Tax Facts
3601 / Are death benefits under a Section 457 plan excludable from gross income?
If a death benefit is provided by a nongovernmental Section 457 plan, whether a 457(b) “eligible” or 457(f) “ineligible” plan, any such death benefit will not qualify for exclusion from gross income as the proceeds of life insurance under IRC Section 101(a). The life insurance proceeds must first be paid to the employer as sole beneficiary; hence, are “washed” through the employing entity and lose their tax-free character.1 Prior to the enactment of Section 409A, both 457 “eligible” and “ineligible” plans would have to be treated under the deferred compensation rules of Section 457.2
Since the enactment of Section 409A, however, an “eligible” plan would be subject only to Section 457 treatment on the deferred compensation death benefit, while a Section 457(f) ineligible plan would have to comply with both Sections 457 and 409A. However, the outcome is still the same because a death benefit paid from the employer rather than directly from the life insurance carrier (e.g., as in the case of endorsement split dollar) will still be treated as deferred compensation and thereby as income-in-respect of a decedent, etc. rather than the proceeds of life insurance ( Q 3602). The proposed 457/409A integration regulations have not changed this result.
Planning Point: As a practical matter, what this means is that tax-exempt organizations cannot create the combination of an endorsement split dollar life insurance arrangement on a single organization-owned policy acquired to help support a 457 supplemental deferred compensation plan. It will only be able to support a DBO plan and the payment will produce IRD.
Since the enactment of Section 409A, however, an “eligible” plan would be subject only to Section 457 treatment on the deferred compensation death benefit, while a Section 457(f) ineligible plan would have to comply with both Sections 457 and 409A. However, the outcome is still the same because a death benefit paid from the employer rather than directly from the life insurance carrier (e.g., as in the case of endorsement split dollar) will still be treated as deferred compensation and thereby as income-in-respect of a decedent, etc. rather than the proceeds of life insurance ( Q 3602). The proposed 457/409A integration regulations have not changed this result.
Planning Point: As a practical matter, what this means is that tax-exempt organizations cannot create the combination of an endorsement split dollar life insurance arrangement on a single organization-owned policy acquired to help support a 457 supplemental deferred compensation plan. It will only be able to support a DBO plan and the payment will produce IRD.
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