“I realize one of the differences between a 457(b) and a 403(b) plan is that technically, the 457(b) plan assets are assets of the employer until distributed to the employee. But what is the consequence of that difference to the employee? Is this only a concern in the unlikely event our company becomes insolvent, or are there other concerns as well?”
Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:
Excellent question, especially in light of the difficult financial situations many nonprofits are facing in the current economic environment.
First, it is important to know that, by definition, 457(b) plans of private tax-exempts are unfunded; unlike 403(b) plans, a separate account is not created to hold assets irrevocably set aside for the participant. Due to such unfunded status, 457(b) assets can become subject to creditors of the plan sponsor, and thus a participant is at risk in such situations of possibly not receiving all of his/her 457(b) plan benefits.
To address this risk to participants somewhat, some 457(b) plan sponsors set aside assets in what is called a “rabbi” trust (because the first IRS ruling that permitted such trusts was made on behalf of a synagogue). The rabbi trust, though owned by the employer, may only be accessed by the employer’s creditors in the event of the actual bankruptcy or insolvency of the employer. Thus the employer would not necessarily have access to the funds if, for example, it simply had difficulty in paying its creditors or otherwise encountered financial difficulties—unless the trust so provides or can be revoked. Because many such rabbi trusts do not so provide and cannot be revoked, the rabbi trust can help ensure that 457(b) plan participants will be paid unless the plan sponsor becomes bankrupt or otherwise insolvent.
It is important for employees to understand the bankruptcy/insolvency risk when they first become eligible for the 457(b) plan, so they can make a decision as to whether to make elective deferrals to this plan if they are permitted to do so. Fortunately, select management or highly compensated employees often are aware of the financial condition of the plan sponsor and thus can make an educated decision in this regard.
In the case of a church-related 457(b) plan (for example, of a “non-qualified church-controlled organization” such as a hospital, university or nursing home, the limitation to such a select group may not apply (because the plan is a church plan) and so rank and file employees might participate in it.
Also, keep in mind these are not concerns for governmental 457(b) plans, since the assets of those plans are required to be set aside in a regular qualified plan-type trust, and are thus protected.
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NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.