Regulatory Update

Expected impact of 457(f) regulations on credit union plans

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.

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.)

§ 457(f) regs to "clean-up" § 409A

A key IRS attorney said last week that the § 457(f) regulations will be used as a vehicle to do some § 409A "clean-up." He also referred to the initial guidance being proposed rules. These comments seem to indicate that the regulations are moving forward, are broader than originally thought, and have a better chance of receiving earlier rather than later attention. The indication that they will come out in proposed form is positive news as it will not only give a chance for comment, but a longer period for easing into the new rules. From:

Advanced notice of proposed rules gives glimpse of IRS position on federal credit unions' §§ 457(b) and (f) plans

This week the IRS published draft proposed rules defining governments and government related entities for qualified plan purposes.  76 FR 69172. Resolving a six-year controversy, the draft rules also state that for purposes of non-qualified deferred compensation plans, federal credit unions are tax-exempt non-government entities, not federal instrumentalities. The result is that federal credit unions can sponsor 457(b) plans and 457(f) plans as any other tax-exempt organization. If the final regulations look like the proposed rules, few, if any, changes to current plans will be required. 457(b) plans designed to meet the 409A requirements could remove the 409A restrictions (such as annual deferral elections and five-year postponements for changing the time and form of benefit payments). Even now, new plans can be installed with greater confidence in the 457(b)/457(f) approach.

IRS announces pension plan limits for 2012

The IRS bumped the 2012 elective deferral limit for 457(b) plans from $16,500 to $17,000, along with a number of inflation adjustments.  Highlights include:

  • The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457(b) plans, and the federal government’s Thrift Savings Plan is increased from $16,500 to $17,000.
  • The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.
  • The limitation on the annual benefit under a defined benefit plan under Section 415(b)(1)(A) is increased from $195,000 to $200,000.
  • The limitation for defined contribution plans under Section 415(c)(1)(A) is increased from $49,000 to $50,000.
  • The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) is increased from $110,000 to $115,000.
  • The annual compensation limit under Section 401(a)(17) is increased from $245,000 to $250,000.


IRS releases Priority Guidance Plan

Last week the IRS released its 2011-2012 Priority Guidance Plan, detailing the areas it will focus on in its work year that began July 1. There aren't any surprises or new items of significance to key employee compensation.  It is nice to see that final regulations on §125 cafeteria plans and §457(f) deferred compensation regulations remain on the list. Maybe five years will be sufficient to finish the §457(f) regulations.

IRS Walks Back September Date

Recent chatter about the new 457(f) regulations being published in September may have been premature.  Cheryl Press, the senior IRS attorney who was quoted as targeting the September date, on June 15 stated that her projection might be "wishful thinking." She noted that healthcare regulations continue to demand a lot of time. She continued, "We're very slim staffed and our higher-ups are at an even slimmer level.  And once we clear [the proposed regulations] through our building and work through everything, we have to get it through Treasury, and they're pretty slimly staffed too."

Regarding the substance of the new regulations, Press reiterated that the regulations will be "similar" to the 409A rules (e.g., disallow pre-tax voluntary deferrals and the use of noncompete restrictions to defer taxes), but that the IRS is not "going to worry about having everything being exactly the same as 409A."

For those keeping track, August 2011 will be the fourth anniversary of the original IRS announcement that it would publish the new regulations.  Only time will tell how much longer we must wait.


NCUA Regulation §701.4

New NCUA Regulation §701.4 has some federal credit unions scrambling to make sure their directors have “at least a working familiarity with basic finance and accounting practices.”  Many are on their way to assuring their directors have the training they need.  The NCUA has given directors without such financial skills, whether new or currently serving, six months to receive the training.  Given the effective date of January 27, 2011 for Rule 701.4, directors who were at FCUs on such date and who need the training have just over four months to get it completed. The NCUA explained this standard in more depth in Letter No. 11-FCU-02.  It explained that “[a]t a minimum, a director should be able to examine the credit union’s balance sheet, income statement and be able to answer the following questions”:

  • What does this line item mean?
  • Why is it important?
  • Is the item’s value changing over time?  Why?
  • Is the change important?

The NCUA stated in the letter that direction and control of the credit union lie with the board, and that boards set the compensation of their executives.  Given this heightened attention to board management issues, and the importance of the board’s role in setting compensation, we set out below 10 best practices of compensation oversight.

  1. Develop a written compensation philosophy
  2. Specify covered positions
  3. Seek comparability data
  4. Annually review compensation
  5. Consider multiplier effect (e.g., salary increases may increase Defined Benefit SERP benefits)
  6. Engage periodic consultant review
  7. Consultants report to the board (NCUA is concerned about CEOs “screening” or “filtering” information)
  8. Inspect plan modifications
  9. Ensure plan documentation is compliant; and
  10. Associate with professionals to monitor legal developments (e.g., expected regulations under IRC §457(f))

Boards of federal credit unions that are already doing these things should make sure that they are documenting their process, so they can demonstrate compliance if requested by a regulator.  Although these rules do not apply to state-chartered credit unions, they provide helpful standards for those boards to follow as well.


Section 457(f) Regulations -- Getting Closer to Publication?

After nearly a year's silence, Cheryl Press, an IRS Senior Attorney working on the regulations, addressed the regulations on March 10, 2011. Speaking at a conference, she did not address when the regulations might be issued, but instead described a couple of provisions that had not previously been discussed. In addition to addressing substantial risks of forfeiture (presumably moving to the Section 409A non-elective, cliff vesting only model), Ms. Press said that the regulations will also cover illness and vacation leave, and what they require to be deemed "bona fide" arrangements that are exempt from the substantial risk of forfeiture requirement. Regarding the illness and vacation leave, she expressed concern that these arrangements are being used to increase 403(b) deferrals (presumably the ability to convert illness and vacation leave accruals to 403(b) contributions at the time of termination), or to be a type of "savings account" where the participant can take funds out and put them back in.

The last word we had from Ms. Press regarding the timing of the regulations was in April 2010, when she said the regulations were "substantially done." The new comments may signal they are not so far away from being published. But then again ...

IRS announcement on impact of Health Reform Act

As anticipated, yesterday the IRS announced that compliance with the new rules will not be required until the IRS is able to issue guidance/regulations with more details about what the rules mean and how to comply. Like most of the health reform act, in the absence of good legislative history and clear statutory language, the regulators are having to make things up as they go. The IRS has allowed for a comment period that extends to March 11, 2011.  That means that the new regulations likely will not be out until summer at the earliest.  Even then, they may have a deferred effective date.

Regarding the substance of the new rules, many questions remain to be answered as to how they apply to post-termination continuation of health benefits.  The biggest question is whether the rules even apply at all to post-termination continuation.