Attachment 1: Notification to CalPERS Participants
IMPORTANT INFORMATION ON TRANSFERS FROM 403(b) OR 457 PLANS
TO PURCHASE ARSC AND THE FEDERAL TAX LAW
Assembly Bill 719 added section 20909 to the Government Code. This new section allows eligible members of the California Public Employees’ Retirement System (CalPERS) to purchase up to five years of Additional Retirement Service Credit (ARSC). ARSC is not based on actual employment with a CalPERS covered employer. Instead, it is “permissive” service credit available to members to increase their retirement by making voluntary, additional contributions.
The Internal Revenue Service (IRS) has not yet issued formal rules on purchases of permissive service credit. Some have suggested that the Internal Revenue Service (IRS) will require the purchase of permissive service credit to reflect some sort of actual “service” in order for in-service, plan-to-plan transfers1 from 403(b) or 457 governmental plans to be used to pay for ARSC. As a result, CalPERS is acting prudently by requiring members to certify to “corresponding service” before assets from 403(b) and 457 plans may be transferred in-service to purchase ARSC. The corresponding service may be for compensated private sector or self-employment, as well as prior government or military service that has not been credited under the CalPERS plan.
However, there is a slight risk that even with certifying to the “corresponding service,” the IRS may find that in-service transfers from 403(b) or 457 plans are not permissible to purchase ARSC. In this event, CalPERS may be required to take corrective measures, such as reversing the transferred amounts and related earnings back to the transferor plan. Alternatively, the IRS could treat the amount transferred from these accounts as taxable income on the date it was transferred. In addition, the transfers made to the CalPERS defined benefit plan might be treated as after-tax contributions and subject to the $41,000 annual additions limit imposed by section 415(c) of the Internal Revenue Code.
To help CalPERS members achieve the greatest amount of portability of their retirement accounts with the least amount of risk, CalPERS is requesting a ruling from the IRS that amounts may be transferred from a 457 plan to the CalPERS defined benefit plan to purchase ARSC without corresponding service. Therefore, in the interim, CalPERS is including this notice to members so they are aware of the potential risks associated with in-service transfers from 403(b) and 457 plans to purchase ARSC. Members should be aware of these risks, however slight, before electing an in-service transfer of funds from these accounts to purchase ARSC.
1 An in-service, plan-to-plan transfer (also referred to as an in-service transfer) is a direct transfer of assets between retirement plans in which the funds go directly to CalPERS. An in-service transfer allows a participant to avoid current taxation on the amount transferred and, unlike a rollover, it is permitted in the absence of a distribution event (i.e., separation from service, retirement, disability, or death).
Attachment 2: Results of Research on Use of 457 Funds to Purchase ARC
Because the IRS has not formally addressed the issue of using 457 Deferred Compensation funds to purchase ARC, those jurisdictions that have implemented the option have solicited legal opinions.
For 1937 Act systems, the use of 457 funds to purchase of ARC time has been reviewed by a few tax counsels. The consensus appears to be as follows. The member must be an active member to enter into the contract to purchase the ARC time, however, if the County has adopted Section 31485.7 which allows the purchases of time to be completed within 120 days from termination of employment, then the completion of the payment can be made during this 120 post-employment period. (Section 31485.7 has been adopted in this County.) The tax counsels are of the opinion that an active employee cannot use 457 funds during employment for the purchase but believe that “If a distribution and transfer were made from the county’s 457 plan after termination of service to purchase ARC time, this distribution should be allowed under the IRS interpretation of section 457(e)(17)”. The three systems that do allow purchase of ARC each allow the use of 457 funds to complete the purchase during the 120 day post employment period.
PERS acknowledges that if the IRS ultimately rules that 403(b) or 457 funds may only be used to purchase actual service, then those purchases that agencies have permitted under AB 719 will need to be reversed. We contacted the City of Redwood City and were informed that they are not permitting 457 funds to be used to purchase credit nor are they familiar with other agencies who do permit such resources.
Both of the above interpretations differ from some of the Deferred Compensation providers as quoted in the next section.
Hartford, ICMA and Nationwide were again contacted to determine if there has been any change in either their or the IRS’s view of using 457 funds to purchase additional time that was not linked to actual services.
Hartford stated that the PERS service credits “may not satisfy the Code 415(n) limitation exception due to the nature of the ‘service’ to be credited and the fact that an individual need not be employed to effect the purchase.” Hartford goes on to state: “Of note, we understand that the California Public Employees’ Retirement System (CalPERS) will no longer allow for the purchase of service credits unless actual service has been performed and the individual has yet to retire.”
ICMA stated that they continue to “strongly recommend against employers allowing plan participants to use 457 assets to purchase “Air Time” until either Congress passes legislation or the IRS provides formal guidance expressly allowing for these types of purchases.” ICMA does believe it is acceptable to purchase credits within the 120 day post employment period using a rollover of 457 funds.
Nationwide stated that “informally, the IRS has conveyed at various times that governmental 457 plans should not permit the transfer of assets to qualified defined benefit plans for the purchase of air time. Consequently, governmental 457 plans are risking the eligibility of their 457 plans if the IRS determines that such transfers are prohibited. For these reasons, Nationwide is recommending that plan sponsors defer a decision to permit the transfer of 457 assets to purchase air time until the IRS provides formal guidance regarding this issue”.
Until the IRS indicates that the use of such funds is permissible, either through their issuance of guidelines or in a response to PERS’ request for a ruling, employers who permit use of such funds risk plan non-compliance and individual participant taxation.
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