Tech Talk: 457(b) Payments to Retirees When the Employer Closes

Q. A not-for-profit organization that has been around since the mid-1940s is closing its operation. A prior/retired Executive Officer has been receiving a monthly payment from their 457(b) eligible deferred compensation plan which is reported by the employer each year via IRS Form W-2. 

How should this be addressed? One possibility is to purchase an annuity from an insurance company which will act as a third party; however, the insurance company states they will not file an IRS Form W-2, but they will file IRS Form 1099. How good is this approach, versus another that does not include a lump sum payment?      

A. Under the Code Section 457 regulations (Treas. Reg. §1.457-10(a)), the answer is pretty clear. 

The first thing to do is to look at the 457(b) plan document, which should indicate what happens upon either (1) “plan termination” regarding the assets that remain in the plan or (2) freezing the plan. In this case, the employer is dissolving, so it appears that plan termination would be the only way to go. The regulations also indicate that the fact that the remaining assets are distributed (and they must be as soon as administratively feasible) will not cause the 457(b) plan to fail to satisfy the requirements of Section 457(b) or the regulations. Of course, this could cause an extremely high tax bill for the participants under that 457(b) top-hat plan. 

Unfortunately, this is probably the only option. It appears that this particular participant has been retired. If the participant was taking another job with a nonprofit that also was going to set up a 457(b) plan, then it is possible that the account could be transferred to the new employer.