Just the other day, a public agency client contacted us to find out what to do with a participant’s 457(b) plan deferral election following the participant’s untimely death due to COVID. As with most cases, cities and special districts would owe the former employee (or the employee’s estate) significant amounts of unpaid wages, overtime, or unused PTO. And, although the W-2 reporting and FICA/Medicare tax withholding are discussed in the W-2 Form instructions, it isn’t always clear whether to withhold 457(b) deferral elections based on the form currently on file.
How might a 457(b) deferral election be revoked? There are a number of possible answers: pursuant to the terms of the election itself; pursuant to the terms of the plan; or by operation of law. After this question came up, we decided to look at a number of 457(b) plan documents and election forms to see what they said. Based on our limited, non-scientific sampling of the plan documents readily available to us, we can say with confidence that all of the forms and documents we’ve looked at do not address whether a deferral election is revoked upon the participant’s death – that is, all are silent on the matter. Furthermore, we have looked at the California Labor Code provision that requires written authorization for deductions from an employee’s paycheck. Unfortunately, there does not appear to be any case law addressing whether the employee’s death automatically revokes plan election.
What is the best way to handle the situation? Assuming that you have carefully examined the above-mentioned documents and authority – and still don’t have a clear answer – what are your choices? First, you can recognize that amounts of pay, accrued leave, etc., that are paid in the year of death are reportable on the decedent’s W-2 for the year (at least for Social Security and Medicare purposes). Since most plan documents use a participant’s W-2 compensation as the basis for compensation subject to deferrals, it would seem plausible to subject the deceased employee’s final pay to their deferral election on those grounds. Furthermore, placing a portion of the decedent’s wages into a 457(b) plan would arguably preserve some of the tax planning flexibility available to the beneficiaries. Second, you can base your handling of the deferral election on the fact that the IRS also directs the employer to issue a Form 1099-MISC to the estate or beneficiary of the decedent – that is, the amounts are taxable to the estate or the beneficiary. One could use this to argue, or interpret the plan, to exclude such amounts from compensation that should be subject to the outstanding deferral election.
Whichever way you choose, remember that you are administering the plan and that you need to prudently document your reasons for doing what you decide to do as well as handle similar situations in a consistent, non-arbitrary manner.
Follow-up discussions with highly respected advisers and recordkeeping specialists make it clear to us that this is something that 457(b) plan administrators should think about and plan for before it happens. The best practice is to deal clearly and explicitly with this potential situation in the participant’s written deferral election. As far as we can tell, it should be acceptable for the deferral election to clearly state that such (post-death) amounts will be subject to the election, will not be subject to the election, or will be subject to a special election made by each participant as part of the form. The form should also state what will happen in the event the participant makes no such election.
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 email@example.com or (916) 329-3685.