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457(f) Proposed Regulations Relating to Deferred Compensation Plans

457(f) Proposed Regulations Relating to Deferred Compensation Plans

Because the final 457(f) regulations were not issued in 2016, the earliest effective date now becomes January 1, 2018. Also, note that the IRS may or may not choose to modify its proposed regulations based on feedback received during the public comment period and public hearing.

The IRS and the Treasury Department have released the long-awaited, proposed 457(f) regulations relating to deferred compensation plans of tax-exempt organizations and state or local governments.  These regulations flesh out the general rule that deferred compensation in tax-exempt or governmental organizations becomes taxable once it is no longer subject to a substantial risk of forfeiture.

These proposed regulations, which the IRS notes can be relied on immediately when making decisions on current plans, now specify in greater detail when amounts deferred under these plans are includible in income, the amounts that are includible, and the types of plans that are excluded.  Before the new regulations become final, the IRS is holding a public comment period that closes September 20, and a public hearing on October 18.  Thereafter, based on feedback, the IRS may or may not make further adjustments to the proposed regulations, and will then issue final regulations. The regulations could become effective as early as January 1, 2017, if final regulations are published by year-end 2016. If the IRS misses the January 1, 2017 date, the next possible effective date would not be until January 1, 2018.

Some key provisions in the proposed regulations include: 

  • A non-compete can still be a substantial risk of forfeiture (SRF), but is now subject to more restrictive criteria, requiring an analysis of the actual competitive threat posed by each individual to be covered by the restrictions.
  • Final regulations are expected to clarify that pre-effective date deferrals are taxed under the pre-effective date rules (which are not black and white).  New rules apply to all deferrals that occur on or after the effective date of the new 457(f) regulations, whether under an old plan or a new plan. This offers a type of grandfathering, but not a “no challenge” protection.

  • Voluntary deferrals and elections to extend vesting dates will still be permitted as long as the present value of the deferred compensation will be more than 25% greater than the current present value of the compensation to be deferred.  Also, the deferral must be for at least two years from the original payment date for each dollar deferred. There is potential for this to apply to participant elections of benefits under a FLEX Plan (allowance allocated toward supplemental benefits) that includes a deferral option, or to electing anything longer than the minimum possible deferred vesting date.
  • Under a new 457(f) short-term deferral plan exemption, benefits will be subject to income taxes when paid rather than when the SRF ends (e.g., amounts vested as of 12/31/16 can be paid and taxed in 2017, subject to the 2½-month restriction). The exemption applies to nonelective deferrals that are subject to a 457(f) SRF where benefits are paid within 2½ months after the end of the year in which the SRF is met (FICA taxes still apply in the year of vesting).
  • Bona fide severance pay plans (up to two times annual total compensation) will be exempt from Section 457(f) deferred compensation regulations if criteria are met. Severance amounts above two times annual compensation are subject to lump sum taxation at the beginning of the severance period.
  • Supplemental Executive Retirement Plan (SERP) rescissions in exchange for loan regime split dollar arrangements will be deemed to provide deferred compensation, which will likely preclude exchanging prior SERP accruals for loan regime split dollar plans after the final regulations become effective.
  • Post-retirement medical plans with cash payments to the executive will be subject to the new rules.
  • The regulations describe how Section 457(b) plans sponsored by state and local governments (not by non-governmental tax-exempt organizations) can comply with prior legislation addressing topics such as Roth contributions.

The regulations are helpful, but they also raise many questions about how the new standards and rules actually apply.  We will conduct a joint webinar with Sherman & Patterson, Ltd., to help you better understand the proposed regulations and their potential impact.  We will send an invitation for that webinar within the next two weeks.

Once we have more information about how the rules apply, we will be prepared to recommend specific actions to take with your plans.

In the meantime, please feel free to contact us with any questions you may have.  You can reach us at 800-836-3014 to pose your questions or to schedule a time to discuss your plans and the proposed regulations.

Marilyn Kern


Marilyn Kern is a Senior Consultant with the Total Compensation and Rewards service line of Integrated Healthcare Strategies, part of the Gallagher Human Resources & Compensation Consulting practice.

As an experienced executive compensation consultant, she works with a wide variety of healthcare organizations, including some of the largest healthcare systems, academic medical centers, independent community hospitals and healthcare associations.

Ms. Kern works with health care boards and senior executives on all aspects of executive compensation ...

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