3589 / Is a Section 457(b) “eligible” nonqualified deferred compensation plan required to include provisions regarding unforeseeable emergency situations?

A financial hardship provision allowing distributions to participants with financial difficulties is optional at the employer’s discretion. However, if included an “unforeseeable emergency” must be defined in the plan as a severe financial hardship of participants or beneficiaries resulting from illnesses or accidents of the participants or beneficiaries or of their spouses or dependents, the loss of the participants’ or beneficiaries’ property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond their control. It should be noted that Section 457 uses terminology that is different from that in 401(k) and 403(b) plans but very similar to that used in Section 409A, which is also an optional plan provision. Moreover, the IRS has made it clear that it intends to treat the definitions as having the same meaning in both Code sections, especially as to 457(f) “ineligible” plans.¹

Examples of valid emergencies in the Section 457 regulations and in Revenue Ruling 2010-27 include the imminent foreclosure of, or eviction from, a primary residence; the need to pay for medical or funeral expenses, including funeral expenses for an adult child who is not a dependent; and significant water damage to a principal residence. However, the most recent ruling indicates that paying off high credit card debt is not unforeseeable and therefore does not qualify.

Whether an event is an unforeseeable emergency will depend upon the relevant facts and circumstances of each case. However, a distribution on account of an unforeseeable emergency may not be made where the emergency may be relieved through reimbursement or compensation from insurance or otherwise, by liquidation of a participant’s assets if liquidation in itself would not cause severe financial hardship, or cessation of deferrals under the plan. In addition, the distribution must be limited to the amount reasonably necessary to satisfy the emergency need (including amounts necessary to pay taxes or penalties reasonably expected to result from the distribution).² In order to ensure that the distribution is limited to the amount reasonably necessary to satisfy the emergency need, the IRS requires documentation in the form of receipts so that the plan administrator can verify the necessity of the amounts requested.³

A court did find a severe financial hardship where the participant’s spouse gave birth to a severely ill child and had to cease working in order to care for such child.⁴