With very few exceptions, the rules governing governmental 457(b) plans require a “severance of employment” to occur before a distribution can be made. Recently, we came across yet another of those arcane, little-known rules that will likely trip-up hundreds of California workers who have terminated their current employment and now want to take a distribution from the 457(b) plan they participate in.
Basically, the problem appears to arise in connection with the CalPERS-sponsored multiple employer 457(b) plan. Why?
The 457(b) regulations provide, in part, that distributions cannot be made earlier than severance of employment or age 70½. They go on to state that an employee has a severance from employment with the eligible employer if the employee dies, retires or otherwise has a severance from employment with the eligible employer. However, the 457 regulations also direct readers to the 401(k) regulations for additional guidance concerning severance from employment. The relevant 401(k) regulation states: “An employee has a severance from employment when the employee ceases to be an employee of the employer maintaining the plan. An employee does not have a severance from employment if, in connection with a change of employment, the employee’s new employer maintains such plan with respect to the employee.”
Since the mid-90’s, CalPERS has provided a deferred compensation plan (a 457(b) plan), called the CalPERS Supplemental Income 457 Plan, to public agency employers and their employees. According to the CalPERS website, there are more than 800 participating employers in the Plan.
According to the Plan’s terms, a “severance from employment” is:
“The date that the Employee dies, retires, or otherwise has a severance from employment with the Employer, as determined by the Employer (and taking into account guidance issued under the Code). A Rehired Employee shall no longer be treated as having a Severance from Employment upon the date of his or her rehire.”
In turn, the Plan states that a “Rehired Employee” is:
“An Employee who has had a Severance from Employment with an Employer, and thereafter becomes an Employee of that Employer or another Employer that has adopted this Plan. An Employee shall be treated as a Rehired Employee on the date he or she becomes reemployed with the Employer or another Employer that has adopted this Plan.”
Reading these provisions together, you would conclude that, if you are a participant in the Plan and terminate employment, you may have experienced “severance from employment” entitling you to a distribution from the Plan, unless, prior to your distribution, you become employed by another participating employer. For example, if you are a Plan participant, you terminate employment, but become immediately employed by another of the 800+ participating employers, you have not had a severance from employment and cannot receive a current distribution. Unfortunately, with the size and complexity of the Plan, it may not be that easy for the employee or CalPERS to keep track of this.
Because compliance with the “severance of employment” rule is a requirement of the 457(b) regulations and the Plan’s terms, this is not something to be ignored. A tax-free rollover distribution made from the Plan when there is no corresponding distributable event would not be valid and would be taxable.
We have reached out to CalPERS and they acknowledge that this is an issue. They are looking at it and will decide what, if anything, they will do to address it. We’ll provide an update when we hear back from them.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at firstname.lastname@example.org or (916) 329-3685.