After years of waiting, we are hearing rumblings that the proposed 457(f) regulations should be issued in 2012, perhaps during the first part of the year. The IRS “anticipates” changing the current 457(f) rules to recognize only cliff vesting and disallow elective deferrals. Plans using noncompete restrictions as the sole risks of forfeiture will no longer defer taxes. Fortunately, 457(b) plans would not be affected. As nonqualified deferral plans for credit unions normally use cliff vesting to qualify for tax deferral under 457(f), and supplemental employer contributions rather than elective deferrals, the new rules should require few if any changes to credit union plans.

The guidance is also expected to address what qualifies as a bona fide severance benefit for purposes of 457(f). Compensation paid under a bona fide severance plan will be taxed as received. Compensation in excess of the bona fide severance limits will be taxed in a lump sum at termination. We expect the bona fide  plan limit to be two times the lesser of (i) the executive’s annual compensation, or (ii) the qualified plan compensation limit ($250,000 in 2012).

As with deferred compensation, we expect that few changes will be required to comply with the new rules, and certainly there is no expectation that severance will actually have to be limited to the two-times limit.

As we wait for the proposed 457(f) regulations to be issued, credit union boards and management should consider:

1. Does the credit union have any nonqualified deferral plans that use noncompetes or elective deferrals?
2. Has the credit union established severance arrangements (contained in employment agreements or in separate arrangements) that exceed the expected bona fide limits?

If so, you should be prepared to update your plans when the new rules come out. If not, it will still be important to verify that no other changes to your plans are required.