August 9, 2005
SUBJECT: Amendment to the City of Sunnyvale 457 Deferred Compensation Plan
REPORT IN BRIEF
This report recommends amendments to three sections of the Deferred Compensation Plan: Section 2(l) to amend the definition of the Unforeseeable Emergency, to clarify language to conform to current Internal Revenue Code (IRC) regulations; Sections 3 (b), 8(a) and 8(c) to amend the application process and procedures for Unforeseeable Emergency; and to add Section 12(C) to allow for Permissive Service Credit Transfers.
BACKGROUND
The City of Sunnyvale has established per Resolution No. 301-80 (and as amended thereafter), a Deferred Compensation Plan under Section 457 of the Internal Revenue Code (IRC) which allows eligible employees to participate in an agreement to allow compensation contributions to be tax deferred and excluded from income until the tax year that the deferred compensation or income attributable to such deferred amounts is actually paid or made available to the employee.
From time to time amendments are needed to the Plan due to modifications in IRC regulations or because the City wants to make procedural changes. These amendments need to be approved by the City Council.
EXISTING POLICY
The General Plan, Planning and Management Element, Sub-element 7.3 Legislative Management, Goal 7.3D: Maintain a quality workforce, consistent with laws, the Charter, and adopted policies in order to assure that City services are provided in an effective manner. Action Statement 7.3D.1a states: to maintain a competitive pay and benefits package for employees.
Generally, a Deferred Compensation Plan is considered to be a component of the benefits package for employees as included in the Memoranda of Understanding and the Salary Resolution.
DISCUSSION
The recommended amendments include the following :
- Section 2(l) as currently written requires corrections to conform to the current language of the IRC regulations on definition of Unforeseeable Emergency Withdrawal.
- Section 3(b) and Section 8(a) and 8(c) makes a change in the procedures for applying for an Emergency Withdrawal to the City. Currently, an employee seeking an emergency withdrawal must present the need to the Personnel Board in an open public meeting. This experience exposes the employee to potential loss of privacy for personal and/or financial affairs. It can be an embarrassment and a humiliating experience for the employee, who may already be suffering stress associated with the emergency. It is proposed that the power to approve or deny requests for emergency withdrawals be conferred upon the City Manager, who will still be subject to the Plan’s parameters and regulations, to avoid the exposure that the employee is currently subjected to in an open public forum. This proposed amendment has been reviewed by the City Attorney and has been found to be legally permitted. This is also a model found in other cities.
Under the proposed amendment, the City Manager will make the final decision regarding whether or not to grant an employee's request for an emergency withdrawal. In the past, the City Attorney has reviewed the requests and provided advice to the Personnel Board regarding whether a request meets the legal requirements to qualify for an emergency withdrawal under the terms of the Plan (which mirror IRC regulations). The City Attorney will continue to provide such review and advice to the City Manager.
Section 12(c) will add a new provision regarding Permissive Service Credit Transfers. California Government Code Section 20909, which became effective January 1, 2004, allows public employees in California to purchase up to five (5) additional years of service credit (ARSC) from the California Public Employees Retirement System (PERS). It should be noted that any time bought under this provision does not meet the requirement for PERS vesting and that the cost of the purchase is fully paid by the employee.
PERS, like other public pension plans, has long allowed employees to “buy back” service credit for years spent in military agencies or while working for other public agencies. The new legislation is unique in that the service credit does not have to be based on any specific prior service. Soon after Government Code Section 20909 went into effect, most public employers, including Sunnyvale, decided to prohibit employees from using 457 funds to purchase ARSC. This conclusion was based on concerns that the IRS might consider such transfers to be improper, potentially jeopardizing the plan’s tax-deferred status. More recently, however, a number of public entities throughout California, including Santa Clara County and some neighboring cities, have decided to allow employees to use 457 funds to purchase ARSC. Likewise, PERS now permits employees to purchase ARSC through cash payments, payroll deductions, rollovers, and in-service, plan-to-plan transfers from IRC 401 (a), 401(k), 403(b) and 457 plans.
For transfers from 403(b) and 457 plans, PERS requires the employee to identify a previous period of “service” (e.g. time spent working for compensation or while self employed) for the service credit purchased. Again, none of this time will serve to meet the PERS vesting requirement.
The City of Sunnyvale, together with the cities of Mountain View and Santa Clara, recently sought legal advice from Washington D.C. tax attorney John Stanton. Mr. Stanton concluded that the IRC regulations permit employees to use 457 funds to purchase ARSC from PERS. Mr. Stanton recommended that the City, like PERS, take the cautious approach and require an employee seeking to purchase ARSC to identify a commensurate period of actual employment for compensation as an employee of another employer or as a self-employed businessperson.
Even though the IRS has yet to issue a definitive ruling on the subject, careful interpretation of the IRC regulations and IRS letter opinions suggest that using 457 funds to purchase ARSC is permitted. Furthermore, even if the IRS eventually rules that such transfers are improper, this should not jeopardize the plan’s tax-deferred status, because IRS regulations require that the employer be given 180 days to take corrective action.
The greatest risk may be that the IRS rules in the future that these transfers were not permissible. The amount of the transfer will become taxable income for the employee and the IRS may demand payment from the individual. The employer could, in this situation, potentially owe taxes for its share of payroll costs since the original sums paid into the 457 plan were tax deferred. On the other hand, if the IRS never issues such a ruling, the employer could be subject to claims by employees claiming they were damaged due to the employer’s interference with their right to use 457 funds for a legitimate and authorized purpose.
The amendment language in this section follows a model plan amendment that the IRS has issued for the authorization of permissive service credit transfers.
It should also be mentioned that many employees in the different bargaining units have been approaching the Human Resources Department since January 2004 requesting that they be allowed to use 457 funds to purchase ARSC.
FISCAL IMPACT
The amendments to (Sections Section 2(l), Section 3(b), Section 8(a) and 8(c)) amendments are administrative in nature and any associated costs will be absorbed through the current administrative processes already in the Plan. Section 12(c) regarding Permissive Service Credit Transfers will require Human Resources staff to produce informational packages and to meet with employees to process the transfers. However, it unknown at this time the number of employees who will immediately want to participate. There is no other fiscal impact on the City since employees are financially responsible for the cost of the additional service credit purchase.
Conclusion
The proposed amendments will keep the plan current with IRC regulations and provide a private administrative approach for processing requests for emergency withdrawals.
Regarding the addition of the Permissive Service Credit Transfers, PERS and a number of other public agencies have chosen to allow employees to use 457 funds to purchase ARSC. Accordingly, it seems reasonable for the City to allow it as well. This action is subject to the restrictions imposed by PERS and recommended by the City Attorney's office and outside counsel to tie the ARSC to a commensurate period of employment with another non-PERS employer, or period of self-employment. In addition, employees will be required to sign a liability waiver that will protect the City. Employees will acknowledge and accept any potential future liability if the IRS eventually rules that the transfers were not permissible. It is recommended that the City Manager be given the authority to develop procedures to implement and administer the details of service credit transfers.
PUBLIC CONTACT
Public Contact was made through posting of the Council agenda on the City’s official notice bulletin board, posting of the agenda and report on the City’s web page, and the availability of the report in the Library and the City Clerk’s Office.
ALTERNATIVES
1. Adopt amendments to three sections of the Deferred Compensation Plan: Section 2(l) to amend the definition of Unforseeable Emergency, to clarify language to conform to current Internal Revenue Code (IRC) regulations; Section 3(b), 8(a) and 8(c) to amend the application process and procedures for Unforeseeable Emergency: and to add Section 12(C) to allow for Permissive Service Credit Transfers.
2. Adopt amendments to any of the recommended sections of the City's Deferred Compensation Plan.
3. Do not adopt recommended amendments to the City's Deferred Compensation Plan
RECOMMENDATION
Staff recommends approval of Alternative #1: Adopt amendments to three sections of the Deferred Compensation Plan: Section 2(l) to amend the definition of Unforseeable Emergency, to clarify language to conform to current Internal Revenue Code (IRC) regulations; Section 3(b), 8(a) and 8(c) to amend the application process and procedures for Unforeseeable Emergency: and to add Section 12(C) to allow for Permissive Service Credit Transfers.