Repeat Lesson from Great-grandfathered 457(f) Plans

Individuals who participated in a tax-exempt organization's nonqualified deferred compensation plan on August 16, 1986, are not subject to 457(f). Rather, they are taxed on basic constructive receipt principles, the same as participants in plans sponsored by taxable employers. That "great-grandfathered" status remains so long as the plan's "fixed formula" is not changed. Consistent with prior practice, the IRS just published another private letter ruling concluding that a reduction in the benefit formula is not a change in the formula that forfeits great-grandfathering.

Given the limited (and dwindling) number of great-grandfathered plans, the more important impact of the ruling is its confirmation that reducing benefits is generally not treated as a change in benefits. This is important for law and regulatory changes that, like the Tax Reform Act of 1986, are not express about the issue. For example, the 2003 split dollar regulations give nearly no guidance on what constitutes a "material modification" that forfeits grandfathering. This new private ruling gives additional analogous support for reducing split dollar benefits without forfeiting grandfathering and subjecting the plan to the new regulations. (Compare 409A, which specifically states that a reduction in benefits is not a material modification that forfeits grandfathering.)