457(b) Plan Contributions Based on Severance Pay

“I know from previous Ask the Experts column that you cannot make contributions to a 403(b) plan based on severance pay (payments to a former employee for NOT working). But what about 457(b) plans? Are the rules the same?”

Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

Good question, as the rules are indeed a bit different for 457(b) plans.

For 457(b) elective deferrals, the rules on making contributions based on severance pay are indeed the same as for 403(b)s (and 401(k)s, for that matter). Specifically, the regulations promulgated under both Internal Revenue Code (IRC) sections 457 and 403(b) provide that only “includible compensation” within the meaning of Code Section 415(c) is eligible for deferral. See Treasury Regulation sections 1.457-2(g); 1.403(b)-2(b)(11). Because “includible compensation” does not include severance pay, a participant cannot make elective deferrals on true severance pay into a 457(b) plan at all, regardless of when such severance is paid.

However, unlike elective deferrals, there does not appear to be any direct prohibition with respect to employer contributions being made to a 457(b) plan based on severance pay. However, in 2020 and 2021, the overall limit on contributions to a 457(b) is the lesser of $19,500 in 2020 (indexed in future years) or 100% of includible compensation, and that includible compensation does not include severance pay. See Notice 2020-79.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.