. Thus, to the extent that a
participant participated solely in one or
more of the other pre-2002 coordination
plans during a prior taxable year (and
not the eligible plan), the participant is
not subject to the coordinated limitation
for that prior taxable year. However, the
participant is treated as having deferred
amounts in a prior taxable year for
purposes of determining the
underutilized limitation for that prior
taxable year under this paragraph
(c)(3)(iv)(C), but only to the extent that
the participant’s salary reduction
contributions or elective deferrals under
all pre-2002 coordination plans have not
exceeded the maximum deferral
limitations in effect under section
457(b) for that prior taxable year. To the
extent an employer did not offer an
eligible plan to an individual in a prior
given year, no underutilized limitation
is available to the individual for that
prior year, even if the employee
subsequently becomes eligible to
participate in an eligible plan of the
employer.
(D) Examples. The provisions of this
paragraph (c)(3)(iv) are illustrated by the
following examples:
Example 1. (i) Facts. In 2001 and in years
prior to 2001, Participant D earned $50,000
a year and was eligible to participate in both
an eligible plan and a section 401(k) plan.
However, D had always participated only in
the section 401(k) plan and had always
deferred the maximum amount possible. For
each year before 2002, the maximum amount
permitted under section 401(k) exceeded the
limitation of paragraph (c)(3)(i) of this
section. In 2002, D is in the 3-year period
prior to D’s attainment of the eligible plan’s
normal retirement age of 65, and D now
wants to participate in the eligible plan and
make annual deferrals of up to $30,000 under
the plan’s special section 457 catch-up
provisions.
(ii) Conclusion. Participant D is treated as
having no underutilized amount under
paragraph (c)(3)(ii)(B) of this section for 2002
for purposes of the catch-up limitation under
section 457(b)(3) and paragraph (c)(3) of this
section because, in each of the years before
2002, D has deferred an amount in excess of

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30835

the limitation of paragraph (c)(3)(i) of this
section.
Example 2. (i) Facts. Assume the same
facts as in Example 1, except that D only
deferred $2,500 per year under the section
401(k) plan for one year before 2002.
(ii) Conclusion. D is treated as having an
underutilized amount under paragraph
(c)(3)(ii)(B) of this section for 2002 for
purposes of the special section 457 catch-up
limitation. This is because D has deferred an
amount for prior years that is less than the
limitation of paragraph (c)(1)(i) of this
section.
Example 3. (i) Facts. Participant E, who
earned $15,000 for 2000, entered into a salary
reduction agreement in 2000 with E’s eligible
employer and elected to defer $3,000 for that
year. For 2000, E’s eligible employer
provided an immediately vested, matching
employer contribution under the plan for
participants who make salary reduction
deferrals under E’s eligible plan. The
matching contribution was equal to 100
percent of elective contributions, but not in
excess of 10 percent of compensation before
salary reduction deferrals (in E’s case,
$1,500). For 2000, E was not eligible for any
catch-up contribution, participated in no
other retirement plan, and had no other
income exclusions taken into account in
computing taxable compensation.
(ii) Conclusion. Participant E’s annual
deferral exceeded the limitations of section
457(b) for 2000. E’s maximum deferral
limitation in 2000 was $4,000 because E’s
includible compensation was $12,000
($15,000 minus the deferral of $3,000) and
the applicable limitation for 2000 was onethird of the individual’s includible
compensation (one-third of $12,000 equals
$4,000). E’s salary reduction deferral of
$3,000 combined with E’s eligible employer’s
matching contribution of $1,500 exceeded
the limitation of section 457(b) for 2000
because E’s annual deferrals totaled $4,500.
E had an excess deferral for 2000 of $500, the
amount exceeding E’s permitted annual
deferral limitation, and E’s underutilized
amount for 2000 is zero.

(v) Normal retirement age—(A)
General rule. For purposes of the special
section 457 catch-up in this paragraph
(c)(3), a plan must specify the normal
retirement age under the plan. A plan
may define normal retirement age as any
age that is on or after the earlier of age
65 or the age at which participants have
the right to retire and receive, under the
basic defined benefit pension plan of
the state or tax-exempt entity,
immediate retirement benefits without
actuarial or similar reduction because of
retirement before some later specified
age, and that is not later than age 701⁄2.
Alternatively, a plan may provide that a
participant is allowed to designate a
normal retirement age within these ages.
For purposes of the special section 457
catch-up in this paragraph (c)(3), an
entity sponsoring more than one eligible
plan may not permit a participant to
have more than one normal retirement
age under the eligible plans it sponsors.

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules

(B) Special rule for eligible plans of
qualified police or firefighters. An
eligible plan with participants that
include qualified police or firefighters
as defined under section
415(b)(2)(H)(ii)(I) may designate a
normal retirement age for such qualified
police or firefighters that is earlier than
the earliest normal retirement age
designated under the general rule of
paragraph (c)(3)(i)(A) of this section, but
in no event may the normal retirement
age be earlier than age 40. Alternatively,
a plan may allow a qualified police or
firefighter participant to designate a
normal retirement age that is between
age 40 and age 701⁄2.
(vi) Examples. The provisions of this
paragraph (c)(3) are illustrated by the
following examples:
Example 1. (i) Facts. Participant F, who
will turn 61 on April 1, 2006, becomes
eligible to participate in an eligible plan on
January 1, 2006. The plan provides a normal
retirement age of 65. The plan provides
limitations on annual deferrals up to the
maximum permitted under paragraphs (c)(1)
through (3) of this section. For 2006, F will
receive compensation of $40,000 from the
eligible employer. F desires to defer the
maximum amount possible in 2006. The
applicable basic dollar limit of paragraph
(c)(1)(i)(A) of this section is $15,000 for 2006
and the additional dollar amount permitted
under the age 50 catch-up in paragraph (c)(2)
of this section for an individual who is at
least age 50 is $5,000 for 2006.
(ii) Conclusion. F is not eligible for the
special section 457 catch-up under paragraph
(c)(3) of this section in 2006 because 2006 is
not one of the last three taxable years ending
before F attains normal retirement age.
Accordingly, the maximum that F may defer
for 2006 is $20,000. See also paragraph
(c)(2)(iii) Example 1 of this section.
Example 2. (i) Facts. The facts are the same
as in Example 1 except that, in 2006, F elects
to defer only $2,000 under the plan (rather
than the maximum permitted amount of
$20,000). In addition, assume that the
applicable basic dollar limit of paragraph
(c)(1)(i)(A) of this section continues to be
$15,000 for 2007 and the additional dollar
amount permitted under the age 50 catch-up
in paragraph (c)(2) of this section for an
individual who is at least age 50 continues
to be $5,000 for 2007. In F’s taxable year
2007, which is one of the last three taxable
years ending before F attains the plan’s
normal retirement age of 65, F again receives
a salary of $40,000 and elects to defer the
maximum amount permissible under the
plan’s catch-up provisions prescribed under
paragraph (c) of this section.
(ii) Conclusion. For 2007, which is one of
the last three taxable years ending before F
attains the plan’s normal retirement age of
65, the applicable limit on deferrals for F is
the larger of the amount under the special
section 457 catch-up or $20,000, which is the
basic annual limitation ($15,000) and the age
50 catch-up limit of section 414(v) ($5,000).
For 2007, F’s special section 457 catch-up
amount is the lesser of two times the basic

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annual limitation ($30,000) or the sum of the
basic annual limitation ($15,000) plus the
$13,000 underutilized limitation under
paragraph (c)(3)(ii) of this section (the
$15,000 plan ceiling in 2006, minus the
$2,000 contributed for F in 2006), or $28,000.
Thus, the maximum amount that F may defer
in 2007 is $28,000.
Example 3. (i) Facts. The facts are the same
as in Examples 1 and 2, except that F does
not make any contributions to the plan before
2010. In addition, assume that the applicable
basic dollar limitation of paragraph
(c)(1)(i)(A) of this section continues to be
$15,000 for 2010 and the additional dollar
amount permitted under the age 50 catch-up
in paragraph (c)(2) of this section for an
individual who is at least age 50 continues
to be $5,000 for 2010. In F’s taxable year
2010, the year in which F attains age 65
(which is the normal retirement age under
the plan), F desires to defer the maximum
amount possible under the plan. F’s
compensation for 2010 is again $40,000.
(ii) Conclusion. For 2010, the maximum
amount that F may defer is $20,000. The
special section 457 catch-up provisions
under paragraph (c)(3) of this section are not
applicable because 2010 is not a taxable year
ending before the year in which F attains
normal retirement age.

(4) Cost-of-living adjustment. For
years beginning after December 31,
2006, the $15,000 dollar limitation in
paragraph (c)(1)(i)(A) of this section will
be adjusted to take into account
increases in the cost-of-living. The
adjustment in the dollar limitation is
made at the same time and in the same
manner as under section 415(d) (relating
to qualified plans under section 401(a)),
except that the base period is the
calendar quarter beginning July 1, 2005
and any increase which is not a
multiple of $500 will be rounded to the
next lowest multiple of $500.
(d) Deferral of sick, vacation, and
back pay under an eligible plan—(1) In
general. An eligible plan may provide
that a participant may elect to defer
accumulated sick pay, accumulated
vacation pay, and back pay under an
eligible plan if certain conditions are
satisfied. The plan must provide, in
accordance with paragraph (b) of this
section, that these amounts may be
deferred for any calendar month only if
an agreement providing for the deferral
is entered into before the beginning of
the month in which the amounts would
otherwise be paid or made available and
the participant is an employee in that
month. Any deferrals made under this
paragraph (d)(1) under an eligible plan
are subject to the maximum deferral
limitations of paragraph (c) of this
section.
(2) Examples. The provisions of this
paragraph (d) are illustrated by the
following examples:
Example 1. (i) Facts. Participant G, age 62,
is a participant in an eligible plan providing

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a normal retirement age of 65. Under the
terms of G’s employer’s eligible plan and G’s
sick leave plan, G may, during November of
2003 (which is one of the three years prior
to normal retirement age), make a one-time
election to contribute amounts representing
accumulated sick pay to the eligible plan in
December of 2003 (within the maximum
deferral limitations). Alternatively, such
amounts may remain in the ‘‘bank’’ under the
sick leave plan. No cash out of the sick pay
is available at any time prior to termination
of employment. The total value of G’s
accumulated sick pay (determined, in
accordance with the terms of the sick leave
plan, by reference to G’s current salary) is
$4,000 in December of 2003.
(ii) Conclusion. Under the terms of the
eligible plan and sick leave plan, G may elect
before December of 2003 to defer the $4,000
value of accumulated sick pay under the
eligible plan, provided that G’s other annual
deferrals to the eligible plan for 2003, when
added to the $4,000, do not exceed G’s
maximum deferral limitation for the year.
Example 2. (i) Facts. Employer X maintains
an eligible plan and a vacation leave plan.
Under the terms of the vacation leave plan,
employees generally accrue three weeks of
vacation per year. Up to one week’s unused
vacation may be carried over from one year
to the next, so that in any single year an
employee may have a maximum of four
weeks vacation time. At the beginning of
each calendar year, under the terms of the
eligible plan (which constitutes an agreement
providing for the deferral), the value of any
unused vacation time from the prior year in
excess of one week is automatically
contributed to the eligible plan, to the extent
of the employee’s maximum deferral
limitations. Amounts in excess of the
maximum deferral limitations are forfeited.
(ii) Conclusion. The value of the unused
vacation pay contributed to X’s eligible plan
pursuant to the terms of the plan and the
terms of the vacation leave plan is treated as
an annual deferral to the eligible plan in the
calendar year the contribution is made. No
amounts contributed to the eligible plan will
be considered made available to a participant
in X’s eligible plan.

(e) Excess deferrals under an eligible
plan—(1) In general. Any amount
deferred under an eligible plan for the
taxable year of a participant that
exceeds the maximum deferral
limitations set forth in paragraphs (c)(1)
through (3) of this section, and any
amount that exceeds the individual
limitation under § 1.457–5, constitutes
an excess deferral taxable in accordance
with § 1.457–11 for that taxable year.
Thus, an excess deferral is includible in
gross income in the taxable year
deferred or, if later, the first taxable year
in which there is no substantial risk of
forfeiture.
(2) Excess deferrals under an eligible
governmental plan other than as a result
of the individual limitation. In order to
be an eligible governmental plan, the
plan must provide that any excess
deferrals resulting from a failure of a

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
plan to apply the limitations of
paragraphs (c)(1) through (3) of this
section to amounts deferred under the
eligible plan (computed without regard
to the individual limitation under
§ 1.457–5) will be distributed to the
participant, with allocable net income,
as soon as administratively practicable
after the plan determines that the
amount is an excess deferral. For
purposes of determining whether there
is an excess deferral resulting from a
failure of a plan to apply the limitations
of paragraphs (c)(1) through (3) of this
section, all plans under which an
individual participates by virtue of his
or her relationship with a single
employer are treated as a single plan.
An eligible governmental plan does not
fail to satisfy the requirements of
paragraphs (a) through (d) of this section
or §§ 1.457–6 through 1.457–10
(including the distribution rules under
§ 1.457–6 and the funding rules under
§ 1.457–8) solely by reason of a
distribution made under this paragraph
(e)(2). If such excess deferrals are not
corrected by distribution under this
paragraph (e)(2), the plan will be an
ineligible plan under which benefits are
taxable in accordance with § 1.457–11.
(3) Excess deferrals under an eligible
plan of a tax-exempt employer other
than as a result of the individual
limitation. If a plan of a tax-exempt
employer fails to comply with the
limitations of paragraphs (c)(1) through
(3) of this section, the plan will be an
ineligible plan under which benefits are
taxable in accordance with § 1.457–11.
For purposes of determining whether
there is an excess deferral resulting from
a failure of a plan to apply the
limitations of paragraphs (c)(1) through
(3) of this section, all plans under which
an individual participates by virtue of
his or her relationship with a single
employer are treated as a single plan.
(4) Excess deferrals arising from
application of the individual limitation.
An eligible plan may provide that an
excess deferral as a result of a failure to
comply with the individual limitation
under § 1.457–5 for a taxable year may
be distributed to the participant, with
allocable net income, as soon as
administratively practicable after the
plan determines that the amount is an
excess deferral. An eligible plan does
not fail to satisfy the requirements of
paragraphs (a) through (d) of this section
or §§ 1.457–6 through 1.457–10
(including the distribution rules under
§ 1.457–6 and the funding rules under
§ 1.457–8) solely by reason of a
distribution made under this paragraph
(e)(4). Although a plan will still
maintain eligible status if excess
deferrals are not distributed under this

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paragraph (e)(4), a participant must
include the excess amounts in income
as provided in paragraph (e)(1) of this
section.
(5) Examples. The provisions of this
paragraph (e) are illustrated by the
following examples:
Example 1. (i) Facts. In 2006, the eligible
plan of State Employer X in which
Participant H participates permits a
maximum deferral of the lesser of $15,000 or
100 percent of includible compensation. In
2006, H, who has compensation of $28,000,
nevertheless defers $16,000 under the
eligible plan. Participant H is age 45 and
normal retirement age under the plan is age
65. For 2006, the applicable dollar limit
under paragraph (c)(1)(i)(A) of this section is
$15,000.
(ii) Conclusion. Participant H has deferred
$1,000 in excess of the $15,000 limitation
provided for under the plan for 2006. The
$1,000 excess must be included by H into H’s
income for 2006. In order to correct the
failure and still be an eligible plan, the plan
must distribute the excess deferral, with
allocable net income, as soon as
administratively practicable after
determining that the amount exceeds the
plan deferral limitations. If the excess
deferral is not distributed, the plan will be
an ineligible plan with respect to which
benefits are taxable in accordance with
§ 1.457–11.
Example 2. (i) Facts. The facts are the same
as in Example 1, except that H’s deferral
under the eligible plan is limited to $11,000
and H also makes a salary reduction
contribution of $5,000 to an annuity contract
under section 403(b) with the same Employer
X.
(ii) Conclusion. H’s deferrals are within the
plan deferral limitations of Employer X.
Because of the repeal of the application of the
coordination limitation under former
paragraph (2) of section 457(c), H’s salary
reduction deferrals under the annuity
contract are no longer considered in
determining H’s applicable deferral limits
under paragraphs (c)(1) through (3) of this
section.
Example 3. (i) Facts. The facts are the same
as in Example 1, except that H’s deferral
under the eligible governmental plan is
limited to $14,000 and H also makes a
deferral of $4,000 to an eligible governmental
plan of a different employer. Participant H is
age 45 and normal retirement age under both
eligible plans is age 65.
(ii) Conclusion. Because of the application
of the individual limitation under § 1.457–5,
H has an excess deferral of $3,000 (the sum
of $14,000 plus $4,000 equals $18,000, which
is $3,000 in excess of the dollar limitation of
$15,000). The $3,000 excess deferral, with
allocable net income, may be distributed
from either plan as soon as administratively
practicable after determining that the
combined amount exceeds the deferral
limitations. If the $3,000 excess deferral is
not distributed to H, each plan will continue
to be an eligible plan, but the $3,000 must
be included by H into H’s income for 2006.
Example 4. (i) Facts. Assume the same
facts as in Example 3, except that H’s deferral

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30837

under the eligible governmental plan is
limited to $14,000 and H also makes a
deferral of $4,000 to an eligible plan of
Employer Y, a tax-exempt entity.
(ii) Conclusion. The results are the same as
in Example 3, i.e., because of the application
of the individual limitation under § 1.457–5,
H has an excess deferral of $3,000. If the
$3,000 excess deferral is not distributed to H,
each plan will continue to be an eligible
plan, but the $3,000 must be included by H
into H’s income for 2006.

Par. 3. Sections 1.457–5 through
1.457–12 are added to read as follows:
§ 1.457–5 Individual limitation for
combined annual deferrals under multiple
eligible plans

(a) General rule. The individual
limitation under section 457(c) and this
section equals the basic annual deferral
limitation under § 1.457–4(c)(1)(i)(A),
the age 50 catch-up amount under
§ 1.457–4(c)(2), and the special section
457 catch-up amount under § 1.457–
4(c)(3), applied by taking into account
the combined annual deferral for the
participant for any taxable year under
all eligible plans. While an eligible plan
may include provisions under which it
will meet the individual limitation
under section 457(c) and this section,
annual deferrals by a participant that
exceed the individual limit under
section 457(c) and this section will not
cause a plan to lose its eligible status.
However, to the extent the combined
annual deferrals for a participant for any
taxable year exceed the individual
limitation under section 457(c) and this
section for that year, the amounts are
treated as excess deferrals as described
in § 1.457–4(e).
(b) Limitation applied to participant.
The individual limitation in this section
applies to eligible plans of all employers
for whom a participant has performed
services, including both eligible
governmental plans and eligible plans of
a tax-exempt entity and both eligible
plans of the employer and eligible plans
of other employers. Thus, for purposes
of determining the amount excluded
from a participant’s gross income in any
taxable year (including the
underutilized limitation under § 1.457–
4(c)(3)(ii)(B)), the participant’s annual
deferral under an eligible plan, and the
participant’s annual deferrals under all
other eligible plans, must be determined
on an aggregate basis. To the extent that
the combined annual deferral amount
exceeds the maximum deferral
limitation applicable under § 1.457–
4(c)(1)(i)(A), (c)(2), or (c)(3), the amount
is treated as an excess deferral under
§ 1.457–4(e).
(c) Special rules for catch-up amounts
under multiple eligible plans. For
purposes of applying section 457(c) and

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules

this section, the special section 457
catch-up under § 1.457–4(c)(3) is taken
into account only to the extent that an
annual deferral is made for a participant
under an eligible plan as a result of plan
provisions permitted under § 1.457–
4(c)(3). In addition, if a participant has
annual deferrals under more than one
eligible plan and the applicable catchup amount under § 1.457–4(c)(2) or (3)
is not the same for each such eligible
plan for the taxable year, section 457(c)
and this section are applied using the
catch-up amount under whichever plan
has the largest catch-up amount
applicable to the participant.
(d) Examples. The provisions of this
section are illustrated by the following
examples:
Example 1. (i) Facts. Participant F is age 62
in 2006 and participates in two eligible plans
during 2006, Plans J and K, which are each
eligible plans of two different governmental
entities. Each plan includes provisions
allowing the maximum annual deferral
permitted under § 1.457–4(c)(1) through (3).
For 2006, the underutilized amount under
§ 1.457–4(c)(3)(ii)(B) is $20,000 under Plan J
and is $40,000 under Plan K. Normal
retirement age is age 65 under both plans.
Participant F defers $15,000 under each plan.
Participant F’s includible compensation is in
each case in excess of the deferral. Neither
plan designates the $15,000 contribution as
a catch-up permitted under each plan’s
special section 457 catch-up provisions.
(ii) Conclusion. For purposes of applying
this section to Participant F for 2006, the
maximum exclusion is $20,000. This is equal
to the sum of $15,000 plus $5,000, which is
the age 50 catch-up amount. Thus, F has an
excess amount of $10,000 which is treated as
an excess deferral for Participant F for 2006
under § 1.457–4(e).
Example 2. (i) Facts. Participant E, who
will turn 63 on April 1, 2006, participates in
four eligible plans during 2006: Plan W
which is an eligible governmental plan; and
Plans X, Y, and Z which are each eligible
plans of three different tax-exempt entities.
For 2006, the limitation under these plans
that apply to Participant E under all four
plans under § 1.457–4(c)(1)(i)(A) is $15,000.
For 2006, the additional age 50 catch-up
limitation that applies to Participant E under
Plan W under § 1.457–4(c)(2) is $5,000.
Further, for 2006, different limitations under
§§ 1.457–4(c)(3) and (c)(3)(ii)(B) apply to
Participant E under each of these plans, as
follows: Under Plan W, the underutilized
limitation under § 1.457–4(c)(3)(ii)(B) is
$7,000; under Plan X, the underutilized
limitation under § 1.457–4(c)(3)(ii)(B) is
$2,000; under Plan Y, the underutilized
limitation under § 1.457–4(c)(3)(ii)(B) is
$8,000; and under Plan Z, § 1.457–4(c)(3) is
not applicable since normal retirement age is
age 62 under Plan Z. Participant E’s
includible compensation is in each case in
excess of any applicable deferral.
(ii) Conclusion. For purposes of applying
this section to Participant E for 2006,
Participant E could elect to defer $23,000
under Plan Y, which is the maximum

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deferral limitation under §§ 1.457–4(c)(1)
through (3), and to defer no amount under
Plans W, X, and Z. The $23,000 maximum
amount is equal to the sum of $15,000 plus
$8,000, which is the catch-up amount
applicable to Participant E under Plan Y and
which is the largest catch-up amount
applicable to Participant E under any of the
four plans for 2006. Alternatively, Participant
E could instead elect to defer the following
combination of amounts: $5,000 to Plan W
and an aggregate total of $15,000 to Plans X,
Y, and Z; $22,000 to Plan W and none to any
of the other three plans; $17,000 to Plan X
and none to any of the other three plans; or
$15,000 to Plan Z and none to any of the
other three plans.
(iii) If the underutilized amount under
Plans W, X, and Y for 2006 were in each case
zero (because E had always contributed the
maximum amount or E was a new
participant) or an amount not in excess of
$5,000, the maximum exclusion under this
section would be $20,000 for Participant E
for 2006 ($15,000 plus the $5,000 age 50
catch-up amount), which Participant E could
contribute to Plan W.
§ 1.457–6 Timing of distributions under
eligible plans.

(a) In general. Except as provided in
paragraph (c) of this section (relating to
distributions on account of an
unforeseeable emergency), paragraph (e)
of this section (relating to distributions
of small accounts), § 1.457–10(a)
(relating to plan terminations), or
§ 1.457–10(c) (relating to domestic
relations orders), amounts deferred
under an eligible governmental plan
may not be paid to a participant or
beneficiary before the participant has a
severance from employment with the
eligible employer. For rules relating to
loans, see paragraph (f) of this section.
(b) Severance from employment—(1)
Employees. An employee has a
severance from employment with the
eligible employer if the employee dies,
retires, or otherwise has a severance
from employment with the eligible
employer.
(2) Independent contractors—(i) In
general. An independent contractor is
considered to have a severance from
employment with the eligible employer
upon the expiration of the contract (or
in the case of more than one contract,
all contracts) under which services are
performed for the eligible employer, if
the expiration constitutes a good-faith
and complete termination of the
contractual relationship. An expiration
does not constitute a good faith and
complete termination of the contractual
relationship if the eligible employer
anticipates a renewal of a contractual
relationship or the independent
contractor becoming an employee. For
this purpose, an eligible employer is
considered to anticipate the renewal of
the contractual relationship with an

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independent contractor if it intends to
again contract for the services provided
under the expired contract, and neither
the eligible employer nor the
independent contractor has eliminated
the independent contractor as a possible
provider of services under any such new
contract. Further, an eligible employer
is considered to intend to again contract
for the services provided under an
expired contract if the eligible
employer’s doing so is conditioned only
upon incurring a need for the services,
the availability of funds, or both.
(ii) Special rule. Notwithstanding
paragraph (b)(2)(i) of this section, the
plan is considered to satisfy the
requirement described in paragraph (a)
of this section that no amounts deferred
under the plan be paid or made
available to the participant before the
participant has a severance from
employment with the eligible employer,
if, with respect to amounts payable to a
participant who is an independent
contractor, an eligible plan provides
that—
(A) No amount will be paid to the
participant before a date at least 12
months after the day on which the
contract expires under which services
are performed for the eligible employer
(or, in the case of more than one
contract, all such contracts expire); and
(B) No amount payable to the
participant on that date will be paid to
the participant if, after the expiration of
the contract (or contracts) and before
that date, the participant performs
services for the eligible employer as an
independent contractor or an employee.
(c) Rules applicable to distributions
for unforeseeable emergencies—(1) In
general. An eligible plan may permit a
distribution to a participant or
beneficiary faced with an unforeseeable
emergency. The distribution must
satisfy the requirement of paragraph
(c)(2) of this section.
(2) Requirements—(i) Unforeseeable
emergency defined. An unforeseeable
emergency must be defined in the plan
as a severe financial hardship of the
participant or beneficiary resulting from
an illness or accident of the participant
or beneficiary, the participant’s or
beneficiary’s spouse or the participant’s
or beneficiary’s dependent (as defined
in section 152(a)); loss of the
participant’s or beneficiary’s property
due to casualty; or other similar
extraordinary and unforeseeable
circumstances arising as a result of
events beyond the control of the
participant or the beneficiary. For
example, the imminent foreclosure of or
eviction from the participant’s or
beneficiary’s primary residence may
constitute an unforeseeable emergency.

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
In addition, the need to pay for medical
expenses, including non-refundable
deductibles, as well as for the cost of
prescription drug medication, may
constitute an unforeseeable emergency.
Finally, the need to pay for the funeral
expenses of a family member may also
constitute an unforeseeable emergency.
Except in extraordinary circumstances,
the purchase of a home and the payment
of college tuition are not unforeseeable
emergencies under this paragraph (c)(2).
(ii) Unforeseeable emergency
distribution standard. Whether a
participant or beneficiary is faced with
an unforeseeable emergency permitting
a distribution under this paragraph (c) is
to be determined based on the relevant
facts and circumstances of each case,
but, in any case, a distribution on
account of unforeseeable emergency
may not be made to the extent that such
emergency is or may be relieved through
reimbursement or compensation from
insurance or otherwise; by liquidation
of the participant’s assets, to the extent
the liquidation of such assets would not
itself cause severe financial hardship; or
by cessation of deferrals under the plan.
(iii) Distribution necessary to satisfy
emergency need. Distributions because
of an unforeseeable emergency must be
limited to the amount reasonably
necessary to satisfy the emergency need
(which may include any amounts
necessary to pay any federal, state, or
local income taxes or penalties
reasonably anticipated to result from the
distribution).
(d) Minimum required distributions
for eligible plans. In order to be an
eligible plan, a plan must meet the
distribution requirements of section
457(d)(1) and (2). Under section
457(d)(2), a plan must meet the
minimum distribution requirements of
section 401(a)(9). See section 401(a)(9)
and the regulations thereunder for these
requirements. Section 401(a)(9) requires
that a plan begin lifetime distributions
to a participant no later than April 1 of
the calendar year following the later of
the calendar year in which the
participant attains age 701⁄2 or the
calendar year in which the participant
retires.
(e) Distributions of smaller accounts—
(1) In general. An eligible plan may
provide for a distribution of all or a
portion of a dollar amount which is not
attributable to rollover contributions (as
defined in section 411(a)(11)(D)). In
order to permit such a distribution, an
eligible plan must provide that the
amount of the distribution must not
exceed the dollar limit under section
411(a)(11)(A) (which is $5,000 for 2002)
and that the distribution is made only
if no amount has been deferred under

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the plan by or for the participant during
the two-year period ending on the date
of the distribution and there has been no
prior distribution under the plan to the
participant under this paragraph (e). An
eligible plan is not required to permit
distributions under this paragraph (e).
(2) Alternative provisions possible.
Consistent with the provisions of
paragraph (e)(1) of this section, a plan
may provide that the total amount
deferred for a participant or beneficiary,
if not in excess of the applicable dollar
limit of section 411(a)(11)(A), will be
distributed automatically to the
participant or beneficiary if the
requirements of paragraph (e)(1) of this
section are met. Alternatively, the plan
may provide for the total amount
deferred for a participant or beneficiary,
if not in excess of the applicable dollar
limit of section 411(a)(11)(A), to be
distributed to the participant or
beneficiary only if the participant or
beneficiary so elects. The plan is
permitted to substitute a specified dollar
amount that is less than the applicable
dollar limit of section 411(a)(11)(A)
under either of these alternatives. In
addition, these two alternatives can be
combined; for example, a plan could
provide for automatic distributions for
account balances totaling an amount not
in excess of the applicable dollar limit
of section 411(a)(11)(A) but allow
participants or beneficiary to elect a
distribution if the total account balance
is above $500 but not above the
applicable dollar limit of section
411(a)(11)(A).
(f) Loans from eligible plans—(1)
Eligible plans of tax-exempt entities. If
a participant or beneficiary receives
(directly or indirectly) any amount
deferred as a loan from an eligible plan
of a tax-exempt entity, that amount will
be treated as having been paid or made
available to the individual as a
distribution under the plan, in violation
of the distribution requirements of
section 457(d).
(2) Eligible governmental plans. The
determination of whether the
availability of a loan, the making of a
loan, or a failure to repay a loan made
from a trustee (or a person treated as a
trustee under section 457(g)) of an
eligible governmental plan to a
participant or beneficiary is treated as a
distribution (directly or indirectly) for
purposes of this section, and the
determination of whether the
availability of the loan, the making of
the loan, or a failure to repay the loan
is in any other respect a violation of the
requirements of section 457(b) and the
regulations, depends on the facts and
circumstances. Thus, for example, a
loan must bear a reasonable rate of

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30839

interest in order to satisfy the exclusive
benefit requirement of section 457(g)(1)
and § 1.457–8(a)(1). See also § 1.457–
7(b)(3) relating to the application of
section 72(p) with respect to the
taxation of a loan made under an
eligible governmental plan, and
§ 1.72(p)–1 relating to section 72(p)(2).
(3) Example. The provisions of
paragraph (f)(2) of this section are
illustrated by the following example:
Example. (i) Facts. Eligible Plan X of State
Y is funded through Trust Z. Plan X provides
for an employee’s account balance under
Plan X to be paid in 5 annual installments
(of 1⁄5th the account balance the first year,
1⁄4th the account balance the second year,
etc.) beginning at severance from
employment with State Y. Plan X includes a
loan program under which any active
employee with a vested account balance may
receive a loan from Trust Z. Loans are made
pursuant to plan provisions regarding loans
that are set forth in the plan under which
loans bear a reasonable rate of interest and
are secured by the employee’s account
balance. In order to avoid taxation under
§ 1.457–7(b)(3) and section 72(p)(1), the plan
provisions limit the amount of loans and
require loans to be repaid in level
installments as required under section
72(p)(2). Participant J’s vested account
balance under Plan X is $50,000. J receives
a loan from Trust Z in the amount of $5,000
on December 1, 2003 to be repaid in level
installments made quarterly over the 5-year
period ending on November 30, 2008.
Participant J makes the required repayments
until J has a severance from employment
from State Y in 2005 and subsequently fails
to repay the outstanding loan balance of
$2,250. The $2,250 loan balance is offset
against J’s $80,000 account balance benefit
under Plan X, and J is paid one fifth of the
remaining $77,750 in 2005.
(ii) Conclusion. The making of the loan to
J will not be treated as a violation of the
requirements of section 457(b) or the
regulations. The cancellation of the loan at
severance from employment does not cause
Plan X to fail to satisfy the requirements for
plan eligibility under section 457. In
addition, because the loan satisfies the
maximum amount and repayment
requirements of section 72(p)(2), J is not
required to include any amount in income as
a result of the loan until 2005, when J has
income of $2,250 as a result of the offset
(which is a permissible distribution under
this section) and income of $15,550 (one fifth
of $77,750) as a result of the first annual
installment payment.
§ 1.457–7 Taxation of distributions under
eligible plans.

(a) General rules for when amounts
are included in gross income. The rules
for determining when an amount
deferred under an eligible plan is
includible in the gross income of a
participant or beneficiary depend on
whether the plan is an eligible
governmental plan or an eligible plan of
a tax-exempt entity. Paragraph (b) of this

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules

section sets forth the rules for an eligible
governmental plan. Paragraph (c) of this
section sets forth the rules for an eligible
plan of a tax-exempt entity.
(b) Amounts included in gross income
under an eligible governmental plan—
(1) Amounts included in gross income
in year paid under an eligible
governmental plan. Except as provided
in paragraphs (b)(2) and (3) of this
section (or in § 1.457–10(c) relating to
payments to a spouse or former spouse
pursuant to a qualified domestic
relations order), amounts deferred under
an eligible governmental plan are
includible in the gross income of a
participant or beneficiary for the taxable
year in which paid to the participant or
beneficiary under the plan.
(2) Rollovers to individual retirement
arrangements and other eligible
retirement plans. A trustee-to-trustee
transfer in accordance with section
401(a)(31) (generally referred to as a
direct rollover) is not includible in gross
income of a participant or beneficiary in
the year transferred. In addition, any
payment made in the form of an eligible
rollover distribution (as defined in
section 402(c)(4)) is not includible in
gross income in the year paid to the
extent the payment is transferred to an
eligible retirement plan (as defined in
section 402(c)(8)(B)) within 60 days,
including the transfer to the eligible
retirement plan of any property
distributed from the eligible
governmental plan. For this purpose,
the rules of section 402(c)(2) through (7)
and (9) apply. Any trustee-to-trustee
transfer under this paragraph (b)(2) is a
distribution that is subject to the
distribution requirements of § 1.457–6.
(3) Amounts taxable under section
72(p)(1). In accordance with section
72(p), the amount of any loan from an
eligible governmental plan to a
participant or beneficiary (including any
pledge or assignment treated as a loan
under section 72(p)(1)(B)) is treated as
having been received as a distribution
from the plan under section 72(p)(1),
except to the extent set forth in section
72(p)(2) (relating to loans that do not
exceed a maximum amount and that are
repayable in accordance with certain
terms) and § 1.72(p)–1. Thus, except to
the extent a loan satisfies section
72(p)(2), any amount loaned from an
eligible governmental plan to a
participant or beneficiary (including any
pledge or assignment treated as a loan
under section 72(p)(1)(B)) is includible
in the gross income of the participant or
beneficiary for the taxable year in which
the loan is made. See generally
§ 1.72(p)–1.

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(4) Examples. The provisions of this
paragraph (b) are illustrated by the
following examples:
Example 1. (i) Facts. Eligible Plan G of a
governmental entity permits distribution of
benefits in a single sum or in installments of
up to 20 years, with such benefits to
commence at any date that is after severance
from employment (but not later than the
plan’s normal retirement age of 65). Effective
for participants who have a severance from
employment after December 31, 2001, Plan X
allows an election—as to both the date on
which payments are to begin and the form in
which payments are to be made—to be made
by the participant at any time that is before
the commencement date selected. However,
Plan X chooses to require elections to be filed
at least 30 days before the commencement
date selected in order for Plan X to have
enough time to be able to effectuate the
election.
(ii) Conclusion. No amounts are included
in gross income before actual payments
begin. If installment payments begin (and the
installment payments are payable over at
least 10 years so as not to be eligible rollover
distributions), the amount included in gross
income for any year is equal to the amount
of the installment payment paid during the
year.
Example 2. (i) Facts. Same facts as in
Example 1, except that the same rules are
extended to participants who had a severance
from employment before January 1, 2002.
(ii) Conclusion. For all participants (i.e.,
both those who have a severance from
employment after December 31, 2001 and
those who have a severance from
employment before January 1, 2002
(including those whose benefit payments
have commenced before January 1, 2002)), no
amounts are included in gross income before
actual payments begin. If installment
payments begin (and the installment
payments are payable over at least 10 years
so as not to be eligible rollover distributions),
the amount included in gross income for any
year is equal to the amount of the installment
payment paid during the year.

(c) Amounts included in gross income
under an eligible plan of a tax-exempt
entity—(1) Amounts included in gross
income in year paid or made available
under an eligible plan of a tax-exempt
entity. Amounts deferred under an
eligible plan of a tax-exempt entity are
includible in the gross income of a
participant or beneficiary for the taxable
year in which paid or otherwise made
available to the participant or
beneficiary under the plan. Thus,
amounts deferred under an eligible plan
of a tax-exempt entity are includible in
the gross income of the participant or
beneficiary in the year the amounts are
first made available under the terms of
the plan, even if the plan has not
distributed the amounts deferred.
Amounts deferred under an eligible
plan of a tax-exempt entity are not
considered made available to the
participant or beneficiary solely because

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the participant or beneficiary is
permitted to choose among various
investments under the plan.
(2) When amounts deferred are
considered to be made available under
an eligible plan of a tax-exempt entity—
(i) General rule. Except as provided in
paragraphs (c)(2)(ii) through (iv) of this
section, amounts deferred under an
eligible plan of a tax-exempt entity are
considered made available (and, thus,
are includible in the gross income of the
participant or beneficiary under this
paragraph (c)) at the earliest date, on or
after severance from employment, on
which the plan allows distributions to
commence, but in no event later than
the date on which distributions must
commence pursuant to section 401(a)(9).
For example, in the case of a plan that
permits distribution to commence on
the date that is 60 days after the close
of the plan year in which the participant
has a severance from employment with
the eligible employer, amounts deferred
are considered to be made available on
that date. However, distributions
deferred in accordance with paragraphs
(c)(2)(ii) through (iv) of this section are
not considered made available prior to
the applicable date under paragraphs
(c)(2)(ii) through (iv) of this section. In
addition, no portion of a participant or
beneficiary’s account is treated as made
available (and thus currently includible
in income) under an eligible plan of a
tax-exempt entity merely because the
participant or beneficiary under the
plan may elect to receive a distribution
in any of the following circumstances:
(A) If the requirements of § 1.457–4(d)
are met, a distribution of amounts
representing accumulated sick and
vacation pay solely because a
participant was entitled to take paid
sick or vacation leave in lieu of regular
compensation or because the participant
could have deferred these amounts
under an eligible plan at an earlier date.
However, to the extent that the
participant is able to receive the value
of accumulated sick and vacation pay in
cash (in addition to regular
compensation) at the time of the
election to defer, these amounts are
considered made available.
(B) If the requirements of § 1.457–
6(c)(2) are met, a distribution in the
event of an unforeseeable emergency.
(C) If the requirements of § 1.457–
6(e)(1) are met, a distribution not in
excess of the dollar limit under section
411(a)(11)(A) (which is $5,000 for 2002)
either before or after the participant has
a severance from employment with the
employer.
(ii) Initial election to defer
commencement of distributions—(A) In
general. An eligible plan of a tax-exempt

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entity may provide a period for making
an initial election during which the
participant or beneficiary may elect, in
accordance with the terms of the plan,
to defer the payment of some or all of
the amounts deferred to a fixed or
determinable future time. The period for
making this initial election must expire
prior to the first time that any such
amounts would be considered made
available under the plan under
paragraph (c)(2)(i) of this section.
(B) Failure to make initial election to
defer commencement of distributions.
Generally, if no initial election is made
by a participant or beneficiary under
this paragraph (c)(2)(ii), then the
amounts deferred under an eligible plan
of a tax-exempt entity are considered
made available and taxable to the
participant or beneficiary in accordance
with paragraph (c)(2)(i) of this section at
the earliest time, on or after severance
from employment (but in no event later
than the date on which distributions
must commence pursuant to section
401(a)(9)), that distribution is permitted
to commence under the terms of the
plan. However, the plan may provide for
a default payment schedule that applies
if no election is made. If the plan
provides for a default payment
schedule, the amounts deferred are
includible in the gross income of the
participant or beneficiary in the year the
amounts deferred are first made
available under the terms of the default
payment schedule.
(iii) Additional election to defer
commencement of distribution. An
eligible plan of a tax-exempt entity is
permitted to provide that a participant
or beneficiary who has made an initial
election under paragraph (c)(2)(ii)(A) of
this section may make one additional
election to defer (but not accelerate)
commencement of distributions under
the plan before distributions have
commenced in accordance with the
initial deferral election under paragraph
(c)(2)(ii)(A) of this section. Amounts
payable to a participant or beneficiary
under an eligible plan of a tax-exempt
entity are not treated as made available
merely because the plan allows the
participant to make an additional
election under this paragraph (c)(2)(iii).
A participant or beneficiary is not
precluded from making an additional
election to defer commencement of
distributions merely because the
participant or beneficiary has previously
received a distribution under § 1.457–
6(c) because of an unforeseeable
emergency, has received a distribution
of smaller amounts under § 1.457–6(e),
has made (and revoked) other deferral or
method of payment elections within the
initial election period, or is subject to a

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default payment schedule under which
the commencement of benefits is
deferred (for example, until a
participant is age 65).
(iv) Election as to method of payment.
An eligible plan of a tax-exempt entity
may provide that the election as to the
method of payment under the plan may
be made at any time prior to the time
the amounts are distributed in
accordance with the participant or
beneficiary’s initial or additional
election to defer commencement of
distributions under paragraph (c)(2)(ii)
or (iii) of this section. Where no method
of payment is elected, the entire amount
deferred will be includible in the gross
income of the participant or beneficiary
when the amounts first become made
available in accordance with a
participant’s initial or additional
elections to defer under paragraphs
(c)(2)(ii) and (iii) of this section, unless
the eligible plan provides for a default
method of payment (in which case
amounts are considered made available
and taxable when paid under the terms
of the default payment schedule).
(3) Examples. The provisions of this
paragraph (c) are illustrated by the
following examples:
Example 1. (i) Facts. Eligible Plan X of a
tax-exempt entity provides that a
participant’s total account balance,
representing all amounts deferred under the
plan, is payable to a participant in a single
sum 60 days after severance from
employment throughout these examples,
unless, during a 30-day period immediately
following the severance, the participant
elects to receive the single sum payment at
a later date (that is not later than the plan’s
normal retirement age of 65) or elects to
receive distribution in 10 annual installments
to begin 60 days after severance from
employment (or at a later date, if so elected,
that is not later than the plan’s normal
retirement age of 65). On November 13, 2002,
participant K, a calendar year taxpayer, has
a severance from employment with the
eligible employer. K does not, within the 30day window period, elect to postpone
distributions to a later date or to receive
payment in 10 fixed annual installments.
(ii) Conclusion. The single sum payment is
payable to K 60 days after the date K has a
severance from employment (January 12,
2003), and is includible in the gross income
of K in 2003 under section 457(a).
Example 2. (i) Facts. The terms of eligible
Plan X are the same as described in Example
1. Participant L participates in eligible Plan
X. On November 11, 2002, participant L has
a severance from the employment of the
eligible employer. On November 24, 2002, L
makes an initial deferral election not to
receive the single sum payment payable 60
days after the severance, and instead elects
to receive the amounts in 10 annual
installments to begin 60 days after severance
from employment.
(ii) Conclusion. No portion of L’s account
is considered made available in 2002 or 2003

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30841

before a payment is made and no amount is
includible in the gross income of L until
distributions commence. The annual
installment payable in 2003 will be
includible in L’s gross income in 2003.
Example 3. (i) Facts. The facts are the same
as in Example 1, except that eligible Plan X
also provides that those participants who are
receiving distributions in 10 annual
installments may, at any time and without
restriction, elect to receive a cash out of all
remaining installments. Participant M elects
to receive a distribution in 10 annual
installments commencing in 2003.
(ii) Conclusion. M’s total account balance,
representing the total of the amounts deferred
under the plan, is considered made available
in, and is includible in M’s gross income, in
2003.
Example 4. (i) Facts. The facts are the same
as in Example 3, except that, instead of
providing for an unrestricted cash out of
remaining payments, the plan provides that
participants or beneficiaries who are
receiving distributions in 10 annual
installments may accelerate the payment of
the amount remaining payable to the
participant upon the occurrence of an
unforeseeable emergency as described in
§ 1.457–6(c)(1) in an amount not exceeding
that described in § 1.457–6(c)(2).
(ii) Conclusion. No amount is considered
made available to participant M on account
of M’s right to accelerate payments upon the
occurrence of an unforeseeable emergency.
Example 5. (i) Facts. Eligible Plan Y of a
tax-exempt entity provides that distributions
will commence 60 days after a participant’s
severance from employment unless the
participant elects, within a 30-day window
period following severance from
employment, to defer distributions to a later
date (but no later than the year following the
calendar year the participant attains age
701⁄2). The plan provides that a participant
who has elected to defer distributions to a
later date may make an election as to form
of distribution at any time prior to the 30th
day before distributions are to commence.
(ii) Conclusion. No amount is considered
made available prior to the date distributions
are to commence by reason of a participant’s
right to defer or make an election as to the
form of distribution.
Example 6. (i) Facts. The facts are the same
as in Example 1, except that the plan also
permits participants who have earlier made
an election to defer distribution to make one
additional deferral election at any time prior
to the date distributions are scheduled to
commence. Participant N has a severance
from employment at age 50. The next day,
during the 30-day period provided in the
plan, N elects to receive distribution in the
form of 10 annual installment payments
beginning at age 55. Two weeks later, within
the 30-day window period, N makes a new
election permitted under the plan to receive
10 annual installment payments beginning at
age 60 (instead of age 55). When N is age 59,
N elects under the additional deferral
election provisions, to defer distributions
until age 65.
(ii) Conclusion. In this example, N’s
election to defer distributions until age 65 is
a valid election. The two elections N makes

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during the 30-day window period are not
additional deferral elections described in
paragraph (c)(2)(iii) of this section because
they are made before the first permissible
payout date under the plan. Therefore, the
plan is not precluded from allowing N to
make the additional deferral election.
However, N can make no further election to
defer distributions beyond age 65 because
this additional deferral election can only be
made once.

contracts described in section 401(f) that
satisfy the requirements of this
paragraph (a)(3) are treated as trusts
under rules similar to the rules of
section 401(f). Therefore, the provisions
of § 1.401(f)–1(b) will generally apply to
determine whether a custodial account
or an annuity contract is treated as a
trust. The use of a custodial account or
annuity contract as part of an eligible
governmental plan does not preclude
§ 1.457–8 Funding rules for eligible plans.
(a) Eligible governmental plans—(1) In the use of a trust or another custodial
account or annuity contract as part of
general. In order to be an eligible
governmental plan, all amounts deferred the same plan, provided that all such
vehicles satisfy the requirements of
under the plan, all property and rights
section 457(g)(1) and (3) and paragraphs
purchased with such amounts, and all
(a)(1) and (2) of this section and that all
income attributable to such amounts,
property, or rights, must be held in trust assets and income of the plan are held
in such vehicles.
for the exclusive benefit of participants
(ii) Custodial accounts—(A) In
and their beneficiaries. A trust
general. A custodial account is treated
described in this paragraph (a) that also
as a trust, for purposes of section
meets the requirements of §§ 1.457–3
457(g)(1) and paragraph (a)(1) and (2) of
through 1.457–10 is treated as an
this section, if the custodian is a bank,
organization exempt from tax under
as described in section 408(n), or a
section 501(a), and a participant’s or
person who meets the nonbank trustee
beneficiary’s interest in amounts in the
requirements of paragraph (a)(3)(ii)(B) of
trust is includible in the gross income
this section, and the account meets the
of the participants and beneficiaries
requirements of paragraphs (a)(1) and
only to the extent, and at the time,
(2) of this section, other than the
provided for in section 457(a) and
requirement that it be a trust.
§§ 1.457–4 through 1.457–10.
(B) Nonbank trustee status. The
(2) Trust requirement. (i) A trust
custodian of a custodial account may be
described in this paragraph (a) must be
a person other than a bank only if the
established pursuant to a written
person demonstrates to the satisfaction
agreement that constitutes a valid trust
of the Commissioner that the manner in
under state law. The terms of the trust
which the person will administer the
must make it impossible, prior to the
satisfaction of all liabilities with respect custodial account will be consistent
with the requirements of section
to participants and their beneficiaries,
457(g)(1) and (3). To do so, the person
for any part of the assets and income of
must demonstrate that the requirements
the trust to be used for, or diverted to,
of § 1.408–2(e)(2) through (6) (relating to
purposes other than for the exclusive
nonbank trustees) are met. The written
benefit of participants and their
application must be sent to the address
beneficiaries.
prescribed by the Commissioner in the
(ii) Amounts deferred under an
same manner as prescribed under
eligible governmental plan must be
§ 1.408–2(e). To the extent that a person
transferred to a trust within a period
has already demonstrated to the
that is not longer than is reasonable for
satisfaction of the Commissioner that
the proper administration of the
the person satisfies the requirements of
participant accounts (if any). For
§ 1.408–2(e) in connection with a
purposes of this requirement, the plan
qualified trust (or custodial account or
may provide for amounts deferred for a
annuity contract) under section 401(a),
participant under the plan to be
that person is deemed to satisfy the
transferred to the trust within a
requirements of this paragraph
specified period after the date the
(a)(3)(ii)(B).
amounts would otherwise have been
(iii) Annuity contracts. An annuity
paid to the participant. For example, the
plan could provide for amounts deferred contract is treated as a trust for purposes
of section 457(g)(1) and paragraph (a)(1)
under the plan to be contributed to the
of this section if the contract is an
trust within 15 business days following
annuity contract, as defined in section
the month in which these amounts
401(g), that has been issued by an
would otherwise have been paid to the
insurance company qualified to do
participant.
business in the State, and the contract
(3) Custodial accounts and annuity
meets the requirements of paragraphs
contracts treated as trusts—(i) In
(a)(1) and (2) of this section, other than
general. For purposes of the trust
the requirement that it be a trust. An
requirement of this paragraph (a),
annuity contract does not include a life,
custodial accounts and annuity

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health or accident, property, casualty, or
liability insurance contract.
(4) Combining assets. [Reserved]
(b) Eligible plans maintained by taxexempt entity—(1) General rule. In order
to be an eligible plan of a tax-exempt
entity, the plan must be unfunded and
plan assets must not be set aside for
participants or their beneficiaries.
Under section 457(b)(6) and this
paragraph (b), an eligible plan of a taxexempt entity must provide that all
amounts deferred under the plan, all
property and rights to property
(including rights as a beneficiary of a
contract providing life insurance
protection) purchased with such
amounts, and all income attributable to
such amounts, property, or rights, must
remain (until paid or made available to
the participant or beneficiary) solely the
property and rights of the eligible
employer (without being restricted to
the provision of benefits under the
plan), subject only to the claims of the
eligible employer’s general creditors.
(2) Additional requirements. For
purposes of paragraph (b)(1) of this
section, the plan must be unfunded
regardless of whether or not the
amounts were deferred pursuant to a
salary reduction agreement between the
eligible employer and the participant.
Any funding arrangement under an
eligible plan of a tax-exempt entity that
sets aside assets for the exclusive benefit
of participants violates this requirement,
and amounts deferred are generally
immediately includible in the gross
income of plan participants and
beneficiaries. Nothing in this paragraph
(b) prohibits an eligible plan from
permitting participants and their
beneficiaries to make an election among
different investment options available
under the plan, such as an election
affecting the investment of the amounts
described in paragraph (b)(1) of this
section.
§ 1.457–9 Effect on eligible governmental
plan when not administered in accordance
with eligibility requirements.

A plan of a state ceases to be an
eligible governmental plan on the first
day of the first plan year beginning more
than 180 days after the date on which
the Commissioner notifies the state in
writing that the plan is being
administered in a manner that is
inconsistent with one or more of the
requirements of §§ 1.457–3 through
1.457–8, or 1.457–10. However, the plan
may correct the plan inconsistencies
specified in the written notification
before the first day of that plan year and
continue to maintain plan eligibility. If
a plan ceases to be an eligible
governmental plan, amounts

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subsequently deferred by participants
will be includible in income when
deferred, or, if later, when the amounts
deferred cease to be subject to a
substantial risk of forfeiture, as provided
at § 1.457–11. Amounts deferred before
the date on which the plan ceases to be
an eligible governmental plan, and any
earnings thereon, will be treated as if
the plan continues to be an eligible
governmental plan and will not be
includible in participant’s or
beneficiary’s gross income until paid to
the participant or beneficiary.
§ 1.457–10

Miscellaneous provisions.

(a) Plan terminations and frozen
plans—(1) In general. An eligible
employer may amend its plan to
eliminate future deferrals for existing
participants or to limit participation to
existing participants and employees. An
eligible plan may also contain
provisions that permit plan termination
and permit amounts deferred to be
distributed on termination. In order for
a plan to be considered terminated,
amounts deferred under an eligible plan
must be distributed to all plan
participants and beneficiaries as soon as
administratively practicable after
termination of the eligible plan. The
mere provision for, and making of,
distributions to participants or
beneficiaries upon a plan termination
will not cause an eligible plan to cease
to satisfy the requirements of section
457(b) of the regulations.
(2) Employers that cease to be eligible
employers—(i) Plan not terminated. An
eligible employer that ceases to be an
eligible employer may no longer
maintain an eligible plan. If the
employer was a tax-exempt entity and
the plan is not terminated as permitted
under paragraph (a)(2)(ii) of this section,
the tax consequences to participants and
beneficiaries in the previously eligible
(unfunded) plan of an ineligible
employer will be determined in
accordance with either section 451 if the
employer becomes an entity other than
a state or § 1.457–11 if the employer
becomes a state. If the employer was a
state and the plan is neither terminated
as permitted under paragraph (a)(2)(ii)
of this section nor transferred to another
eligible plan of that state as permitted
under paragraph (b) of this section, the
tax consequences to participants in the
previously eligible governmental plan of
an ineligible employer, the assets of
which are held in trust pursuant to
§ 1.457–8(a), will be determined in
accordance with section 402(b) (section
403(c) in the case of an annuity
contract) and the trust will no longer be
treated as a trust that is exempt from tax
under section 501(a).

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(ii) Plan termination. As an
alternative to determining the tax
consequences to the plan and
participants under paragraph (a)(2)(i) of
this section, the employer may
terminate the plan and distribute the
amounts deferred (and all plan assets) to
all plan participants as soon as
administratively practicable in
accordance with paragraph (a)(1) of this
section. Such distribution may include
eligible rollover distributions in the case
of a plan that was an eligible
governmental plan. In addition, if the
employer is a state, another alternative
to determining the tax consequences
under paragraph (a)(2)(i) of this section
is to transfer the assets of the eligible
governmental plan to an eligible
governmental plan of another eligible
employer within the same state under
the plan-to-plan transfer rules of
paragraph (b) of this section.
(3) Examples. The provisions of this
paragraph (a) are illustrated by the
following examples:
Example 1. (i) Facts. Employer Y, a
corporation that owns a state hospital,
sponsors an eligible governmental plan
funded through a trust. Employer Y is
acquired by a for-profit hospital and
Employer Y ceases to be an eligible employer
under section 457(e)(1) or § 1.457–2(e).
Employer Y terminates the plan and, during
the next 6 months, distributes to participants
and beneficiaries all amounts deferred that
were under the plan.
(ii) Conclusion. The termination and
distribution does not cause the plan to fail to
be an eligible governmental plan. Amounts
that are distributed as eligible rollover
distributions may be rolled over to an eligible
retirement plan described in section
402(c)(8)(B).
Example 2. (i) Facts. The facts are the same
as in Example 1, except that Employer Y
decides to continue to maintain the plan.
(ii) Conclusion. If Employer Y continues to
maintains the plan, the tax consequences to
participants and beneficiaries with respect to
compensation deferred thereafter will be
determined in accordance with either section
402(b) if the compensation deferred is funded
through a trust, section 403(c) if the
compensation deferred is funded through
annuity contracts, or § 1.457–11 if the
compensation deferred is not funded through
a trust or annuity contract. In addition, if
Employer Y continues to maintain the plan,
the trust (including amounts deferred before
the date on which the plan ceases to be an
eligible governmental plan and any earnings
thereon) will no longer be treated as exempt
from tax under section 501(a).
Example 3. (i) Facts. Employer Z, a
corporation that owns a tax-exempt hospital,
sponsors an unfunded eligible plan.
Employer Z is acquired by a for-profit
hospital and is no longer an eligible
employer under section 457(e)(1) or § 1.457–
2(e). Employer Z terminates the plan and
distributes all amounts deferred under the
eligible plan to participants and beneficiaries
within a one-year period.

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(ii) Conclusion. Distributions under the
plan are treated as made under an eligible
plan of a tax-exempt entity and the
distributions of the amounts deferred are
includible in the gross income of the
participant or beneficiary in the year
distributed.
Example 4. (i) Facts. The facts are the same
as in Example 3, except that Employer Z
decides to maintain instead of terminate the
plan.
(ii) Conclusion. If Employer Z maintains
the plan, the tax consequences to participants
and beneficiaries in the plan will thereafter
be determined in accordance with section
451.

(b) Plan-to-plan transfers—(1) General
rule. An eligible governmental plan may
provide for the transfer of amounts
deferred by a participant or beneficiary
to another eligible governmental plan,
and an eligible plan of a tax-exempt
entity may provide for transfers of
amounts deferred by a participant to
another eligible plan of a tax-exempt
entity, if the conditions in paragraph
(b)(2) of this section are met. An eligible
governmental plan may accept transfers
from another eligible governmental plan
as described in the preceding sentence,
and an eligible plan of a tax-exempt
entity may accept transfers from another
eligible plan of a tax-exempt entity as
described in the preceding sentence.
However, a state may not transfer the
assets of its eligible governmental plan
to a tax-exempt entity’s eligible plan
and the plan of a tax-exempt entity may
not accept such a transfer. Similarly, a
tax-exempt entity may not transfer the
assets of its eligible plan to an eligible
governmental plan and an eligible
governmental plan may not accept such
a transfer. In addition, if the conditions
in paragraph (b)(4) of this section
(relating to permissive past service
credit and repayments under section
415) are met, an eligible governmental
plan of a state may provide for the
transfer of amounts deferred by a
participant or beneficiary to a qualified
plan (under section 401(a)) maintained
by a state. However, a qualified plan
may not transfer assets to an eligible
governmental plan or to an eligible plan
of a tax-exempt entity, and an eligible
governmental plan or the plan of a taxexempt entity may not accept such a
transfer.
(2) Requirements for plan-to-plan
transfers among eligible plans. A
transfer under paragraph (b)(1) of this
section from an eligible governmental
plan to another eligible governmental
plan is permitted only if the following
conditions are met—
(i) The transferor plan provides for
transfers;
(ii) The receiving plan provides for
the receipt of transfers;

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(iii) The participant or beneficiary
whose amounts deferred are being
transferred will have an amount
deferred immediately after the transfer
at least equal to the amount deferred
with respect to that participant or
beneficiary immediately before the
transfer; and
(iv) The participant or beneficiary
whose amounts deferred are being
transferred has had a severance from
employment with the transferring
employer and is performing services for
the entity maintaining the receiving
plan. However, this paragraph (b)(2)(iv)
is not required to be satisfied if—
(A) All of the assets held by the
eligible governmental plan are
transferred;
(B) The transfer is to another eligible
governmental plan maintained by an
eligible employer that is a state entity
within the same state; and
(C) The participants whose deferred
amounts are being transferred are not
eligible for additional annual deferrals
in the receiving plan unless they are
performing services for the entity
maintaining the receiving plan.
(3) Examples. The provisions of
paragraphs (b)(1) and (2) of this section
are illustrated by the following
examples:
Example 1. (i) Facts. Participant A, the
president of City X’s hospital, has accepted
a position with another hospital which is a
tax-exempt entity. A participates in the
eligible governmental plan of City X. A
would like to transfer the amounts deferred
under City X’s eligible governmental plan to
the eligible plan of the tax-exempt hospital.
(ii) Conclusion. City X’s plan may not
transfer A’s amounts deferred to the taxexempt employer’s eligible plan. In addition,
because the amounts deferred would no
longer be held in trust for the exclusive
benefit of participants and their beneficiaries,
the transfer would violate the exclusive
benefit rule of section 457(g) and § 1.457–
8(a).
Example 2. (i) Facts. County M, located in
State S, operates several health clinics and
maintains an eligible governmental plan for
employees of those clinics. One of the clinics
operated by County M is being acquired by
a hospital operated by State S, and
employees of that clinic will become
employees of State S. County M permits
those employees to transfer their balances
under County M’s eligible governmental plan
to the eligible governmental plan of State S.
(ii) Conclusion. If the eligible governmental
plans of County M and State S provide for
the transfer and acceptance of the transfer
(and the other requirements of paragraph
(b)(1) of this section are satisfied), the
transfer will not cause either plan to violate
the requirements of section 457 or these
regulations.
Example 3. (i) Facts. City Employer Z, a
hospital, sponsors an eligible governmental
plan. City Employer Z is located in State B.

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All of the assets of City Employer Z are being
acquired by a tax-exempt hospital. City
Employer Z, in accordance with the plan-toplan transfer rules of paragraph (b) of this
section, would like to transfer the total
amount of assets deferred under City
Employer Z’s eligible governmental plan to
the acquiring tax-exempt entity’s eligible
plan.
(ii) Conclusion. City Employer Z may not
permit participants to transfer the amounts to
the eligible plan of the tax-exempt entity. In
addition, because the amounts deferred
would no longer be held in trust for the
exclusive benefit of participants and their
beneficiaries, the transfer would violate the
exclusive benefit rule of section 457(g) and
§ 1.457–8(a).
Example 4. (i) Facts. The facts are the
same as in Example 3, except that City
Employer Z, prior to the transfer of all of its
assets to the eligible plan of the tax-exempt
entity, decides to transfer all of the amounts
deferred under City Z’s eligible governmental
plan to the eligible governmental plan of the
related state government entity, State B.
(ii) Conclusion. If City Employer Z’s
(transferor) eligible governmental plan
provides for such transfer and the eligible
governmental plan of the State B permits the
acceptance of such a transfer (and the other
requirements of paragraph (b)(1) of this
section are satisfied), City Employer Z may
transfer the total amounts deferred under its
eligible governmental plan, prior to
termination of that plan, to the eligible
governmental plan maintained by State B.
However, the participants of City Employer
Z whose deferred amounts are being
transferred are not eligible to participate in
the eligible governmental plan of State B, the
receiving plan, unless they are performing
services for State B.

(4) Purchase of permissive past
service credit by plan-to-plan transfers
from an eligible governmental plan to a
qualified plan—(i) General rule. An
eligible governmental plan of a state
may provide for the transfer of amounts
deferred by a participant or beneficiary
to a defined benefit governmental plan
(as defined in section 414(d)) of that
state, and no amount shall be includible
in gross income by reason of the
transfer, if the conditions in paragraph
(b)(4)(ii) of this section are met. A
transfer under this paragraph (b)(4) is
not treated as a distribution for purposes
of § 1.457–6. Therefore, such a transfer
may be made before severance from
employment.
(ii) Conditions for plan-to-plan
transfers from an eligible governmental
plan to a qualified plan. A transfer may
be made under this paragraph (b)(4)
only if the transfer is either—
(A) For the purchase of permissive
past service credit (as defined in section
415(n)(3)(A)) under the receiving
defined benefit governmental plan; or
(B) A repayment to which section 415
does not apply by reason of section
415(k)(3).

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(iii) Example. The provisions of this
paragraph (b)(4) are illustrated by the
following example:
Example. (i) Facts. Plan X is an eligible
governmental plan maintained by County Y
for its employees. Plan X provides for
distributions only in the event of death, an
unforeseeable emergency, or severance from
employment with Y (including retirement
from Y). Plan S is a qualified defined benefit
plan maintained by State T for its employees.
County Y is within State T. Employee A is
an employee of Y and is a participant in Plan
X. Employee A previously was an employee
of T and is still entitled to benefits under
Plan S. Plan S includes provisions allowing
participants in certain plans, including Plan
X, to transfer assets to Plan S for the purchase
past service credit under Plan S not in excess
of the credit permitted under section 415(n)
and does not permit the amount transferred
to exceed the amount necessary to fund the
benefit resulting from the past service credit.
Although not required to do so, Plan X
allows A to transfer assets to Plan T to
provide a past service benefit under Plan T.
(ii) Conclusion. Assuming that the special
rules at section 415(n)(3) are satisfied with
respect to the transfer, the transfer is
permitted under this paragraph (b)(4).

(c) Qualified domestic relations orders
under eligible plans—(1) General rule.
An eligible plan does not become an
ineligible plan described in section
457(f) solely because its administrator or
sponsor complies with a qualified
domestic relations order as defined in
section 414(p), including an order
requiring the distribution of the benefits
of a participant to an alternate payee in
advance of the general rules for eligible
plan distributions under § 1.457–6. If a
distribution or payment is made from an
eligible plan to an alternate payee
pursuant to a qualified domestic
relations order, rules similar to the rules
of section 402(e)(1)(A) shall apply to the
distribution or payment.
(2) Examples. The provisions of this
paragraph (c) are illustrated by the
following examples:
Example 1. (i) Facts. Participant C and C’s
spouse D are divorcing. C is employed by
State S and is a participant in an eligible plan
maintained by S. C has an account valued at
$100,000 under the plan. Pursuant to the
divorce, a court issues a qualified domestic
relations order on September 1, 2003 that
allocates 50 percent of C’s $100,000 plan
account to D and specifically provides for an
immediate distribution to D of D’s share
within 6 months of the order. Payment is
made to D in January of 2004.
(ii) Conclusion. S’s eligible plan does not
become an ineligible plan described in
section 457(f) and § 1.457–11 solely because
its administrator or sponsor complies with
the qualified domestic relations order
requiring the immediate distribution to D in
advance of the general rules for eligible plan
distributions under § 1.457–6. In accordance
with section 402(e)(1)(A), D (not C) must
include the distribution in gross income. The

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules
distribution is includible in D’s gross income
in 2004. If the qualified domestic relations
order were to provide for distribution to D at
a future date, amounts deferred attributable
to D’s share will be includible in D’s gross
income when paid to D.
Example 2. (i) Facts. The facts are the same
as in Example 1, except that S is a tax-exempt
entity, instead of a state.
(ii) Conclusion. S’s eligible plan does not
become an ineligible plan described in
section 457(f) and § 1.457–11 solely because
its administrator or sponsor complies with
the qualified domestic relations order
requiring the immediate distribution to D in
advance of the general rules for eligible plan
distributions under § 1.457–6. In accordance
with section 402(e)(1)(A), D (not C) must
include the distribution in gross income. The
distribution is includible in D’s gross income
in 2004, assuming that the plan did not make
the distribution available to D in 2003. If the
qualified domestic relations order were to
provide for distribution to D at a future date,
amounts deferred attributable to D’s share
would be includible in D’s gross income
when paid or made available to D.

(d) Death benefits and life insurance
proceeds. A death benefit plan under
section 457(e)(11) is not an eligible plan.
In addition, no amount paid or made
available under an eligible plan as death
benefits or life insurance proceeds is
excludable from gross income under
section 101.
(e) Rollovers to eligible governmental
plans—(1) General rule. An eligible
governmental plan may accept
contributions that are eligible rollover
distributions (as defined in section
402(c)(4)) made from another eligible
retirement plan (as defined in section
402(c)(8)(B)) if the conditions in
paragraph (e)(2) of this section are met.
Amounts contributed to an eligible
governmental plan as eligible rollover
distributions are not taken into account
for purposes of the annual limit on
annual deferrals by a participant in
§ 1.457–4(c) or § 1.457–5, but are
otherwise treated in the same manner as
amounts deferred under section 457 for
purposes of §§ 1.457–3 through 1.457–9
and this section.
(2) Conditions for rollovers to an
eligible governmental plan. An eligible
governmental plan that permits eligible
rollover distributions made from
another eligible retirement plan to be
paid into the eligible governmental plan
is required under this paragraph (e)(2) to
provide that it will separately account
for any eligible rollover distributions it
receives.
(3) Example. The provisions of this
paragraph (e) are illustrated by the
following example:
Example. (i) Facts. Plan T is an eligible
governmental plan that provides that
employees who are eligible to participate in
Plan T may make rollover contributions to

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Plan T from amounts distributed to an
employee from an eligible retirement plan.
An eligible retirement plan is defined in Plan
T as another eligible governmental plan, a
qualified section 401(a) or 403(a) plan, or a
section 403(b) contract, or an individual
retirement arrangement (IRA) that holds such
amounts. Plan T requires rollover
contributions to be paid by the eligible
retirement plan directly to Plan T (a direct
rollover) or to be paid by the participant
within 60 days after the date on which the
participant received the amount from the
other eligible retirement plan. Plan T does
not take rollover contributions into account
for purposes of the plan’s limits on amounts
deferred that conform to § 1.457–4(c).
Rollover contributions paid to Plan T are
invested in the trust in the same manner as
amounts deferred under Plan T and rollover
contributions (and earnings thereon) are
available for distribution to the participant at
the same time and in the same manner as
amounts deferred under Plan T. In addition,
Plan T provides that, for each participant
who makes a rollover contribution to Plan T,
the Plan T recordkeeper is to establish a
separate account for the participant’s rollover
contributions. The recordkeeper calculates
earnings and losses for investments held in
the rollover account separately from earnings
and losses on other amounts held under the
plan and calculates disbursements from and
payments made to the rollover account
separately from disbursements from and
payments made to other amounts held under
the plan.
(ii) Conclusion. Plan T does not lose its
status as an eligible governmental plan as a
result of the receipt of rollover contributions.

(f) Deemed IRAs under eligible
governmental plans. [Reserved]
§ 1.457–11 Tax treatment of participants if
plan is not an eligible plan.

(a) In general. Under section 457(f), if
an eligible employer provides for a
deferral of compensation under any
agreement or arrangement that is an
ineligible plan—
(1) Compensation deferred under the
agreement or arrangement is includible
in the gross income of the participant or
beneficiary for the first taxable year in
which there is no substantial risk of
forfeiture (within the meaning of section
457(f)(3)(B)) of the rights to such
compensation;
(2) If the compensation deferred is
subject to a substantial risk of forfeiture,
the amount includible in gross income
for the first taxable year in which there
is no substantial risk of forfeiture
includes earnings thereon to the date on
which there is no substantial risk of
forfeiture;
(3) Earnings credited on the
compensation deferred under the
agreement or arrangement that are not
includible in gross income under
paragraph (a)(2) of this section are
includible in the gross income of the
participant or beneficiary only when

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30845

paid or made available to the participant
or beneficiary, provided that the interest
of the participant or beneficiary in any
assets (including amounts deferred
under the plan) of the entity sponsoring
the agreement or arrangement is not
senior to the entity’s general creditors;
and
(4) Amounts paid or made available to
a participant or beneficiary under the
agreement or arrangement are includible
in the gross income of the participant or
beneficiary under section 72, relating to
annuities.
(b) Exceptions. Paragraph (a) of this
section does not apply with respect to—
(1) A plan described in section 401(a)
which includes a trust exempt from tax
under section 501(a);
(2) An annuity plan or contract
described in section 403;
(3) That portion of any plan which
consists of a transfer of property
described in section 83;
(4) That portion of any plan which
consists of a trust to which section
402(b) applies; or
(5) A qualified governmental excess
benefit arrangement described in section
415(m).
(c) Coordination of section 457(f) with
section 83—(1) Transfer of property
described in section 83. Under
paragraph (b)(3) of this section, section
457(f) and paragraph (a) of this section
do not apply to that portion of any plan
which consists of a transfer of property
described in section 83. For this
purpose, a transfer of property described
in section 83 means a transfer of
property to which section 83 applies.
Section 457(f) and paragraph (a) of this
section do not apply if the date on
which there is no substantial risk of
forfeiture with respect to compensation
deferred under an agreement or
arrangement that is not an eligible plan
is on or after the date on which there is
a transfer of property to which section
83 applies. However, section 457(f) and
paragraph (a) of this section apply if the
date on which there is no substantial
risk of forfeiture with respect to
compensation deferred under an
agreement or arrangement that is not an
eligible plan precedes the date on which
there is a transfer of property to which
section 83 applies. If deferred
compensation payable in property is
includible in gross income under
section 457(f), then, as provided in
section 72, the amount includible in
gross income when that property is later
transferred or made available to the
service provider is the excess of the
value of the property at that time over
the amount previously included in gross
income under section 457(f).

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Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / Proposed Rules

(2) Examples. The provisions of this
paragraph (c) are illustrated in the
following examples:
Example 1. (i) Facts. As part of an
arrangement for the deferral of compensation,
an eligible employer agrees on December 1,
2002 to pay an individual rendering services
for the eligible employer a specified dollar
amount on January 15, 2005. The
arrangement provides for the payment to be
made in the form of property having a fair
market value equal to the specified dollar
amount. The individual’s rights to the
payment are not subject to a substantial risk
of forfeiture (within the meaning of section
457(f)(3)(B)).
(ii) Conclusion. In this example, because
there is no substantial risk of forfeiture with
respect to the agreement to transfer property
in 2005, the present value (as of December 1,
2002) of the payment is includible in the
individual’s gross income for 2002. Under
paragraph (a)(4) of this section, when the
payment is made on January 15, 2005, the
amount includible in the individual’s gross
income is equal to the excess of the fair
market value of the property when paid, over
the amount that was includible in gross
income for 2002 (which is the basis allocable
to that payment).
Example 2. (i) Facts. As part of an
arrangement for the deferral of compensation,
individuals A and B rendering services for a
tax-exempt entity each receive in 2010
property that is subject to a substantial risk
of forfeiture (within the meaning of section
457(f)(3)(B) and within the meaning of
section 83(c)(1)). Individual A makes an
election to include the fair market value of
the property in gross income under section
83(b) and individual B does not make this
election. The substantial risk of forfeiture for
the property transferred to individual A
lapses in 2012 and the substantial risk of
forfeiture for the property transferred to
individual B also lapses in 2012. Thus, the
property transferred to individual A is
included in A’s gross income for 2010 when
A makes a section 83(b) election and the
property transferred to individual B is
included in B’s gross income for 2012 when
the substantial risk of forfeiture for the
property lapses.
(ii) Conclusion. In this example 2, in each
case, the compensation deferred is not
subject to section 457(f) or this section
because section 83 applies to the transfer of
property on or before the date on which there
is no substantial risk of forfeiture with
respect to compensation deferred under the
arrangement.
Example 3. (i) Facts. In 2010, X, a taxexempt entity, agrees to pay deferred
compensation to employee C. The amount
payable is $100,000 to be paid 10 years later
in 2020. The commitment to make the
$100,000 payment is not subject to a
substantial risk of forfeiture. In 2010, the
present value of the $100,000 is $50,000. In
2018, X transfers to C property having a fair
market value (for purposes of section 83)
equal to $70,000. The transfer is in partial
settlement of the commitment made in 2010
and, at the time of the transfer in 2018, the
present value of the commitment is $80,000.

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In 2020, X pays C the $12,500 that remains
due.
(ii) Conclusion. In this example 3, C has
income of $50,000 in 2010. In 2018, C has
income of $30,000, which is the amount
transferred in 2018, minus the allocable
portion of the basis that results from the
$50,000 of income in 2010. (Under section
72(e)(2)(B), income is allocated first. The
income is equal to $30,000 ($80,000 minus
the $50,000 basis), with the result that the
allocable portion of the basis is equal to
$40,000 ($70,000 minus the $30,000 of
income).) In 2020, C has income of $2,500
($12,500 minus $10,000, which is the excess
of the original $50,000 basis over the $40,000
basis allocated to the transfer made in 2018).
§ 1.457–12

Effective dates.

Sections 1.457–1 through 1.457–11
apply for taxable years beginning after
December 31, 2001, except that § 1.457–
11(c) does not apply with respect to an
option without a readily ascertainable
fair market value (within the meaning of
section 83(e)(3)) that was granted on or
before May 8, 2002 and, except that
§ 1.457–10(c) (relating to qualified
domestic relations orders) applies for
transfers, distributions, and payments
made afer December 31, 2001.
Robert E. Wenzel,
Deputy Commissioner of the Internal Revenue
Service.
[FR Doc. 02–11036 Filed 5–7–02; 8:45 am]
BILLING CODE 4830–01–P

DEPARTMENT OF TRANSPORTATION
Coast Guard
33 CFR Part 165
[CGD09–02–011]
RIN 2115–AA97

Security Zones; Captain of the Port
Toledo Zone, Lake Erie
Coast Guard, DOT.
Notice of proposed rulemaking.

AGENCY:
ACTION:

SUMMARY: The Coast Guard proposes to
establish two permanent security zones
on the navigable waters of Lake Erie in
the Captain of the Port Toledo zone.
These security zones are necessary to
protect the Enrico Fermi 2 Nuclear
Power Station and the Davis Besse
Nuclear Power Station from possible
acts of terrorism. These security zones
are intended to restrict vessel traffic
from a portion of Lake Erie off the
Enrico Fermi 2 Nuclear Power Station
and the Davis Besse Nuclear Power
Stations.
DATES: Comments and related material
must reach the Coast Guard on or before
June 7, 2002.

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ADDRESSES: You may mail comments to
U.S. Coast Guard Marine Safety Office
Toledo, 420 Madison Ave, Suite 700,
Toledo, Ohio 43604. The telephone
number is (419) 418–6050. Marine
Safety Office Toledo maintains the
public docket for this rulemaking.
Comments and materials received from
the public, as well as documents
indicated in this preamble as being
available in the docket, will become part
of this docket and will be available for
inspection or copying between 8 a.m.
and 4 p.m., Monday through Friday,
except Federal Holidays.
FOR FURTHER INFORMATION CONTACT: LT
Herb Oertli, Chief of Port Operations,
Marine Safety Office, 420 Madison Ave,
Suite 700, Toledo, Ohio 43604; (419)
418–6050.
SUPPLEMENTARY INFORMATION:

Request for Comments
We encourage you to participate in
this rulemaking by submitting
comments and related material. If you
do so, please include your name and
address, identify the docket number for
this rulemaking (CGD09–02–011),
indicate the specific section of this
document to which each comment
applies, and give the reason for each
comment. Please submit all comments
and related material in an unbound
format, no larger than 81⁄2 by 11 inches,
suitable for copying. If you would like
to know they reached us, please enclose
a stamped, self-addressed postcard or
envelope. We will consider all
comments and material received during
the comment period. We may change
this proposed rule in view of them.
Public Meeting
We do not now plan to hold a public
meeting. But you may submit a request
for a meeting by writing to U.S. Coast
Guard Marine Safety Office Toledo at
the address under ADDRESSES explaining
why one would be beneficial. If we
determine that one would aid this
rulemaking, we will hold one at a time
and place announced by a later notice
in the Federal Register.
Background and Purpose
On September 11, 2001, the United
States was the target of coordinated
attacks by international terrorists
resulting in the destruction of the World
Trade Center, significant damage to the
Pentagon, and tragic loss of life.
National security and intelligence
officials warn that future terrorists
attacks are likely.
We propose to establish a permanent
security zone off the waters of Enrico
Fermi 2 Nuclear Power Station,
Newport, Michigan. This security zone

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