“Are distributions to retired employees from a 457(b) plan of a private tax-exempt employer reported on a 1099-R or W-2? Does it matter whether the distribution is an annuity or not?”
Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:
In order to answer this question, it is helpful to look at the IRS Form W-2 Instructions, which state the following on page 16 (boldface text reflects the Experts emphasis):
Box 1—Wages, tips, other compensation. “Show the total taxable wages, tips, and other compensation that you paid to your employee during the year. However, do not include elective deferrals (such as employee contributions to a section 401(k) or 403(b) plan) except section 501(c)(18) contributions. Include the following:
. . .
Distributions to an employee or former employee from an NQDC plan (including a rabbi trust) or a nongovernmental section 457(b) plan.”
Thus, distributions to an employee from a 457(b) plan sponsored by a nongovernmental tax-exempt organization are reported in Box 1 of the W-2. Note that this reporting is in contrast to the distribution reporting for a 457(b) governmental plan, where distributions are reported on a 1099-R, not a W-2. Further, death benefits from a 457(b) plan sponsored by a tax-exempt organization paid to the estate or beneficiary of a deceased employee are reportable on Form 1099-MISC.
Note that the W-2 instructions do not make a distinction between types of distributions, so annuity distributions from a private tax-exempt 457(b) plan would be reported on a W-2 as well, even if the employee has long since retired from the plan sponsor. However, plan sponsors should keep in mind that annuity distributions from 457(b) plans of tax-exempt organizations must be carefully structured to maintain the unfunded status of such deferred compensation and avoid immediate taxation under constructive receipt rules.
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.
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Union Plan Member’s Lawsuit Over Unfunded Benefit Liabilities Dismissed
The lawsuit was previously dismissed because the alleged breach of fiduciary duty involved the amendment of plan benefits, which is a settlor, not a fiduciary, function; a judge found the new claims are time-barred.
A second attempt by a participant in the Inlandboatmen’s Union of the Pacific National Pension Plan (IBU Plan) to sue the trustees of the plan for breach of fiduciary duties by allowing the plan to incur unfunded vested benefit liabilities (UVB) has been dismissed.
The plaintiff alleges the operative trust documents provide that the trustees will not permit any incurrence of UVB. According to court documents, the requirement that the trustees not permit UVB was adopted in 1982 through amendment of the 1981 Trust Agreement. The plaintiff says that to amend that particular segment of the agreement, the trustees had to obtain unanimous consent of the participating employers in the plan. However, he asserts, the trustees amended the trust agreement in 2009, eliminating the requirement that they cannot allow the plan to incur UVB and did not get unanimous consent of participating employers.
He alleges this made the amendment invalid, yet the trustees have administered the plan since 2009 as if the trust agreement permitted UVB.
The plaintiff says the trustees allowed the plan to incur UVB by investing in risky investments, assuming a too-high rate of return and not negotiating or incentivizing increased contributions to the plan by employers. He also alleges the trustees did not provide disclosures informing participants about circumstances that threatened the funding of benefits.
The lawsuit was previously dismissed because the alleged breach of fiduciary duty involved modification of plan benefits to address UVB and the amendment of plan benefits is a settlor, not a fiduciary, function. The plaintiff was granted leave to file an amended complaint.
Chief Judge Michael W. Mosman of the U.S. District Court for the District of Oregon ordered dismissal of the latest complaint based on the recommendation of U.S. Magistrate Judge Jolie A. Russo.
According to Russo’s recommendation, all of the plaintiff’s claims in the amended complaint depend upon the allegation that the trustees breached their duty not to incur UVB in the first place based on the 1981 Trust Agreement. “Plaintiff has not alleged that this case is about specific imprudent investments, but involves fiduciaries making decisions about how to manage risk while keeping in compliance with a rule that prohibits UVB,” the document says.
Russo says the heart of the plaintiff’s claims is the alleged failure of the trustees to follow the trust documents’ amendment procedures and operating as if the plan had been properly amended to permit the incurrence of UVB. She notes that the alleged violation was completed in 2009 and, since the plaintiff initiated the lawsuit in 2018, “thus it must be determined if ERISA’s statute of limitations now precludes plaintiff from asserting a breach of fiduciary duty through improper amendment occurring in 2009.”
Finding the alleged Employee Retirement Income Security Act (ERISA) violation constituting a breach of fiduciary duty occurred when the Trust Agreement was amended in 2009, Russo proceeded to determine when actual knowledge of the breach occurred. She found the plaintiff does not allege any facts showing the participants were not aware the UVB could be incurred pursuant to the amendments in 2009. In fact, the plaintiff alleges the amendment was obtained via consent of the union representing the plan participants.
The plaintiff also argues that every time the plan incurs UVB, it is a separate breach of fiduciary duty constituting a continuing violation with the statute of repose beginning to run on the date of the last culpable act. However, beginning in 2009, the Trust Agreement the trustees relied upon allowed the plan to incur UVB. Thus, Russo said, incurring UVB would only be a violation if the amendment was invalid. Because the date for asserting that claim commenced in 2009 when the breach was complete, the subsequent incursion of UVB was not itself a culpable act upon which a breach of fiduciary duty could be asserted. “As noted by the court in previously dismissing the first amended complaint, the incursion of UVB necessitated amendment to plan benefits, which is not a fiduciary function,” she wrote in her recommendation.
Still, Russo addressed underlying claims in the lawsuit. The plaintiff challenges the trustees’ overall investment strategy in light of the alleged prohibition on incurring UVB, alleging the trustees must invest in virtually no risk investments, assume conservative rates of return and create a reserve to stave off UVB. Russo found that the plaintiff does not allege any facts to plausibly demonstrate his chosen investment strategy is any more prudent then the strategy employed by the trustees or how the trustees knew their strategy was imprudent when implemented.
As for whether the trustees should have adopted much lower rates of return and lower benefits, Russo said that lowering benefits, as previously noted, is not a fiduciary function. In addition, she said, the plaintiff does not allege why the chosen rates of return were unreasonable at the time they were adopted.
Regarding the allegation that the trustees did not request increased employer contributions when faced with UVB, Russo said such action is not fiduciary conduct related to the amendment of a plan. And regarding the allegation that the trustees did not ensure that the plan’s advisers accounted for the prohibition on incurring UVB, she reiterated that the plaintiff is time-barred from asserting the plan was improperly amended to permit UVB.
The plaintiff also alleges the trustees failed to disclose a host of issues regarding UVB, rates of return, amendment procedures and failure to create a reserve. Again, Russo said that to the extent the plaintiff asserts the plan was improperly amended to permit UVB, that claim is time-barred.
Russo conceded that an ERISA fiduciary has an affirmative duty to inform beneficiaries of circumstances that threaten the funding of benefits. However, she said a fiduciary need not adhere to stricter deadlines for statutorily required reporting than those provided in ERISA. Russo noted that the plaintiff does not identify what disclosures were untimely or misleading. She found that the judicially noticed documents show that plan participants have been timely provided with changes to benefits, funding status, specific reduction in benefits and even possible cuts.