United States General Accounting Office

GAO Report to Congressional Requesters

April 1996 PUBLIC PENSIONS

Section 457 Plans Pose

Greater Risk Than

Other Supplemental

Plans

G O A

years

1921 - 1996

GAO/HEHS-96-38

GAO United States

General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

B-260634 

April 30, 1996

The Honorable Nancy L. Johnson

Chairman, Subcommittee on Oversight

Committee on Ways and Means

House of Representatives

The Honorable Sam M. Gibbons

Ranking Minority Member

Committee on Ways and Means

House of Representatives

This report is one of three we are issuing in response to your request that we review the status

of public pension plan funding.1

 This report specifically addresses your concerns about the

financial security of amounts deferred by participants into state and local government

supplemental pension plans.

In this report we discuss how plans established under Internal Revenue Code (IRC) section 457

differ from plans created under IRC sections 401(k) and 403(b) in terms of protection against

financial loss and other issues.

As agreed with your office, unless you publicly announce its contents earlier, we plan no further

distribution of this report until 15 days from its issue date. At that time, we will send copies to

the Commissioner of the Internal Revenue Service, the Chairman of the Securities and

Exchange Commission, and interested congressional committees. Copies will be made available

to others upon request.

This report was prepared under the direction of Donald C. Snyder, Assistant Director. Mr.

Snyder can be reached on 202-512-7204, if you or your staff have any questions.

Jane L. Ross

Director, Income Security Issues

1

See Public Pensions: Summary of Federal Pension Plan Data (GAO/AIMD-96-6, Feb. 16, 1996) and Public Pensions: State and Local

Government Contributions to Underfunded Plans (GAO/HEHS-96-56, Mar. 14, 1996).
Executive Summary

Purpose Millions of state and local government employees are taking steps to

increase their future retirement benefits by deferring some of their wages

to supplemental pension plans, known as salary reduction arrangements

or plans. The amounts deferred or contributed to some of these plans,

however, may be at risk. Recent media reports have highlighted instances

of imprudent investment, improper use of plan funds by sponsors, and

possible seizure of plan funds by sponsoring governments’ creditors.

Such reports have raised concerns among members of the Ways and

Means Committee of the House of Representatives. Accordingly, the

Committee asked GAO to determine the risks of financial losses inherent in

such plans. GAO was also asked to determine whether the provisions of

such plans treat participants comparably.

Background Salary reduction plans enable participants to defer part of their salary and

the taxes normally due to a future date. Among the arrangements utilized

by state and local governments to augment regular employee pension

plans are three plans authorized under the Internal Revenue Code (IRC) at

sections 401(k), 403(b), and 457(b). Employees contribute to these plans

through salary deferrals, and some governments make matching

contributions. Amounts deferred under these plans and any earnings that

accrue on them generally are not subject to federal income tax until they

are received, usually upon retirement. The benefits received depend on the

amount deferred and any earnings or losses thereon.

The Tax Reform Act of 1986 prohibits state and local governments from

establishing any new 401(k) plans after May 6, 1986, although existing

plans may continue. Federal law generally limits participation in 403(b)

plans to employees of public school systems, including kindergarten

through 12th grade; colleges; and universities. In addition, some

tax-exempt charitable and other not-for-profit organizations, such as

hospitals, may sponsor a 403(b) plan. As a result, most state and local

government employees today have only 457 plans available to augment

their regular government pension.

These plans have different requirements for deferring taxes because they

are derived from separate and distinct tax law theories. Section 401(k) and

section 403(b) plans are qualified or qualified-type plans whose purpose is

to encourage employers to provide plans for rank-and-file workers to

protect their savings for retirement. To be qualified and maintain their

tax-favored status, such plans must, in part, satisfy certain federal rules.

Page 2 GAO/HEHS-96-38 Section 457 Plans
Executive Summary

These rules limit an employer’s ability to exclude rank-and-file employees

from a plan and limit the extent to which contributions and plan benefits

can vary between highly and nonhighly compensated employees. These

rules are known as minimum coverage, minimum participation, and

nondiscrimination rules. In qualified and qualified-type plans, the amounts

deferred from employees’ wages and earnings on these amounts are

funded; that is, they are held in a tax-exempt trust or annuity contract or a

custodial account (such as mutual funds) for the exclusive benefit of

participants and are unreachable by creditors of the sponsor. Any earnings

are also tax-exempt until the amounts are paid out.

Section 457 plans, on the other hand, are nonqualified, unfunded deferred

compensation plans. These plans are driven by the tax law principles of

constructive receipt and economic benefit that require taxation on

income, even if some salary is not actually paid to the taxpayer but is

deferred. One of the keys to avoiding salary deferrals from being taxed

under these principles is that the amounts deferred must remain the

property of the sponsoring employer and be available to the general

creditors of the employer. Although 457 plans are considered unfunded

because salary deferrals are not held specifically for employees, most

sponsors invest their employees’ deferrals to ensure that funds are

available when needed to pay benefits.

Results in Brief Participants in 457 plans are exposed to greater risk than are participants

in section 401(k) and 403(b) plans, because of inherent differences

between qualified, funded and nonqualified, unfunded plans. Amounts

deferred and any earnings under 457 plans are credited to participants’

bookkeeping account balances but are not plan assets maintained solely

for the participants’ benefit as are deferrals under 401(k) and 403(b) plans.

While 401(k) and 403(b) plan deferrals are owned solely by the plan

participants, 457 plan deferrals are owned by the sponsoring employer

until distribution is made to the participant, generally after retiring or

leaving employment. Consequently, amounts deferred under 457 plans

may be used by a sponsoring government for nonplan purposes and are

subject to the claims of its creditors in the event of bankruptcy.

Participants in 457 plans not only have no ownership interest in amounts

deferred under these plans, but they cannot avail themselves of additional

benefits provided through qualified, funded plans. Because deferred

amounts must remain within reach of the employer’s creditors to maintain

tax-deferred status, a 457 plan participant who leaves state or local

Page 3 GAO/HEHS-96-38 Section 457 Plans
Executive Summary

government employment before retirement may not roll over deferred

amounts and earnings to an individual retirement account (IRA) and avoid

paying taxes on the distribution. Participants in qualified plans, such as

401(k), and qualified-type plans, such as 403(b) plans, however, can defer

taxes by rolling over account balances to IRAs.

In addition, in order to maintain tax-deferred status, participants in 457

plans cannot have continuing control over the date of distribution of

deferred amounts. Within a short time after leaving government service,

participants must choose a date to begin receiving benefits. Often, this is a

date selected for retirement many years in the future. That date, once

selected, can seldom be changed. Participants in 401(k) and 403(b) plans

are not limited in this way.

Finally, 457 plan participants and their employers are not allowed to

contribute as much to their retirement savings plans as are participants in

the other two plan types. Moreover, this disparity will continue to grow

because the 457 plan contribution limit is not indexed for inflation as are

the other two plans’ limits. Increasing the maximum amount of

contribution along with indexing for inflation would have no impact on the

tax-deferred status of 457 plans.

Principal Findings

Sponsoring Government

Actions Pose Risk to 457

Plan Deferrals

Because 457 plans maintain their tax-deferred status by requiring that the

sponsoring government own the deferred amounts, plan participants may

risk the loss of some or all their deferrals if their sponsoring government

goes bankrupt or funds are in some way mismanaged or lost. For example,

if Orange County, California, is unable to emerge from its current

bankruptcy proceeding without providing its general creditors with a

settlement under which those creditors receive 100 cents on the dollar, the

county’s 457 plan participants will be forced to share proportionately in

the losses of those general creditors.

Further, because any amounts set aside by the employing governments to

pay section 457 plan obligations are owned by the sponsoring

governments, some governments may view them as funds available for

their own use. IRC section 457 does not prescribe that any 457 plan monies

must be maintained to pay future benefits. In late 1992, the Securities and

Page 4 GAO/HEHS-96-38 Section 457 Plans
Executive Summary

Exchange Commission (SEC) staff learned that Los Angeles County

intended to borrow $250 million from the amount set aside to pay its 457

plan obligations to cover payroll expenses. When SEC questioned this

course of action as potentially impairing the status of the funds under the

federal securities laws, the county abandoned its proposal.

457 Plan Provisions

Disadvantage Participants

Amounts payable from a 457 plan are only portable to other 457 plans.

They cannot be rolled over to an IRA as can 401(k) and 403(b) plan funds

when an employee leaves state or local government employment.

According to IRS officials, changing this feature of 457 plans for state and

local government plan participants would create a taxable event under the

principles of constructive receipt and economic benefit. Also, 457 plan

participants must declare, within a short time after retiring or leaving their

employment, the date on which they will begin receiving their benefits.

The date is final and can only be changed if an emergency occurs. IRS

officials state that this feature of nonqualified, unfunded deferred

compensation plans, such as 457 plans, arises because allowing

participants the option of changing the distribution date would constitute

control over the assets, which is inconsistent with the tax principle that

these assets be owned or under the control of the plan sponsor.

Finally, the maximum annual employee deferral and employer

contribution to 457 plans is $7,500, about $2,000 less than for participants

in 401(k) and 403(b) plans. And because the 457 plan’s maximum

employee contribution is not indexed to inflation as are the employee

deferral maximums of 401(k) and 403(b) plans, the disparity between

plans can be expected to grow with inflation. This limit on 457 plan

deferrals could be increased by legislative changes and indexed to grow in

step with 401(k) and 403(b) plans.

Agency Comments SEC commended our report and agreed with our conclusions (see app. I).

SEC added that if the Congress proceeds with legislation relating to public

plans, it should consider the status of 457 plans under federal securities

laws. SEC also noted some technical changes that we incorporated where

appropriate. IRS also commended our report and provided technical

comments and an overview of 457 plans (see app. II). We incorporated IRS’

technical comments where appropriate.

Page 5 GAO/HEHS-96-38 Section 457 Plans
Contents

Executive Summary 2

Chapter 1 

Introduction

8

Three Types of Salary Reduction Plans 8

Compliance With Employee Participation Rules 10

Principles of Constructive Receipt and Economic Benefit 11

Origins of 457 Plans 12

Requirements for Tax-Deferred Plans 13

Prevalence of State and Local Supplemental Plans 14

Recent Legislative Proposals 14

Objectives, Scope, and Methodology 15

Chapter 2 

Sponsoring

Government Actions

May Pose Risks for

457 Plans

16

Bankruptcy Threat to Orange County 457 Plan 16

Los Angeles County Intended to Use Deferred Amounts for

Payroll Expenses

17

A Rabbi Trust May Provide Some Protection 18

Chapter 3 

Provisions of 457

Plans Disadvantage

Participants

19

Participants’ 457 Plan Benefits Have Limited Portability 19

Date That Benefits Begin Is Irrevocable 19

Maximum Annual Deferrals Allowed Are Lower 20

Chapter 4 

Summary and

Conclusions and

Agency Comments

22

Agency Comments and Our Evaluation 23

Appendixes Appendix I: Comments From the Securities and Exchange

Commission

26

Appendix II: Comments From the Internal Revenue Service 29

Appendix III: GAO Contact and Staff Acknowledgments 38

Page 6 GAO/HEHS-96-38 Section 457 Plans
Contents

Abbreviations

ERISA Employee Retirement Income Security Act of 1974

IRA individual retirement account

IRC Internal Revenue Code

IRS Internal Revenue Service

SEC Securities and Exchange Commission

Page 7 GAO/HEHS-96-38 Section 457 Plans
Chapter 1 

Introduction

Millions of state and local government employees are supplementing their

future retirement benefits by contributing to salary reduction plans called

salary reduction or defined contribution arrangements. Such plans enable

participants to defer part of their current salary for future use. The goal of

these plans is to postpone federal income tax until the amounts deferred

from an employee’s salary and any earnings or losses thereon are received

by the participant at separation or retirement.

All salary reduction plans pose some risk of financial loss from poor

investment performance. However, amounts in plans organized under

Internal Revenue Code (IRC) section 457(b) (hereinafter referred to as 457

plans) bear additional risk because salary deferrals to 457 plans are assets

of the sponsoring employer that may be used for nonplan purposes and

which are subject in the event of bankruptcy to the claims of general

creditors.2

 For example, one municipality’s recent bankruptcy could cause

financial losses to employees who participated in its 457 plans. In addition,

amounts earmarked to pay another county’s 457 plan obligations could

have been at risk when the county intended to use those amounts to meet

payroll expenses. In that case, the county might not have had the funds

available when the time came to pay out the amounts due the 457 plan

participants. In both cases, county officials were entitled to use the money

saved to pay 457 plan obligations for nonplan purposes. As a result,

concerns have been raised about the security of deferrals that participants

make from their salary under 457 plans.

Three Types of Salary

Reduction Plans

A state or local government may elect to offer its employees, among other

retirement plans, a deferred compensation arrangement under IRC sections

403(b), 401(k), and 457(b). In all three types of plans, employees may

voluntarily defer compensation through payroll deductions. Federal

income tax is postponed until employees begin to receive their account

balances, usually at retirement or when they are no longer employed by

the plan’s sponsor. These three salary reduction plans typically are

2

Section 457 creates two types of plans, an eligible section 457 plan, as defined in section 457(b), and

an ineligible section 457 plan, as explained in section 457(f). All section 457 plans are nonqualified,

unfunded deferred compensation plans. Amounts set aside to pay plan obligations must remain the

property of the employer and subject to the employer’s general creditors. Under an eligible plan,

amounts deferred will be includable in gross income only for the taxable year in which the

compensation or other income is paid or otherwise made available to the participant or other

beneficiary. Plan participants involved in a plan subject to section 457(f), which is not an eligible

deferred compensation plan, are subject to immediate tax treatment, which renders all such deferrals

on compensation subject to tax for the first year in which there is no substantial risk of forfeiture.

Page 8 GAO/HEHS-96-38 Section 457 Plans
Chapter 1 

Introduction

intended to supplement an employer-sponsored qualified pension plan

under IRC section 401(a).3

In general, 401(k) plans, sometimes referred to as cash or deferred

arrangements, are qualified plans that allow employees to choose between

receiving current compensation or having part of their compensation

contributed to a qualified profit-sharing or stock bonus plan. A 403(b)

plan, a qualified-type plan sometimes referred to as a tax-sheltered

annuity, is a deferred compensation arrangement that may be sponsored

only on behalf of employees of public educational systems and other

specific tax-exempt organizations.

Section 457(b) plans are nonqualified, unfunded deferred compensation

plans that may cover all employees of a state or local government and

certain highly compensated employees of a tax-exempt organization. Such

plans permit these employees to defer limited amounts of compensation

so that, under the principles of constructive receipt and economic benefit,

tax will also be deferred on the amounts plus their earnings until some

future event.

Eligibility and the security of deferred amounts vary among the three plan

types. Employees of public schools, colleges and universities, and some

private institutions exempt from tax under IRC section 501(c)(3), such as

hospitals, typically participate in 403(b) plans. Contributions to these

plans are generally maintained as an annuity contract4

 or custodial

account,5

 both of which are reserved for the sole benefit of the participant

and his or her beneficiaries.

Employee deferrals under section 401(k) plans are held in trust for the

sole benefit of the participants and their beneficiaries. These participants

are primarily employed in the private sector. However, some state and

local governments established these plans in the late 1970s and early 1980s

3

A qualified plan is one that receives special tax advantages by meeting requirements of section 401(a),

including certain minimum participation, coverage, vesting, and nondiscrimination rules. Among the

tax advantages of a qualified plan is permitting employees to contribute to a tax-exempt trust for their

exclusive benefit. Additionally, benefits from a qualified plan are not includable in the gross income of

a participant until actually paid.

4

An annuity contract is a contract between the sponsoring entity and a life insurance company.

Contributions and their earnings are paid back to the participant at specified intervals over a period of

time after retirement or separation.

5

A custodial account is an arrangement made by the sponsoring government with a third-party agent

who invests the assets.

Page 9 GAO/HEHS-96-38 Section 457 Plans
Chapter 1 

Introduction

for their employees.6 With the enactment of the Tax Reform Act of 1986,7

state and local government employers who had not previously established

401(k) plans were prohibited from establishing new 401(k) plans, but

existing plans could continue. Despite concerns raised by representatives

of state and local governments, among others,8

 the rationale for this

exclusion was that allowing public employees to have access to both

401(k) plans and 457 plans would be “inappropriately duplicative.”9

Only employees of and independent contractors providing service to state

and local government and tax-exempt organizations may participate in 457

plans. Unlike 401(k) and 403(b) plans that are funded and must comply

with the nondiscrimination and minimum participation rules, section 457

plans are unsecured promises of the employer to pay amounts in the

future. A section 457 eligible, salary reduction plan requires that all

deferred compensation and income shall remain solely the property of the

employer and be subject to the claims of the employer’s general creditors.10

Compliance With

Employee

Participation Rules

In 1999, 401(k) and certain 403(b) plans must begin testing for

nondiscrimination and minimum participation rules. Generally, the

nondiscrimination rule requires that benefits or contributions provided

under the plan do not discriminate in favor of highly compensated

employees. The minimum participation rule requires that the plan benefit

at least the lesser of 50 employees or 40 percent of all employees. The

minimum coverage rule requires that the percentage of nonhighly

compensated employees who benefit under the plan must be at least

6

IRC section 401(k) did not expressly authorize participation by public employees. However, the

Internal Revenue Service (IRS) determined in its General Counsel Memorandum 38283 that public

employers could maintain such arrangements and accordingly issued several determination letters

approving section 401(k) arrangements established by public employers.

7

P.L. 95-514.

8

“The particularly appealing feature of the Section 401(k) plan is that it provides security; not just in

the sense that amounts set aside for retirement provide a measure of security, but in the safeguards

which the Code provides. Amounts in a Section 401(k) plan are placed in trust and are inviolate. Thus

they are not subject to claims of creditors, whether of the employee or the employer. This insures that

the employee will get his money when he needs it. In these days of budget deficits and financial

uncertainty for some public sector employers, such protection is not to be taken lightly.” Statement of

Richard B. Dixon, Treasurer and Tax Collector of Los Angeles County, before the Finance Committee,

U.S. Senate, July 11, 1985.

9

Chapter 14.06 of The President’s Tax Proposal to the Congress for Fairness, Growth, and Simplicity

(Washington, D.C.: Office of the President, May 1985), pp. 363-369.

10Participants covered by a plan subject to section 457(f) are subject to immediate tax treatment,

which renders deferrals of compensation subject to tax for the first year in which there is no

substantial risk of forfeiture.

Page 10 GAO/HEHS-96-38 Section 457 Plans
Chapter 1 

Introduction

70 percent of the highly compensated employees who benefit under the

plan, or the nonhighly compensated employees in the workforce must

receive benefits that on average are at least 70 percent of the benefits

received by highly compensated employees. State and local government

sponsors of these plans have expressed concern that required compliance

with these rules will be burdensome and costly.

Principles of

Constructive Receipt

and Economic Benefit

Two tax principles, constructive receipt and economic benefit, are often

intertwined in matters regarding nonqualified, unfunded deferred

compensation. Under the principle of constructive receipt, income is

taxable even when an employee has not actually received current

compensation, if the compensation is credited to the employee’s account,

set apart for the employee, or otherwise made available to the employee.

The principle of economic benefit, on the other hand, taxes assets that

have been unconditionally and irrevocably transferred into a fund for the

employee’s sole benefit because he or she has received a benefit (that is,

some deferred salary) that, although not readily convertible to cash, has an

immediate value (that is, a fund for his or her benefit) that is secured from

the employer’s creditors.

Section 401(k) and 403(b) plans are funded, qualified or qualified-type

arrangements where the deferred amounts are placed in trust;11 that is, set

aside for the exclusive benefit of the employees who participate in the

plans, secured from an employer’s creditors. So that such arrangements

would not cause the participants to be taxed under the basic principles of

constructive receipt and economic benefit, the Congress overrode these

two principles by providing for income to be taxed only when it is

distributed.

Section 457 plans, on the other hand, are nonqualified, unfunded deferred

compensation plans that follow the basic principles of constructive receipt

and economic benefit. Participants are not in constructive receipt of their

deferrals because the amounts are not set apart for or otherwise available

to them at any time. Participants do not derive the economic benefit of

their deferred compensation because the deferred amounts are the

property of their employers and subject to the employers’ general

creditors. Instead, participants have bookkeeping accounts with balances

that represent the amount that the employers promise to pay at some

11A trust is a fiduciary relation with respect to property, subjecting the person by whom the property is

held to equitable duties to deal with the property for the benefit of another person which arises as the

result of a manifestation of an intention to create it. See Black’s Law Dictionary 1681 (4th ed. rev.

1964).

Page 11 GAO/HEHS-96-38 Section 457 Plans
Chapter 1 

Introduction

future time. These account balances are comprised of amounts deferred

under the plan and any earnings or losses that would have accrued to

those amounts if the account balances had been invested as stated under

the plan. Although most employers sponsoring 457 plans invest amounts

as necessary so that they will be able to provide the promised benefit

when due, there is no requirement for them to do so.

Origins of 457 Plans In 1972, IRS issued the first of a number of private letter rulings holding

that tax may be deferred on employee contributions from salary to a

nonqualified, unfunded deferred compensation plan where a state or local

government was the employer. Nonqualified, unfunded deferred

compensation plans of state and local governments and tax-exempt

organizations were not subject at that time to certain restrictions placed

on qualified plans: (1) they did not need to comply with nondiscrimination

rules applicable to qualified plans; (2) there was no limit on the amount

participants could contribute; and (3) participants in nonqualified,

unfunded plans, unlike participants in qualified plans, could make

tax-deductible contributions to individual retirement accounts (IRA).12 In

1977, however, IRS stopped issuing private letter rulings on the income tax

treatment of amounts deferred under nonqualified, unfunded deferred

compensation plans, pending formal review of its position.13 In 1978, IRS

changed its position and published proposed regulations that would have

subjected participants in nonqualified, unfunded deferred compensation

arrangements to immediate taxation on deferred amounts.14

Shortly thereafter, the Congress enacted IRC section 457. The House Ways

and Means Committee, which drafted the provision, expressed concern

that the proposed IRS regulations would impact seriously on the ability of

employees of many states and localities to participate in salary reduction

arrangements as a means of providing themselves with tax-deferred

retirement income.15 The Committee stressed that for a plan to be eligible

for tax deferral, all amounts deferred and income earned thereon must

remain assets of the plan sponsor subject to the claims of its general

creditors. Thus, participants

12House Comm. on Ways and Means, 95th Cong., 2nd Sess. Rep. No. 95-1445, Aug. 4, 1978, at 52.

13IR-1881, September 7, 1977.

1443 Fed.Reg. 4638, February 3, 1978.

15House Comm. on Ways and Means, 95th Cong., 2nd Sess. Rep. No. 95-1445, Aug. 4, 1978, at 52-53.

Page 12 GAO/HEHS-96-38 Section 457 Plans
Chapter 1 

Introduction

“cannot have any secured interest in the assets purchased with their deferred

compensation and the assets may not be segregated for their benefit in any manner which

would put them beyond the reach of the general creditors of the sponsoring entity.”16

Requirements for

Tax-Deferred Plans

Section 401(k) plans must meet three federal requirements for employee

participation to be considered qualified. First, the value of the benefits that

highly compensated employees as a group may receive is limited by the

value of the benefits the less well paid employees collectively receive; this

is the nondiscrimination rule. Second, at least the lesser of 50 employees

or 40 percent of all eligible employees17 must participate in the plan; this is

the minimum participation rule. Third, the plan must benefit a percentage

of nonhighly compensated employees that is at least 70 percent of the

percentage of highly compensated employees benefiting under the plan or

the nonhighly compensated employees in the workforce must receive

benefits that, on average, are at least 70 percent of the benefits received by

highly compensated employees; this is the minimum coverage

requirement. Additionally, among many other requirements, sponsoring

employers must meet certain nondiscrimination tests and report their

annual levels of participation, current assets, and current liabilities.18

Tax-sheltered annuities under section 403(b) must meet nondiscrimination

rules. Salary reduction deferrals to 403(b) plans must also meet special

nondiscrimination rules that are deemed satisfied if all employees defer in

excess of $200. Starting in 1997, section 403(b) plans that provide

employer matching contributions will have to meet special

nondiscrimination rules provided by section 401(m). Starting in 1999,

section 403(b) plans that provide nonelective contributions (employer

contributions that do not reduce a participant’s salary) will be required to

meet the nondiscrimination, minimum coverage, and minimum

participation rules.

For a 457(b) plan to be eligible for tax deferral treatment, the Congress

limited the amount of compensation that may be deferred, but permitted

participants to wait until after separation from employment to elect the

time and method of payout. However, minimum participation, minimum

16House Comm. on Ways and Means, 95th Cong., 2nd Sess.,Rep. No. 95-1445, Aug. 4, 1978, at 55.

17Eligible employees are those who have at least 1 year of service, are at least 21 years old, and are

working full-time.

18State and local governments sponsoring 401(k) plans and those 403(b) plans that provide matching

contributions are not required to begin nondiscrimination testing until 1999. Special nondiscrimination

rules applicable to these plans under section 401(k) and 401(m) will have to be met starting in 1997.

Page 13 GAO/HEHS-96-38 Section 457 Plans
Chapter 1 

Introduction

coverage, and nondiscrimination rules that are a cornerstone for the

tax-favored status of qualified, funded plans were not imposed.

Prevalence of State

and Local

Supplemental Plans

Little information is available on the number of 401(k) and 403(b) plans

sponsored by state and local governments or the number of people

participating in them.19 However, a 1993 study of over 400 state and local

government general pension plans showed that about 8.4 percent of

responding governments sponsored a 401(k) plan and 7.1 percent

sponsored a 403(b) plan.20 In that study, 457 plans were the most

frequently used salary reduction plans. About 90 percent of local

governments and all 50 states provided their employees access to 457

plans. In 1994, an estimated 1,750,000 people participated in about 10,000

plans sponsored by government entities nationwide.21

Recent Legislative

Proposals

Several bills have been introduced in the 104th Congress to redesign

section 457 plans. For example, H.R. 2491, the omnibus budget

reconciliation bill, contained provisions that would require all assets and

income of a 457 plan to be held in trust for the exclusive benefit of

participants and their beneficiaries.22 However, IRS officials told us that

imposition of such a trust requirement would result in immediate taxation

for deferrals to a 457 plan because of the requirements of IRC section

457(b)(6). With respect to section 401(k) plans, another provision of the

reconciliation bill would have provided a simplified and less costly

alternative method of testing for nondiscrimination requirements under

IRC.

23 In separate legislation, under section 14212 of H.R. 2517, which was

incorporated into the reconciliation bill and then dropped, state and local

19State and local plans are not required to file annual reports with the federal government as are most

private plans.

20The 1993 PENDAT database contains the results of a nationwide survey of state and local

government pension plan administrators. It is sponsored by the Public Pension Coordinating Council.

We determined that this study may have underrepresented the percentage of state and local

governments that provide their employees access to 401(k) plans. These plans are usually

administered and managed separately from the general pension plan and, therefore, respondents to the

survey may not have been aware that their government had a 401(k) plan. We also determined that this

study may not have identified all of the IRC section 403(b) plans in operation because such plans

generally are not administered by the state and local government units that responded to the survey.

Instead, 403(b) plans tend to be administered by the individual institutions, such as public school

systems, colleges, universities, and tax-exempt IRC section 501(c)(3) organizations.

21Access Research Corporation, Windsor, Connecticut.

22Section 11458 of H.R. 2491, vetoed by the President on Dec. 6, 1995.

23Section 11019 of H.R. 2491.

Page 14 GAO/HEHS-96-38 Section 457 Plans
Chapter 1 

Introduction

governments and tax-exempt organizations would have been extended the

eligibility to provide 401(k) plans to their employees.

Objectives, Scope,

and Methodology

In response to concerns about financial losses to state and local

government supplemental pension plans, the House Ways and Means

Committee asked us to examine the nature and security of such plans.

After discussions with Committee staff, we agreed to determine

(1) whether amounts held in state and local government salary reduction

plans or otherwise promised to participants inherently are at risk of

financial loss to the participants and (2) how statutory provisions

comparatively treat participants in these plans.

To determine how the plan provisions affect financial risk, we interviewed

representatives from IRS and Securities and Exchange Commission (SEC)

staff. In addition, we discussed the risk of financial loss relative to plan

provisions and whether the provisions treat participants comparably with

representatives of the Government Finance Officers Association; the

International City/County Managers Association-Retirement Corporation;

the National Association of Counties; the National Council on Teacher

Retirement; the National Association of Government Deferred

Compensation Administrators; and the Nationwide Insurance Company

and its subsidiary, the Public Employees Benefit Service Corporation.

To determine how state and local government plans are generally

administered, we contacted plan administrators in Alabama, California,

Connecticut, Florida, Georgia, Michigan, Minnesota, Mississippi,

Nebraska, New Jersey, Ohio, Oklahoma, Tennessee, Texas, and Wisconsin.

We selected these states on the basis of information they reported on their

457 plans in the 1993 PENDAT database. We focused our review on 15

states and on eight counties in California. We selected these counties

because of the Committee’s concerns about the impact of the Orange

County, California, bankruptcy on 457 plans sponsored by other California

counties.

We conducted our work from January 1995 through January 1996 in

accordance with generally accepted government auditing standards.

Page 15 GAO/HEHS-96-38 Section 457 Plans
Chapter 2 

Sponsoring Government Actions May Pose

Risks for 457 Plans

The statutory requirements that provide for tax deferral for 457 plans also

place the assets held to pay participants’ benefits at risk of loss from

creditors of the government sponsor in the event of a bankruptcy and,

unless the sponsor provides for a rabbi trust, from the government’s using

them for other than plan purposes. Two 457 plans in California illustrate

these risks. In one case, a county filed for bankruptcy protection, which

put amounts set aside to pay the county’s obligations under its 457 plan at

risk of being used to satisfy the county’s creditors. Because participants in

457 plans have no greater rights of their employer than general, unsecured

creditors, such actions could reduce the amount participants otherwise

would receive from the plan. In the other case, a county government

intended to use amounts it set aside for its 457 plan obligations to meet

payroll expenses. However, if the amounts held for 457 plan purposes had

been placed in a rabbi trust—as permitted for all nonqualified, unfunded

deferred compensation plans—they may have been protected from use for

nonplan purposes by the sponsor but not from a sponsor’s creditors.

Bankruptcy Threat to

Orange County 457

Plan

Orange County kept its tax revenues in an investment pool managed by its

treasurer and that permitted investments from cities, municipalities, and

political instrumentalities outside Orange County. The county regularly

contributed deferrals to the pool to assist it in meeting its obligations

under this plan. The 457 plan provides that the experience of the

investment pool will be used to determine the final amount due

participants when they separate from service or retire. Thus, participants’

bookkeeping accounts are credited at specified intervals with the interest,

gains, and losses realized by the investment pool.

From July to December 1994, the investment pool sustained heavy losses.

This resulted in both the pool and Orange County filing for Chapter 9

bankruptcy on December 6, 1994. On May 2, 1995, the state Bankruptcy

Court approved a comprehensive settlement of the pool’s bankruptcy

case. Under this court order, Orange County received amounts from the

pool at a rate that was lower than 100 percent of its claims.

No participant funds were used to pay pool creditors and the participants

had no standing as claimants in the pool bankruptcy. The participants are

general, unsecured creditors of Orange County only—not of the

investment pool. However, Orange County’s claim against the pool

included a claim for amounts it invested there so that funds would be

available as needed to pay its yet unmatured obligations under the 457

plan.

Page 16 GAO/HEHS-96-38 Section 457 Plans
Chapter 2 

Sponsoring Government Actions May Pose

Risks for 457 Plans

Technically, because performance of the pool serves as a measure used to

calculate returns for the 457 plan, the investment loss that occurred in the

pool would normally affect the account balances of plan participants. As

of March 1996, the bankruptcy in Orange County is still ongoing. It is

possible that all creditors may eventually be paid 100 percent of their

claims and that participants in the 457 plan that invested in the pool may

have their account balances fully restored. Administrators of the 457 plan

told us that the bookkeeping accounts for each participant would be

credited with interest, but all accounts have been reduced 10 percent for

losses on investments in the pool.

Los Angeles County

Intended to Use

Deferred Amounts for

Payroll Expenses

In 1992, Los Angeles County intended to borrow $250 million of amounts

deferred under its 457 plan to make payroll payments. SEC staff learned of

Los Angeles County’s intentions and questioned the proposed action as

potentially impairing the status of the plan under the federal securities

laws. The SEC staff asserted that borrowing amounts set aside to pay the

county’s obligations under its 457 plan for any reason other than satisfying

obligations to the locality’s general creditors would conflict with

representations made earlier to the SEC staff. These representations had

been made in connection with a request by the insurance company that

operated the separate accounts for participants when it sought the SEC

staff’s no-action assurance that the separate accounts and the interests

therein did not need to be registered under federal securities laws.24 The

SEC raised concerns that the disposition of the assets needed to pay the

county’s obligations under the plan as proposed by Los Angeles County

conflicted with the representations made in seeking the no-action letter.

As a result of both SEC’s questioning and media reports accusing local

officials of wrongdoing, the county created a new investment option under

its plan in the form of a loan fund, offering at least a 6-percent return over

15 years. A few participants agreed to have their deferrals treated as

though invested in the fund and the county was able to raise $19 million of

the $250 million it originally intended to borrow. We note, however, that

SEC does not regulate 457 plans and its ability to influence the operation of

457 plans is limited to instances in which an unregistered collective trust

or separate account seeks to rely on certain exemptions from federal

24The no-action process is an informal procedure whereby the public may obtain the informal views of

SEC staff on proposed transactions that appear to raise issues under applicable federal securities laws

and the rules thereunder. No-action requests were filed by a number of banks and insurance

companies that wanted to offer collective trust funds or separate accounts to 457 plans without

registration of the funds/account or the interests in them under federal securities laws.

Page 17 GAO/HEHS-96-38 Section 457 Plans
Chapter 2 

Sponsoring Government Actions May Pose

Risks for 457 Plans

securities laws in order to hold funds earmarked to pay a 457 plan

obligation.

Although the county chose not to do so, it could have simply used the

assets without paying interest on their use because statutory provisions

governing section 457 mandate that amounts deferred remain the property

of the employer. There is no requirement that sponsoring governments

actually invest amounts participants have deferred or credit their deferrals

with interest earned. Instead, the governments are only responsible for

making payments to participants under the terms of the plan, usually when

they retire or change jobs. The terms of the plans usually provide that the

amounts deferred will be treated as though they were invested in some

identified asset or fund and that the benefit paid will include earnings that

would have accrued on those amounts had they been so invested as well

as any gains or losses that might have been experienced had the amounts

been so invested. Although it is not required under section 457, sponsors

and administrators normally make the actual investments referenced

under the arrangement to insure that they will have the amounts necessary

to meet their 457 plan obligations. Notwithstanding this normal

administration of 457 plans, 457 plan deferrals can never be invested solely

for the benefit of the participant. They must always be available to the

general creditors of the employer. Also, unless amounts set aside by the

employer to meet its obligations are placed in a rabbi trust, these assets

may be used for nonplan purposes.

A Rabbi Trust May

Provide Some

Protection

Under IRC, 457 plans have a means to restrict a government’s nonplan use

of amounts deferred to 457 plans—the rabbi trust.25 Under such a trust, the

plan sponsor typically has no access to the funds but in an insolvency or

bankruptcy, such funds can be reached by the general creditors.26 If the

deferrals held by Los Angeles County for its 457 plan had been placed in a

rabbi trust, the county may not have been in a position to use them to meet

its payroll. However, a rabbi trust arrangement would not have protected

Orange County employees, because that government declared bankruptcy.

25The trust is so named because the first such arrangement was established by a synagogue for the

benefit of its rabbi. IRS Prv. Ltr. Rul. 81-13-107 (Dec. 31, 1980). IRS will rule favorably only on the

model rabbi trust set out in Revenue Procedure 92-64, 1992-2 C.B. 11.

26Insolvency is defined in section 3(a) of the Model Rabbi Trust as: (i) the government being unable to

pay its debts as they become due or (ii) the government being subject to a pending proceeding as a

debtor under the U.S. Bankruptcy Code.

Page 18 GAO/HEHS-96-38 Section 457 Plans
Chapter 3 

Provisions of 457 Plans Disadvantage

Participants

Section 457 plans are substantially different from 401(k) and 403(b) plans.

In addition to the differences discussed in chapter 1, these plans have

limited portability and in some cases participants in 457(b) plans must

irrevocably select a date to begin receiving their benefits. In addition,

participants cannot defer as much as participants in 401(k) or 403(b)

plans.

Participants’ 457 Plan

Benefits Have Limited

Portability

Participants in 457 plans who leave their government employer before

retirement are restricted in their ability to move the amounts in their 457

plan accounts to a funded tax-sheltered account. The plan accounts can

only be transferred to another eligible 457 plan if the new government

employer will accept the transfer. Amounts deferred under section 457

cannot be rolled over to an IRA and have tax deferred on the distribution as

can 401(k) and 403(b) plan funds. Participants in 457 plans who leave

government service and do not have another 457 plan that they can

transfer their bookkeeping accounts to have only two options:

(1) commence immediate payment of benefits and pay income tax on the

distribution or (2) defer the commencement of benefits to any date in the

future that is before they turn 70-1/2 years old. IRS officials told us that

under current law, allowing nonqualified, unfunded deferred

compensation amounts to be transferred to an IRA makes the amounts

immediately taxable to the participant because any distribution, even to an

IRA, results in the participant having an economic benefit in the funds and

being in constructive receipt of the money. The mere promise of the

employer to pay will have been fulfilled. Additionally, under the qualified

plan rules, a transfer of nonqualified, unfunded plan amounts into a

qualified, funded plan could disqualify the qualified plan and make funds

in it immediately taxable to the participants.

Date That Benefits

Begin Is Irrevocable

If a participant cannot transfer the deferred amounts to another 457 plan

or chooses not to do so, he or she must, after leaving employment, select a

date to begin receiving benefits. Selecting the date may be difficult

because the employee’s retirement date may be years in the future.

Moreover, once selected, this date cannot be changed, except for

emergencies. In contrast, separating participants in 401(k) and 403(b)

plans are not required to declare a date for benefits to begin. These

participants may begin collecting their benefits at any time after turning

59-1/2 years old. IRS officials said that the tax principle of constructive

Page 19 GAO/HEHS-96-38 Section 457 Plans
Chapter 3 

Provisions of 457 Plans Disadvantage

Participants

receipt would be compromised if participants in 457 plans were permitted

to change the date previously selected for receiving benefits.27

Maximum Annual

Deferrals Allowed Are

Lower

The maximum annual amount that employees may defer and employers

may contribute is lower for 457 plans than for the other two plan types.

For example, the maximum allowable employee deferral to a 457 plan is

$7,500,28 a limit that is about $2,000 lower than the limits of the other two

tax-deferred plans. In 1995, the maximum employee deferral to a 401(k)

plan was $9,240, and deferrals to a 403(b) plan could not exceed $9,500.

Although employees can defer no more than $7,500 under a 457 plan, this

does not include employer contributions to another plan, usually the

employers’ regular or basic pension plan. Employers sponsoring 401(k) or

403(b) plans can make annual contributions of no more than $30,000.

Moreover, the tax-free deferral limit of a participant in 401(k) and 403(b)

plans is reduced if the participant also defers any amounts under a 457

plan.29 The maximum total deferral a participant can make to a 401(k) or

403(b) plan is governed by the maximum deferral allowed under section

457 when a participant actually makes deferrals under a 457 plan. That is,

total deferrals by participants contributing to both a 457 plan and one of

the other two plan types cannot exceed $7,500. Thus, any deferrals, even if

it is only $1, made to a 457 plan, limits the maximum annual deferral the

participant can make to a 401(k) or 403(b) plan to $7,500. Additionally, any

employer contribution to a 457 plan will limit the deferral the employee

can make under a 401(k) or 403(b) plan to $7,500.

Maximum Annual Deferral

Cap Is Not Indexed

When the Congress enacted IRC section 457 in 1978, it set the annual

deferral limit at $7,500, an amount that exceeded the $7,000 deferral limit

set for 401(k) plans in 1986. However, the 401(k) plan limit was indexed

for inflation, and the 457 plan limit was not. In time, the 401(k) limit

surpassed the 457 limit. Section 403(b) limits will be indexed for inflation

27As noted in chapter 1, income is taxable even when an employee has not actually received

compensation, but could have elected to receive the compensation after it has been earned. The

constructive receipt doctrine limits the extent to which a taxpayer can time the inclusion of amounts

into gross income once those amounts have been earned.

28This limit refers only to the maximum annual amount an employee may defer from his or her pay. It

does not refer to the $15,000 catch-up provision included in section 457, which allows participants to

make a deferral of up to $15,000 during the 3 years prior to retirement. They may do so only to the

extent that they did not defer income at the maximum annual deferral limit in past years.

29The interaction of these deferrals is coordinated through section 457(c).

Page 20 GAO/HEHS-96-38 Section 457 Plans
Chapter 3 

Provisions of 457 Plans Disadvantage

Participants

when the 401(k) limit reaches $9,500, the current deferral limit for 403(b)

plans.

Over time, inflation will continue to reduce the section 457 deferral limit

relative to earnings, and the maximum percentage of income participants

will be able to defer will decrease. For example, using an average annual

inflation rate of 4 percent, 10 years from now the deferral limits for

employee contributions in the other two plans will be $13,677, $6,177 more

than the current section 457 limit.

IRS officials said that the limit on deferrals and the lack of a cost-of-living

adjustment, as in sections 401(k) and 403(b), could be changed by the

Congress without compromising either the nature of 457 plans as

nonqualified, unfunded plans or the tax principles of constructive receipt

and economic benefit. Any such changes to section 457(b) would,

however, cause a tax revenue loss in the future if participants took

advantage of higher deferral limits.

Page 21 GAO/HEHS-96-38 Section 457 Plans
Chapter 4 

Summary and Conclusions and Agency

Comments

With enactment of IRC section 457 in 1978, the Congress specifically

authorized a tax-deferred, nonqualified, and unfunded compensation plan

to enable employees of state and local governments to provide themselves

with additional retirement income. The Congress’ action had been

prompted by proposed IRS regulations that would have subjected all

nonqualified, unfunded deferred compensation amounts to immediate

taxation. Eight years later, in the belief that 457 and 401(k) plans offered

duplicative benefits, the Congress excluded state and local employers

from establishing new 401(k) plans for their employees.

As a nonqualified, unfunded deferred plan, however, section 457 provides

significantly less protection for plan participants compared with qualified,

funded deferred plans such as 401(k) and 403(b) plans. Until recently,

there was little or no evidence that greater protections were needed;

however, events in Orange and Los Angeles Counties have posed possible

financial risks to participants’ deferred amounts in 457 plans that suggest

greater protections may be needed.

Section 457 plan participants voluntarily forego current income in order to

provide for themselves in their retirement years. Yet the money that these

participants forego is at risk. This is because 457 plans are nonqualified,

unfunded deferred plans that require that the amounts deferred may not

be set aside for the exclusive benefit of the employee but must remain the

property of the employer, subject to the claims of the employer’s general

creditors. To date, the use of the Orange County Investment Pool to

calculate how amounts deferred under its 457 plan are to be treated as

invested has resulted in financial paper losses that ultimately may affect

county employees’ retirement benefits. Los Angeles County intended to

use funds of its plan to meet its payroll. Under current law, potential

bankruptcies and financial difficulties of other state and local

governments pose similar risks to the salary deferrals that employees have

made under 457 plans.

Apart from the greater risk to plan participants, as compared with other

salary reduction plans, employees who participate in 457 plans are treated

differently from those in 401(k) and 403(b) plans. For example, as a result

of IRC provisions, the maximum annual amount that may be deferred under

an eligible 457 plan is notably less than the maximum annual amount that

may be contributed to 401(k) and 403(b) plans. Further, those deferred

amount limits are not indexed for inflation. This is particularly noteworthy

because a 457 plan is often the only deferred compensation plan available

Page 22 GAO/HEHS-96-38 Section 457 Plans
Chapter 4 

Summary and Conclusions and Agency

Comments

to most state and local employees to supplement their regular government

pension.

Other disadvantages occur because of differences between nonqualified,

unfunded and qualified, funded plans. For example, participants who leave

employment before retirement have limited portability for their funds.

Participants transferring to another state or local government may transfer

account balances in a 457 plan to another 457 plan only if their new

employer will accept that transfer and their old employer permits

transfers. In lieu of such a transfer, participants leaving state or local

government who choose to withdraw their 457 plan amounts are subject to

immediate taxation. No legal barrier exists under the principles of

constructive receipt and economic benefit for raising the limits that

participants could defer or for indexing the limits for inflation. However,

changes to portability would not comport with these two principles.

Given the risk of financial loss associated with deferrals under 457 plans,

imposing a rabbi trust requirement, where a plan sponsor could not use

such amounts for its own interest, would not be successful in fully

assuring the security of these funds for plan participants. Such a trust

requirement would not preclude a bankruptcy court from securing such

funds for the general creditors of the state or local government employer.

Moreover, a trust may not be successful in barring an employer’s creditors

access to these funds, for example, if an employer experiences a

temporary liquidity shortfall or financial insolvency. Thus, the existence of

a rabbi trust would not have eliminated the risks posed by events in

Orange County and may not have eliminated risks of nonplan use in Los

Angeles County. However, under the tax theories that drive section 457

and other nonqualified, unfunded deferred compensation plans, any trust

that would not subject its assets to the claims of the employer’s creditors

and would provide the participant an unconditional and irrevocable right

to receive the deferred amounts in it would create an immediate—not a

deferred—tax liability for the employee. The complexity of IRC makes

amending section 457 very difficult, as proposed in H.R. 2491, for example,

because of the many ways section 457 dovetails with other provisions.

Agency Comments

and Our Evaluation

SEC provided written comments on a draft of this report (see app. I). SEC

found the report informative and said that it would serve as a reference for

SEC staff as they consider section 457 issues. SEC said it agreed with our

recommendation that the Congress amend IRC section 401(k) to permit

state and local governments to establish 401(k) plans. We did not

Page 23 GAO/HEHS-96-38 Section 457 Plans
Chapter 4 

Summary and Conclusions and Agency

Comments

recommend that the Congress make such an amendment; rather we

concluded that addressing all the problems with section 457 plans that we

identified merely by amending IRC section 457 would be difficult. SEC

added that if the Congress proceeds with legislation relating to public

plans, it should consider statutory changes to clarify the status of 457

plans under federal securities laws. SEC said all qualified plans are now

exempt from SEC regulation. Those governmental plans, as defined in IRC

section 414(d), that are established for the employees’ exclusive benefit

and which cannot be used by the employer for other purposes (exclusivity

and impossibility requirements) are exempt. SEC staff told us that they

have received numerous inquiries with respect to whether 457 plans also

may be considered exempt under federal securities laws, although IRC

prevents 457 plans from meeting the exclusivity and impossibility

requirements. SEC also noted some technical changes that we incorporated

into our report where appropriate.

IRS also provided written comments on a draft of this report (see app. II).

IRS made several general comments primarily concerning technical terms.

IRS pointed out the distinction between the tax-favored status of 401(k)

plans and the tax-deferred status of 457 plans. We clarified these

differences throughout the report. IRS emphasized the fact that 457 plan

deferrals may be treated as invested in a certain way, but in fact there is no

requirement to invest such amounts. As a result, if the sponsor becomes

insolvent, the rights of participants in a 457 plan are no greater than other

general, unsecured creditors. IRS also pointed out that most state and local

governments have basic pension plans for employees and 457 plans are

additional plans. We refer to them as supplemental plans to reflect this

relationship. IRS suggested that we should clarify that only state and local

governments can offer nonqualified plans to their rank-and-file employees,

which we did. IRS clarified some features of rabbi trusts that we did not

include in the report, though the major feature of a rabbi trust—the

inability of the sponsor to have access to the assets therein—is the focus

of chapter 3. IRS also made technical comments that we incorporated into

our report where appropriate.

Page 24 GAO/HEHS-96-38 Section 457 Plans
Page 25 GAO/HEHS-96-38 Section 457 Plans
Appendix I 

Comments From the Securities and

Exchange Commission

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

See pp. 8-15.

See pp. 22-23.

See comment 1.

Page 26 GAO/HEHS-96-38 Section 457 Plans
Appendix I 

Comments From the Securities and

Exchange Commission

See comment 2.

Page 27 GAO/HEHS-96-38 Section 457 Plans
Appendix I 

Comments From the Securities and

Exchange Commission

The following are GAO’s comments on the SEC letter dated February 16,

1996.

GAO Comments 1. Deferrals under section 457 could be at risk of loss in the event of a

sponsor’s insolvency, and our review and IRS officials’ statements led us to

conclude that fixing this problem, as the Congress proposed to do, cannot

easily be accomplished merely by amending section 457. While some of the

disadvantages of section 457 plans, such as lower deferral limits, indexing

of the limits, and imposing a rabbi trust requirement (which is a grantor

trust owned by the employer) could be altered by legislation without

contradicting tax principles, other changes, such as a funded trust whose

assets are set aside from the claims of the employer’s creditors and are

held for the exclusive benefit of participants, portability, and the date of

benefit receipt, could not be accomplished within the context of

nonqualified plans.

SEC recommended that the Congress make statutory changes to clarify the

status of 457 plans under federal securities laws, if it proceeds with

legislation relating to these plans. We do not comment on this

recommendation in this report, as it is outside the scope of our review.

2. SEC also made technical comments on the draft of this report that

clarified its role with respect to 457 plans, which we incorporated.

Page 28 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

See pp. 36-33.

See comment 1.

See pp. 11-12.

Page 29 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

See pp. 13-14.

See pp. 12-13 and 17-18.

Page 30 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

See comment 2.

See pp. 10-11.

See p.8, fn. 2.

See p. 18, fn. 25.

Page 31 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

See pp. 14-15.

See pp. 13-14.

Page 32 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

Page 33 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

Page 34 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

Page 35 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

Page 36 GAO/HEHS-96-38 Section 457 Plans
Appendix II 

Comments From the Internal Revenue

Service

The following are GAO’s comments on the IRS letter dated March 1, 1996.

GAO Comments 1. We have included appendix I with the IRS letter. We agree that certain

terms pertaining to supplemental qualified (tax-favored) and nonqualified,

unfunded (tax-deferred) plans can cause confusion. We have altered the

text throughout the report to reflect this distinction and other “terms of

art.” We also made other IRS technical markups to the draft as appropriate.

2. We recognize that most state and local government employers offer a

basic qualified, funded pension plan and that section 457 plans operate in

addition to the basic plan. We call these plans supplemental plans and

include 401(k) and 403(b) plans in the same category as nearly all these

plans in the state and local sector are in addition to a basic plan.

Page 37 GAO/HEHS-96-38 Section 457 Plans
Appendix III 

GAO Contact and Staff Acknowledgments

GAO Contact Donald C. Snyder, Assistant Director, (202) 512-7204

Staff

Acknowledgments

Dea M. Crittenden was the Evaluator-in-Charge on this project. The

following individuals also made important contributions to this report:

Cynthia L. Giacona-Wilson participated in all phases of the project

including project planning, data gathering and analysis, and report writing;

Endel P. Kaseoru assisted with data gathering and drafting the report; and

Dayna K. Shah, Stefanie G. Weldon, and Roger J. Thomas provided legal

counsel. Also assisting in various phases of the project were Nancy L.

Crothers, Donald P. Ingersoll, and Kenneth J. Bombara.

(207442) Page 38 GAO/HEHS-96-38 Section 457 Plans
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