Public Pensions: Section 457 Plans Posed Greater Risk Than Other
Supplemental Plans (Chapter Report, 04/30/96, GAO/HEHS-96-38).

Pursuant to a congressional request, GAO reviewed the status of public
pension funding, focusing on how plans established under Internal
Revenue Code (IRC) section 457 differ from plans created under IRC
sections 401(k) and 403(b).

GAO found that: (1) most state and local government employees are
covered under section 457 plans because the Tax Reform Act of 1986
prohibited state and local governments from establishing plans under
sections 401(k) and 403(b); (2) section 457 plan participants risk
losses if sponsoring governments go bankrupt or the deferred monies are
mismanaged or lost; (3) section 457 does not require sponsoring
governments to maintain deferred monies to pay future benefits; (4)
section 457 plan participants risk losses because sponsoring governments
may view deferred monies as available for public use; (5) while funds
enrolled in section 401(k) and 403(b) plans can be transferred to
investment retirement accounts (IRA) when the employee leaves state or
local government employment, amounts payable from section 457 plans can
only be rolled over into other section 457 plans; (6) section 457 plan
participants must declare a fixed date for when they will begin
receiving their benefits shortly after retiring or leaving employment;
(7) according to IRS, the transfer of section 457 plan deferrals into
IRA or allowing plan participants to change their distribution dates
would create a taxable event or be incompatible with the plan's tax
deferred condition of government ownership; (8) section 457 plans allow
a lower maximum annual employee deferral and employer contribution than
section 401(k) and 403(b) plans, and are not indexed; and (9) new
legislation could increase the section 457 plan deferral and
contribution limit and index section 457 plans to inflation.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-96-38
     TITLE:  Public Pensions: Section 457 Plans Posed Greater Risk Than 
             Other Supplemental Plans
      DATE:  04/30/96
   SUBJECT:  State employees
             Municipal employees
             Government retirement benefits
             Pension plan cost control
             Civil service pensions
             Retirement pensions
             Tax law
             Employee retirement plans
             Financial management
             Tax exempt status
IDENTIFIER:  Orange County (CA)
             Los Angeles (CA)
             
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Cover
================================================================ COVER


Report to Congressional Requesters

April 1996

PUBLIC PENSIONS - SECTION 457
PLANS POSE GREATER RISK THAN OTHER
SUPPLEMENTAL PLANS

GAO/HEHS-96-38

Section 457 Plans

(207442)


Abbreviations
=============================================================== ABBREV

  ERISA - Employee Retirement Income Security Act of 1974
  IRA - individual retirement account
  IRC - Internal Revenue Code
  IRS - Internal Revenue Service
  SEC - Securities and Exchange Commission

Letter
=============================================================== LETTER


B-260634

April 30, 1996

The Honorable Nancy L.  Johnson
Chairman, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives

The Honorable Sam M.  Gibbons
Ranking Minority Member
Committee on Ways and Means
House of Representatives

This report is one of three we are issuing in response to your
request that we review the status of public pension plan funding.\1
This report specifically addresses your concerns about the financial
security of amounts deferred by participants into state and local
government supplemental pension plans. 

In this report we discuss how plans established under Internal
Revenue Code (IRC) section 457 differ from plans created under IRC
sections 401(k) and 403(b) in terms of protection against financial
loss and other issues. 

As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 15 days
from its issue date.  At that time, we will send copies to the
Commissioner of the Internal Revenue Service, the Chairman of the
Securities and Exchange Commission, and interested congressional
committees.  Copies will be made available to others upon request. 

This report was prepared under the direction of Donald C.  Snyder,
Assistant Director.  Mr.  Snyder can be reached on 202-512-7204, if
you or your staff have any questions. 

Jane L.  Ross
Director, Income Security Issues


--------------------
\1 See Public Pensions:  Summary of Federal Pension Plan Data
(GAO/AIMD-96-6, Feb.  16, 1996) and Public Pensions:  State and Local
Government Contributions to Underfunded Plans (GAO/HEHS-96-56, Mar. 
14, 1996). 


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

Millions of state and local government employees are taking steps to
increase their future retirement benefits by deferring some of their
wages to supplemental pension plans, known as salary reduction
arrangements or plans.  The amounts deferred or contributed to some
of these plans, however, may be at risk.  Recent media reports have
highlighted instances of imprudent investment, improper use of plan
funds by sponsors, and possible seizure of plan funds by sponsoring
governments' creditors. 

Such reports have raised concerns among members of the Ways and Means
Committee of the House of Representatives.  Accordingly, the
Committee asked GAO to determine the risks of financial losses
inherent in such plans.  GAO was also asked to determine whether the
provisions of such plans treat participants comparably. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

Salary reduction plans enable participants to defer part of their
salary and the taxes normally due to a future date.  Among the
arrangements utilized by state and local governments to augment
regular employee pension plans are three plans authorized under the
Internal Revenue Code (IRC) at sections 401(k), 403(b), and 457(b). 
Employees contribute to these plans through salary deferrals, and
some governments make matching contributions.  Amounts deferred under
these plans and any earnings that accrue on them generally are not
subject to federal income tax until they are received, usually upon
retirement.  The benefits received depend on the amount deferred and
any earnings or losses thereon. 

The Tax Reform Act of 1986 prohibits state and local governments from
establishing any new 401(k) plans after May 6, 1986, although
existing plans may continue.  Federal law generally limits
participation in 403(b) plans to employees of public school systems,
including kindergarten through 12th grade; colleges; and
universities.  In addition, some tax-exempt charitable and other
not-for-profit organizations, such as hospitals, may sponsor a 403(b)
plan.  As a result, most state and local government employees today
have only 457 plans available to augment their regular government
pension. 

These plans have different requirements for deferring taxes because
they are derived from separate and distinct tax law theories. 
Section 401(k) and section 403(b) plans are qualified or
qualified-type plans whose purpose is to encourage employers to
provide plans for rank-and-file workers to protect their savings for
retirement.  To be qualified and maintain their tax-favored status,
such plans must, in part, satisfy certain federal rules.  These rules
limit an employer's ability to exclude rank-and-file employees from a
plan and limit the extent to which contributions and plan benefits
can vary between highly and nonhighly compensated employees.  These
rules are known as minimum coverage, minimum participation, and
nondiscrimination rules.  In qualified and qualified-type plans, the
amounts deferred from employees' wages and earnings on these amounts
are funded; that is, they are held in a tax-exempt trust or annuity
contract or a custodial account (such as mutual funds) for the
exclusive benefit of participants and are unreachable by creditors of
the sponsor.  Any earnings are also tax-exempt until the amounts are
paid out. 

Section 457 plans, on the other hand, are nonqualified, unfunded
deferred compensation plans.  These plans are driven by the tax law
principles of constructive receipt and economic benefit that require
taxation on income, even if some salary is not actually paid to the
taxpayer but is deferred.  One of the keys to avoiding salary
deferrals from being taxed under these principles is that the amounts
deferred must remain the property of the sponsoring employer and be
available to the general creditors of the employer.  Although 457
plans are considered unfunded because salary deferrals are not held
specifically for employees, most sponsors invest their employees'
deferrals to ensure that funds are available when needed to pay
benefits. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

Participants in 457 plans are exposed to greater risk than are
participants in section 401(k) and 403(b) plans, because of inherent
differences between qualified, funded and nonqualified, unfunded
plans.  Amounts deferred and any earnings under 457 plans are
credited to participants' bookkeeping account balances but are not
plan assets maintained solely for the participants' benefit as are
deferrals under 401(k) and 403(b) plans.  While 401(k) and 403(b)
plan deferrals are owned solely by the plan participants, 457 plan
deferrals are owned by the sponsoring employer until distribution is
made to the participant, generally after retiring or leaving
employment.  Consequently, amounts deferred under 457 plans may be
used by a sponsoring government for nonplan purposes and are subject
to the claims of its creditors in the event of bankruptcy. 

Participants in 457 plans not only have no ownership interest in
amounts deferred under these plans, but they cannot avail themselves
of additional benefits provided through qualified, funded plans. 
Because deferred amounts must remain within reach of the employer's
creditors to maintain tax-deferred status, a 457 plan participant who
leaves state or local government employment before retirement may not
roll over deferred amounts and earnings to an individual retirement
account (IRA) and avoid paying taxes on the distribution. 
Participants in qualified plans, such as 401(k), and qualified-type
plans, such as 403(b) plans, however, can defer taxes by rolling over
account balances to IRAs. 

In addition, in order to maintain tax-deferred status, participants
in 457 plans cannot have continuing control over the date of
distribution of deferred amounts.  Within a short time after leaving
government service, participants must choose a date to begin
receiving benefits.  Often, this is a date selected for retirement
many years in the future.  That date, once selected, can seldom be
changed.  Participants in 401(k) and 403(b) plans are not limited in
this way. 

Finally, 457 plan participants and their employers are not allowed to
contribute as much to their retirement savings plans as are
participants in the other two plan types.  Moreover, this disparity
will continue to grow because the 457 plan contribution limit is not
indexed for inflation as are the other two plans' limits.  Increasing
the maximum amount of contribution along with indexing for inflation
would have no impact on the tax-deferred status of 457 plans. 


   PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4


      SPONSORING GOVERNMENT
      ACTIONS POSE RISK TO 457
      PLAN DEFERRALS
-------------------------------------------------------- Chapter 0:4.1

Because 457 plans maintain their tax-deferred status by requiring
that the sponsoring government own the deferred amounts, plan
participants may risk the loss of some or all their deferrals if
their sponsoring government goes bankrupt or funds are in some way
mismanaged or lost.  For example, if Orange County, California, is
unable to emerge from its current bankruptcy proceeding without
providing its general creditors with a settlement under which those
creditors receive 100 cents on the dollar, the county's 457 plan
participants will be forced to share proportionately in the losses of
those general creditors. 

Further, because any amounts set aside by the employing governments
to pay section 457 plan obligations are owned by the sponsoring
governments, some governments may view them as funds available for
their own use.  IRC section 457 does not prescribe that any 457 plan
monies must be maintained to pay future benefits.  In late 1992, the
Securities and Exchange Commission (SEC) staff learned that Los
Angeles County intended to borrow $250 million from the amount set
aside to pay its 457 plan obligations to cover payroll expenses. 
When SEC questioned this course of action as potentially impairing
the status of the funds under the federal securities laws, the county
abandoned its proposal. 


      457 PLAN PROVISIONS
      DISADVANTAGE PARTICIPANTS
-------------------------------------------------------- Chapter 0:4.2

Amounts payable from a 457 plan are only portable to other 457 plans. 
They cannot be rolled over to an IRA as can 401(k) and 403(b) plan
funds when an employee leaves state or local government employment. 
According to IRS officials, changing this feature of 457 plans for
state and local government plan participants would create a taxable
event under the principles of constructive receipt and economic
benefit.  Also, 457 plan participants must declare, within a short
time after retiring or leaving their employment, the date on which
they will begin receiving their benefits.  The date is final and can
only be changed if an emergency occurs.  IRS officials state that
this feature of nonqualified, unfunded deferred compensation plans,
such as 457 plans, arises because allowing participants the option of
changing the distribution date would constitute control over the
assets, which is inconsistent with the tax principle that these
assets be owned or under the control of the plan sponsor. 

Finally, the maximum annual employee deferral and employer
contribution to 457 plans is $7,500, about $2,000 less than for
participants in 401(k) and 403(b) plans.  And because the 457 plan's
maximum employee contribution is not indexed to inflation as are the
employee deferral maximums of 401(k) and 403(b) plans, the disparity
between plans can be expected to grow with inflation.  This limit on
457 plan deferrals could be increased by legislative changes and
indexed to grow in step with 401(k) and 403(b) plans. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:5

SEC commended our report and agreed with our conclusions (see app. 
I).  SEC added that if the Congress proceeds with legislation
relating to public plans, it should consider the status of 457 plans
under federal securities laws.  SEC also noted some technical changes
that we incorporated where appropriate.  IRS also commended our
report and provided technical comments and an overview of 457 plans
(see app.  II).  We incorporated IRS' technical comments where
appropriate. 


INTRODUCTION
============================================================ Chapter 1

Millions of state and local government employees are supplementing
their future retirement benefits by contributing to salary reduction
plans called salary reduction or defined contribution arrangements. 
Such plans enable participants to defer part of their current salary
for future use.  The goal of these plans is to postpone federal
income tax until the amounts deferred from an employee's salary and
any earnings or losses thereon are received by the participant at
separation or retirement. 

All salary reduction plans pose some risk of financial loss from poor
investment performance.  However, amounts in plans organized under
Internal Revenue Code (IRC) section 457(b) (hereinafter referred to
as 457 plans) bear additional risk because salary deferrals to 457
plans are assets of the sponsoring employer that may be used for
nonplan purposes and which are subject in the event of bankruptcy to
the claims of general creditors.\2 For example, one municipality's
recent bankruptcy could cause financial losses to employees who
participated in its 457 plans.  In addition, amounts earmarked to pay
another county's 457 plan obligations could have been at risk when
the county intended to use those amounts to meet payroll expenses. 
In that case, the county might not have had the funds available when
the time came to pay out the amounts due the 457 plan participants. 
In both cases, county officials were entitled to use the money saved
to pay 457 plan obligations for nonplan purposes.  As a result,
concerns have been raised about the security of deferrals that
participants make from their salary under 457 plans. 


--------------------
\2 Section 457 creates two types of plans, an eligible section 457
plan, as defined in section 457(b), and an ineligible section 457
plan, as explained in section 457(f).  All section 457 plans are
nonqualified, unfunded deferred compensation plans.  Amounts set
aside to pay plan obligations must remain the property of the
employer and subject to the employer's general creditors.  Under an
eligible plan, amounts deferred will be includable in gross income
only for the taxable year in which the compensation or other income
is paid or otherwise made available to the participant or other
beneficiary.  Plan participants involved in a plan subject to section
457(f), which is not an eligible deferred compensation plan, are
subject to immediate tax treatment, which renders all such deferrals
on compensation subject to tax for the first year in which there is
no substantial risk of forfeiture. 


   THREE TYPES OF SALARY REDUCTION
   PLANS
---------------------------------------------------------- Chapter 1:1

A state or local government may elect to offer its employees, among
other retirement plans, a deferred compensation arrangement under IRC
sections 403(b), 401(k), and 457(b).  In all three types of plans,
employees may voluntarily defer compensation through payroll
deductions.  Federal income tax is postponed until employees begin to
receive their account balances, usually at retirement or when they
are no longer employed by the plan's sponsor.  These three salary
reduction plans typically are intended to supplement an
employer-sponsored qualified pension plan under IRC section 401(a).\3

In general, 401(k) plans, sometimes referred to as cash or deferred
arrangements, are qualified plans that allow employees to choose
between receiving current compensation or having part of their
compensation contributed to a qualified profit-sharing or stock bonus
plan.  A 403(b) plan, a qualified-type plan sometimes referred to as
a tax-sheltered annuity, is a deferred compensation arrangement that
may be sponsored only on behalf of employees of public educational
systems and other specific tax-exempt organizations. 

Section 457(b) plans are nonqualified, unfunded deferred compensation
plans that may cover all employees of a state or local government and
certain highly compensated employees of a tax-exempt organization. 
Such plans permit these employees to defer limited amounts of
compensation so that, under the principles of constructive receipt
and economic benefit, tax will also be deferred on the amounts plus
their earnings until some future event. 

Eligibility and the security of deferred amounts vary among the three
plan types.  Employees of public schools, colleges and universities,
and some private institutions exempt from tax under IRC section
501(c)(3), such as hospitals, typically participate in 403(b) plans. 
Contributions to these plans are generally maintained as an annuity
contract\4 or custodial account,\5 both of which are reserved for the
sole benefit of the participant and his or her beneficiaries. 

Employee deferrals under section 401(k) plans are held in trust for
the sole benefit of the participants and their beneficiaries.  These
participants are primarily employed in the private sector.  However,
some state and local governments established these plans in the late
1970s and early 1980s for their employees.\6 With the enactment of
the Tax Reform Act of 1986,\7 state and local government employers
who had not previously established 401(k) plans were prohibited from
establishing new 401(k) plans, but existing plans could continue. 
Despite concerns raised by representatives of state and local
governments, among others,\8

the rationale for this exclusion was that allowing public employees
to have access to both 401(k) plans and 457 plans would be
"inappropriately duplicative."\9

Only employees of and independent contractors providing service to
state and local government and tax-exempt organizations may
participate in 457 plans.  Unlike 401(k) and 403(b) plans that are
funded and must comply with the nondiscrimination and minimum
participation rules, section 457 plans are unsecured promises of the
employer to pay amounts in the future.  A section 457 eligible,
salary reduction plan requires that all deferred compensation and
income shall remain solely the property of the employer and be
subject to the claims of the employer's general creditors.\10


--------------------
\3 A qualified plan is one that receives special tax advantages by
meeting requirements of section 401(a), including certain minimum
participation, coverage, vesting, and nondiscrimination rules.  Among
the tax advantages of a qualified plan is permitting employees to
contribute to a tax-exempt trust for their exclusive benefit. 
Additionally, benefits from a qualified plan are not includable in
the gross income of a participant until actually paid. 

\4 An annuity contract is a contract between the sponsoring entity
and a life insurance company.  Contributions and their earnings are
paid back to the participant at specified intervals over a period of
time after retirement or separation. 

\5 A custodial account is an arrangement made by the sponsoring
government with a third-party agent who invests the assets. 

\6 IRC section 401(k) did not expressly authorize participation by
public employees.  However, the Internal Revenue Service (IRS)
determined in its General Counsel Memorandum 38283 that public
employers could maintain such arrangements and accordingly issued
several determination letters approving section 401(k) arrangements
established by public employers. 

\7 P.L.  95-514. 

\8 "The particularly appealing feature of the Section 401(k) plan is
that it provides security; not just in the sense that amounts set
aside for retirement provide a measure of security, but in the
safeguards which the Code provides.  Amounts in a Section 401(k) plan
are placed in trust and are inviolate.  Thus they are not subject to
claims of creditors, whether of the employee or the employer.  This
insures that the employee will get his money when he needs it.  In
these days of budget deficits and financial uncertainty for some
public sector employers, such protection is not to be taken lightly."
Statement of Richard B.  Dixon, Treasurer and Tax Collector of Los
Angeles County, before the Finance Committee, U.S.  Senate, July 11,
1985. 

\9 Chapter 14.06 of The President's Tax Proposal to the Congress for
Fairness, Growth, and Simplicity (Washington, D.C.:  Office of the
President, May 1985), pp.  363-369. 

\10 Participants covered by a plan subject to section 457(f) are
subject to immediate tax treatment, which renders deferrals of
compensation subject to tax for the first year in which there is no
substantial risk of forfeiture.




   COMPLIANCE WITH EMPLOYEE
   PARTICIPATION RULES
---------------------------------------------------------- Chapter 1:2

In 1999, 401(k) and certain 403(b) plans must begin testing for
nondiscrimination and minimum participation rules.  Generally, the
nondiscrimination rule requires that benefits or contributions
provided under the plan do not discriminate in favor of highly
compensated employees.  The minimum participation rule requires that
the plan benefit at least the lesser of 50 employees or 40 percent of
all employees.  The minimum coverage rule requires that the
percentage of nonhighly compensated employees who benefit under the
plan must be at least 70 percent of the highly compensated employees
who benefit under the plan, or the nonhighly compensated employees in
the workforce must receive benefits that on average are at least 70
percent of the benefits received by highly compensated employees. 
State and local government sponsors of these plans have expressed
concern that required compliance with these rules will be burdensome
and costly. 


   PRINCIPLES OF CONSTRUCTIVE
   RECEIPT AND ECONOMIC BENEFIT
---------------------------------------------------------- Chapter 1:3

Two tax principles, constructive receipt and economic benefit, are
often intertwined in matters regarding nonqualified, unfunded
deferred compensation.  Under the principle of constructive receipt,
income is taxable even when an employee has not actually received
current compensation, if the compensation is credited to the
employee's account, set apart for the employee, or otherwise made
available to the employee.  The principle of economic benefit, on the
other hand, taxes assets that have been unconditionally and
irrevocably transferred into a fund for the employee's sole benefit
because he or she has received a benefit (that is, some deferred
salary) that, although not readily convertible to cash, has an
immediate value (that is, a fund for his or her benefit) that is
secured from the employer's creditors. 

Section 401(k) and 403(b) plans are funded, qualified or
qualified-type arrangements where the deferred amounts are placed in
trust;\11 that is, set aside for the exclusive benefit of the
employees who participate in the plans, secured from an employer's
creditors.  So that such arrangements would not cause the
participants to be taxed under the basic principles of constructive
receipt and economic benefit, the Congress overrode these two
principles by providing for income to be taxed only when it is
distributed. 

Section 457 plans, on the other hand, are nonqualified, unfunded
deferred compensation plans that follow the basic principles of
constructive receipt and economic benefit.  Participants are not in
constructive receipt of their deferrals because the amounts are not
set apart for or otherwise available to them at any time. 
Participants do not derive the economic benefit of their deferred
compensation because the deferred amounts are the property of their
employers and subject to the employers' general creditors.  Instead,
participants have bookkeeping accounts with balances that represent
the amount that the employers promise to pay at some future time. 
These account balances are comprised of amounts deferred under the
plan and any earnings or losses that would have accrued to those
amounts if the account balances had been invested as stated under the
plan.  Although most employers sponsoring 457 plans invest amounts as
necessary so that they will be able to provide the promised benefit
when due, there is no requirement for them to do so. 


--------------------
\11 A trust is a fiduciary relation with respect to property,
subjecting the person by whom the property is held to equitable
duties to deal with the property for the benefit of another person
which arises as the result of a manifestation of an intention to
create it.  See Black's Law Dictionary 1681 (4th ed.  rev.  1964). 


   ORIGINS OF 457 PLANS
---------------------------------------------------------- Chapter 1:4

In 1972, IRS issued the first of a number of private letter rulings
holding that tax may be deferred on employee contributions from
salary to a nonqualified, unfunded deferred compensation plan where a
state or local government was the employer.  Nonqualified, unfunded
deferred compensation plans of state and local governments and
tax-exempt organizations were not subject at that time to certain
restrictions placed on qualified plans:  (1) they did not need to
comply with nondiscrimination rules applicable to qualified plans;
(2) there was no limit on the amount participants could contribute;
and (3) participants in nonqualified, unfunded plans, unlike
participants in qualified plans, could make tax-deductible
contributions to individual retirement accounts (IRA).\12 In 1977,
however, IRS stopped issuing private letter rulings on the income tax
treatment of amounts deferred under nonqualified, unfunded deferred
compensation plans, pending formal review of its position.\13 In
1978, IRS changed its position and published proposed regulations
that would have subjected participants in nonqualified, unfunded
deferred compensation arrangements to immediate taxation on deferred
amounts.\14

Shortly thereafter, the Congress enacted IRC section 457.  The House
Ways and Means Committee, which drafted the provision, expressed
concern that the proposed IRS regulations would impact seriously on
the ability of employees of many states and localities to participate
in salary reduction arrangements as a means of providing themselves
with tax-deferred retirement income.\15 The Committee stressed that
for a plan to be eligible for tax deferral, all amounts deferred and
income earned thereon must remain assets of the plan sponsor subject
to the claims of its general creditors.  Thus, participants

     "cannot have any secured interest in the assets purchased with
     their deferred compensation and the assets may not be segregated
     for their benefit in any manner which would put them beyond the
     reach of the general creditors of the sponsoring entity."\16


--------------------
\12 House Comm.  on Ways and Means, 95th Cong., 2nd Sess.  Rep.  No. 
95-1445, Aug.  4, 1978, at 52. 

\13 IR-1881, September 7, 1977. 

\14 43 Fed.Reg.  4638, February 3, 1978. 

\15 House Comm.  on Ways and Means, 95th Cong., 2nd Sess.  Rep.  No. 
95-1445, Aug.  4, 1978, at 52-53. 

\16 House Comm.  on Ways and Means, 95th Cong., 2nd Sess.,Rep.  No. 
95-1445, Aug.  4, 1978, at 55. 


   REQUIREMENTS FOR TAX-DEFERRED
   PLANS
---------------------------------------------------------- Chapter 1:5

Section 401(k) plans must meet three federal requirements for
employee participation to be considered qualified.  First, the value
of the benefits that highly compensated employees as a group may
receive is limited by the value of the benefits the less well paid
employees collectively receive; this is the nondiscrimination rule. 
Second, at least the lesser of 50 employees or 40 percent of all
eligible employees\17 must participate in the plan; this is the
minimum participation rule.  Third, the plan must benefit a
percentage of nonhighly compensated employees that is at least 70
percent of the percentage of highly compensated employees benefiting
under the plan or the nonhighly compensated employees in the
workforce must receive benefits that, on average, are at least 70
percent of the benefits received by highly compensated employees;
this is the minimum coverage requirement.  Additionally, among many
other requirements, sponsoring employers must meet certain
nondiscrimination tests and report their annual levels of
participation, current assets, and current liabilities.\18

Tax-sheltered annuities under section 403(b) must meet
nondiscrimination rules.  Salary reduction deferrals to 403(b) plans
must also meet special nondiscrimination rules that are deemed
satisfied if all employees defer in excess of $200.  Starting in
1997, section 403(b) plans that provide employer matching
contributions will have to meet special nondiscrimination rules
provided by section 401(m).  Starting in 1999, section 403(b) plans
that provide nonelective contributions (employer contributions that
do not reduce a participant's salary) will be required to meet the
nondiscrimination, minimum coverage, and minimum participation rules. 

For a 457(b) plan to be eligible for tax deferral treatment, the
Congress limited the amount of compensation that may be deferred, but
permitted participants to wait until after separation from employment
to elect the time and method of payout.  However, minimum
participation, minimum coverage, and nondiscrimination rules that are
a cornerstone for the tax-favored status of qualified, funded plans
were not imposed. 


--------------------
\17 Eligible employees are those who have at least 1 year of service,
are at least 21 years old, and are working full-time. 

\18 State and local governments sponsoring 401(k) plans and those
403(b) plans that provide matching contributions are not required to
begin nondiscrimination testing until 1999.  Special
nondiscrimination rules applicable to these plans under section
401(k) and 401(m) will have to be met starting in 1997. 


   PREVALENCE OF STATE AND LOCAL
   SUPPLEMENTAL PLANS
---------------------------------------------------------- Chapter 1:6

Little information is available on the number of 401(k) and 403(b)
plans sponsored by state and local governments or the number of
people participating in them.\19 However, a 1993 study of over 400
state and local government general pension plans showed that about
8.4 percent of responding governments sponsored a 401(k) plan and 7.1
percent sponsored a 403(b) plan.\20 In that study, 457 plans were the
most frequently used salary reduction plans.  About 90 percent of
local governments and all 50 states provided their employees access
to 457 plans.  In 1994, an estimated 1,750,000 people participated in
about 10,000 plans sponsored by government entities nationwide.\21


--------------------
\19 State and local plans are not required to file annual reports
with the federal government as are most private plans. 

\20 The 1993 PENDAT database contains the results of a nationwide
survey of state and local government pension plan administrators.  It
is sponsored by the Public Pension Coordinating Council.  We
determined that this study may have underrepresented the percentage
of state and local governments that provide their employees access to
401(k) plans.  These plans are usually administered and managed
separately from the general pension plan and, therefore, respondents
to the survey may not have been aware that their government had a
401(k) plan.  We also determined that this study may not have
identified all of the IRC section 403(b) plans in operation because
such plans generally are not administered by the state and local
government units that responded to the survey.  Instead, 403(b) plans
tend to be administered by the individual institutions, such as
public school systems, colleges, universities, and tax-exempt IRC
section 501(c)(3) organizations. 

\21 Access Research Corporation, Windsor, Connecticut. 


   RECENT LEGISLATIVE PROPOSALS
---------------------------------------------------------- Chapter 1:7

Several bills have been introduced in the 104th Congress to redesign
section 457 plans.  For example, H.R.  2491, the omnibus budget
reconciliation bill, contained provisions that would require all
assets and income of a 457 plan to be held in trust for the exclusive
benefit of participants and their beneficiaries.\22 However, IRS
officials told us that imposition of such a trust requirement would
result in immediate taxation for deferrals to a 457 plan because of
the requirements of IRC section 457(b)(6).  With respect to section
401(k) plans, another provision of the reconciliation bill would have
provided a simplified and less costly alternative method of testing
for nondiscrimination requirements under IRC.\23 In separate
legislation, under section 14212 of H.R.  2517, which was
incorporated into the reconciliation bill and then dropped, state and
local governments and tax-exempt organizations would have been
extended the eligibility to provide 401(k) plans to their employees. 


--------------------
\22 Section 11458 of H.R.  2491, vetoed by the President on Dec.  6,
1995. 

\23 Section 11019 of H.R.  2491. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:8

In response to concerns about financial losses to state and local
government supplemental pension plans, the House Ways and Means
Committee asked us to examine the nature and security of such plans. 
After discussions with Committee staff, we agreed to determine (1)
whether amounts held in state and local government salary reduction
plans or otherwise promised to participants inherently are at risk of
financial loss to the participants and (2) how statutory provisions
comparatively treat participants in these plans. 

To determine how the plan provisions affect financial risk, we
interviewed representatives from IRS and Securities and Exchange
Commission (SEC) staff.  In addition, we discussed the risk of
financial loss relative to plan provisions and whether the provisions
treat participants comparably with representatives of the Government
Finance Officers Association; the International City/County Managers
Association-Retirement Corporation; the National Association of
Counties; the National Council on Teacher Retirement; the National
Association of Government Deferred Compensation Administrators; and
the Nationwide Insurance Company and its subsidiary, the Public
Employees Benefit Service Corporation. 

To determine how state and local government plans are generally
administered, we contacted plan administrators in Alabama,
California, Connecticut, Florida, Georgia, Michigan, Minnesota,
Mississippi, Nebraska, New Jersey, Ohio, Oklahoma, Tennessee, Texas,
and Wisconsin.  We selected these states on the basis of information
they reported on their 457 plans in the 1993 PENDAT database.  We
focused our review on 15 states and on eight counties in California. 
We selected these counties because of the Committee's concerns about
the impact of the Orange County, California, bankruptcy on 457 plans
sponsored by other California counties. 

We conducted our work from January 1995 through January 1996 in
accordance with generally accepted government auditing standards. 


SPONSORING GOVERNMENT ACTIONS MAY
POSE RISKS FOR 457 PLANS
============================================================ Chapter 2

The statutory requirements that provide for tax deferral for 457
plans also place the assets held to pay participants' benefits at
risk of loss from creditors of the government sponsor in the event of
a bankruptcy and, unless the sponsor provides for a rabbi trust, from
the government's using them for other than plan purposes.  Two 457
plans in California illustrate these risks.  In one case, a county
filed for bankruptcy protection, which put amounts set aside to pay
the county's obligations under its 457 plan at risk of being used to
satisfy the county's creditors.  Because participants in 457 plans
have no greater rights of their employer than general, unsecured
creditors, such actions could reduce the amount participants
otherwise would receive from the plan.  In the other case, a county
government intended to use amounts it set aside for its 457 plan
obligations to meet payroll expenses.  However, if the amounts held
for 457 plan purposes had been placed in a rabbi trust--as permitted
for all nonqualified, unfunded deferred compensation plans--they may
have been protected from use for nonplan purposes by the sponsor but
not from a sponsor's creditors. 


   BANKRUPTCY THREAT TO ORANGE
   COUNTY 457 PLAN
---------------------------------------------------------- Chapter 2:1

Orange County kept its tax revenues in an investment pool managed by
its treasurer and that permitted investments from cities,
municipalities, and political instrumentalities outside Orange
County.  The county regularly contributed deferrals to the pool to
assist it in meeting its obligations under this plan.  The 457 plan
provides that the experience of the investment pool will be used to
determine the final amount due participants when they separate from
service or retire.  Thus, participants' bookkeeping accounts are
credited at specified intervals with the interest, gains, and losses
realized by the investment pool. 

From July to December 1994, the investment pool sustained heavy
losses.  This resulted in both the pool and Orange County filing for
Chapter 9 bankruptcy on December 6, 1994.  On May 2, 1995, the state
Bankruptcy Court approved a comprehensive settlement of the pool's
bankruptcy case.  Under this court order, Orange County received
amounts from the pool at a rate that was lower than 100 percent of
its claims. 

No participant funds were used to pay pool creditors and the
participants had no standing as claimants in the pool bankruptcy. 
The participants are general, unsecured creditors of Orange County
only--not of the investment pool.  However, Orange County's claim
against the pool included a claim for amounts it invested there so
that funds would be available as needed to pay its yet unmatured
obligations under the 457 plan. 

Technically, because performance of the pool serves as a measure used
to calculate returns for the 457 plan, the investment loss that
occurred in the pool would normally affect the account balances of
plan participants.  As of March 1996, the bankruptcy in Orange County
is still ongoing.  It is possible that all creditors may eventually
be paid 100 percent of their claims and that participants in the 457
plan that invested in the pool may have their account balances fully
restored.  Administrators of the 457 plan told us that the
bookkeeping accounts for each participant would be credited with
interest, but all accounts have been reduced 10 percent for losses on
investments in the pool. 


   LOS ANGELES COUNTY INTENDED TO
   USE DEFERRED AMOUNTS FOR
   PAYROLL EXPENSES
---------------------------------------------------------- Chapter 2:2

In 1992, Los Angeles County intended to borrow $250 million of
amounts deferred under its 457 plan to make payroll payments.  SEC
staff learned of Los Angeles County's intentions and questioned the
proposed action as potentially impairing the status of the plan under
the federal securities laws.  The SEC staff asserted that borrowing
amounts set aside to pay the county's obligations under its 457 plan
for any reason other than satisfying obligations to the locality's
general creditors would conflict with representations made earlier to
the SEC staff.  These representations had been made in connection
with a request by the insurance company that operated the separate
accounts for participants when it sought the SEC staff's no-action
assurance that the separate accounts and the interests therein did
not need to be registered under federal securities laws.\24 The SEC
raised concerns that the disposition of the assets needed to pay the
county's obligations under the plan as proposed by Los Angeles County
conflicted with the representations made in seeking the no-action
letter. 

As a result of both SEC's questioning and media reports accusing
local officials of wrongdoing, the county created a new investment
option under its plan in the form of a loan fund, offering at least a
6-percent return over 15 years.  A few participants agreed to have
their deferrals treated as though invested in the fund and the county
was able to raise $19 million of the $250 million it originally
intended to borrow.  We note, however, that SEC does not regulate 457
plans and its ability to influence the operation of 457 plans is
limited to instances in which an unregistered collective trust or
separate account seeks to rely on certain exemptions from federal
securities laws in order to hold funds earmarked to pay a 457 plan
obligation. 

Although the county chose not to do so, it could have simply used the
assets without paying interest on their use because statutory
provisions governing section 457 mandate that amounts deferred remain
the property of the employer.  There is no requirement that
sponsoring governments actually invest amounts participants have
deferred or credit their deferrals with interest earned.  Instead,
the governments are only responsible for making payments to
participants under the terms of the plan, usually when they retire or
change jobs.  The terms of the plans usually provide that the amounts
deferred will be treated as though they were invested in some
identified asset or fund and that the benefit paid will include
earnings that would have accrued on those amounts had they been so
invested as well as any gains or losses that might have been
experienced had the amounts been so invested.  Although it is not
required under section 457, sponsors and administrators normally make
the actual investments referenced under the arrangement to insure
that they will have the amounts necessary to meet their 457 plan
obligations.  Notwithstanding this normal administration of 457
plans, 457 plan deferrals can never be invested solely for the
benefit of the participant.  They must always be available to the
general creditors of the employer.  Also, unless amounts set aside by
the employer to meet its obligations are placed in a rabbi trust,
these assets may be used for nonplan purposes. 


--------------------
\24 The no-action process is an informal procedure whereby the public
may obtain the informal views of SEC staff on proposed transactions
that appear to raise issues under applicable federal securities laws
and the rules thereunder.  No-action requests were filed by a number
of banks and insurance companies that wanted to offer collective
trust funds or separate accounts to 457 plans without registration of
the funds/account or the interests in them under federal securities
laws. 


   A RABBI TRUST MAY PROVIDE SOME
   PROTECTION
---------------------------------------------------------- Chapter 2:3

Under IRC, 457 plans have a means to restrict a government's nonplan
use of amounts deferred to 457 plans--the rabbi trust.\25

Under such a trust, the plan sponsor typically has no access to the
funds but in an insolvency or bankruptcy, such funds can be reached
by the general creditors.\26 If the deferrals held by Los Angeles
County for its 457 plan had been placed in a rabbi trust, the county
may not have been in a position to use them to meet its payroll. 
However, a rabbi trust arrangement would not have protected Orange
County employees, because that government declared bankruptcy. 


--------------------
\25 The trust is so named because the first such arrangement was
established by a synagogue for the benefit of its rabbi.  IRS Prv. 
Ltr.  Rul.  81-13-107 (Dec.  31, 1980).  IRS will rule favorably only
on the model rabbi trust set out in Revenue Procedure 92-64, 1992-2
C.B.  11. 

\26 Insolvency is defined in section 3(a) of the Model Rabbi Trust
as:  (i) the government being unable to pay its debts as they become
due or (ii) the government being subject to a pending proceeding as a
debtor under the U.S.  Bankruptcy Code. 


PROVISIONS OF 457 PLANS
DISADVANTAGE PARTICIPANTS
============================================================ Chapter 3

Section 457 plans are substantially different from 401(k) and 403(b)
plans.  In addition to the differences discussed in chapter 1, these
plans have limited portability and in some cases participants in
457(b) plans must irrevocably select a date to begin receiving their
benefits.  In addition, participants cannot defer as much as
participants in 401(k) or 403(b) plans. 


   PARTICIPANTS' 457 PLAN BENEFITS
   HAVE LIMITED PORTABILITY
---------------------------------------------------------- Chapter 3:1

Participants in 457 plans who leave their government employer before
retirement are restricted in their ability to move the amounts in
their 457 plan accounts to a funded tax-sheltered account.  The plan
accounts can only be transferred to another eligible 457 plan if the
new government employer will accept the transfer.  Amounts deferred
under section 457 cannot be rolled over to an IRA and have tax
deferred on the distribution as can 401(k) and 403(b) plan funds. 
Participants in 457 plans who leave government service and do not
have another 457 plan that they can transfer their bookkeeping
accounts to have only two options:  (1) commence immediate payment of
benefits and pay income tax on the distribution or (2) defer the
commencement of benefits to any date in the future that is before
they turn 70-1/2 years old.  IRS officials told us that under current
law, allowing nonqualified, unfunded deferred compensation amounts to
be transferred to an IRA makes the amounts immediately taxable to the
participant because any distribution, even to an IRA, results in the
participant having an economic benefit in the funds and being in
constructive receipt of the money.  The mere promise of the employer
to pay will have been fulfilled.  Additionally, under the qualified
plan rules, a transfer of nonqualified, unfunded plan amounts into a
qualified, funded plan could disqualify the qualified plan and make
funds in it immediately taxable to the participants. 


   DATE THAT BENEFITS BEGIN IS
   IRREVOCABLE
---------------------------------------------------------- Chapter 3:2

If a participant cannot transfer the deferred amounts to another 457
plan or chooses not to do so, he or she must, after leaving
employment, select a date to begin receiving benefits.  Selecting the
date may be difficult because the employee's retirement date may be
years in the future.  Moreover, once selected, this date cannot be
changed, except for emergencies.  In contrast, separating
participants in 401(k) and 403(b) plans are not required to declare a
date for benefits to begin.  These participants may begin collecting
their benefits at any time after turning 59-1/2 years old.  IRS
officials said that the tax principle of constructive receipt would
be compromised if participants in 457 plans were permitted to change
the date previously selected for receiving benefits.\27


--------------------
\27 As noted in chapter 1, income is taxable even when an employee
has not actually received compensation, but could have elected to
receive the compensation after it has been earned.  The constructive
receipt doctrine limits the extent to which a taxpayer can time the
inclusion of amounts into gross income once those amounts have been
earned. 


   MAXIMUM ANNUAL DEFERRALS
   ALLOWED ARE LOWER
---------------------------------------------------------- Chapter 3:3

The maximum annual amount that employees may defer and employers may
contribute is lower for 457 plans than for the other two plan types. 
For example, the maximum allowable employee deferral to a 457 plan is
$7,500,\28 a limit that is about $2,000 lower than the limits of the
other two tax-deferred plans.  In 1995, the maximum employee deferral
to a 401(k) plan was $9,240, and deferrals to a 403(b) plan could not
exceed $9,500. 

Although employees can defer no more than $7,500 under a 457 plan,
this does not include employer contributions to another plan, usually
the employers' regular or basic pension plan.  Employers sponsoring
401(k) or 403(b) plans can make annual contributions of no more than
$30,000. 

Moreover, the tax-free deferral limit of a participant in 401(k) and
403(b) plans is reduced if the participant also defers any amounts
under a 457 plan.\29 The maximum total deferral a participant can
make to a 401(k) or 403(b) plan is governed by the maximum deferral
allowed under section 457 when a participant actually makes deferrals
under a 457 plan.  That is, total deferrals by participants
contributing to both a 457 plan and one of the other two plan types
cannot exceed $7,500.  Thus, any deferrals, even if it is only $1,
made to a 457 plan, limits the maximum annual deferral the
participant can make to a 401(k) or 403(b) plan to $7,500. 
Additionally, any employer contribution to a 457 plan will limit the
deferral the employee can make under a 401(k) or 403(b) plan to
$7,500. 


--------------------
\28 This limit refers only to the maximum annual amount an employee
may defer from his or her pay.  It does not refer to the $15,000
catch-up provision included in section 457, which allows participants
to make a deferral of up to $15,000 during the 3 years prior to
retirement.  They may do so only to the extent that they did not
defer income at the maximum annual deferral limit in past years. 

\29 The interaction of these deferrals is coordinated through section
457(c). 


      MAXIMUM ANNUAL DEFERRAL CAP
      IS NOT INDEXED
-------------------------------------------------------- Chapter 3:3.1

When the Congress enacted IRC section 457 in 1978, it set the annual
deferral limit at $7,500, an amount that exceeded the $7,000 deferral
limit set for 401(k) plans in 1986.  However, the 401(k) plan limit
was indexed for inflation, and the 457 plan limit was not.  In time,
the 401(k) limit surpassed the 457 limit.  Section 403(b) limits will
be indexed for inflation when the 401(k) limit reaches $9,500, the
current deferral limit for 403(b) plans. 

Over time, inflation will continue to reduce the section 457 deferral
limit relative to earnings, and the maximum percentage of income
participants will be able to defer will decrease.  For example, using
an average annual inflation rate of 4 percent, 10 years from now the
deferral limits for employee contributions in the other two plans
will be $13,677, $6,177 more than the current section 457 limit. 

IRS officials said that the limit on deferrals and the lack of a
cost-of-living adjustment, as in sections 401(k) and 403(b), could be
changed by the Congress without compromising either the nature of 457
plans as nonqualified, unfunded plans or the tax principles of
constructive receipt and economic benefit.  Any such changes to
section 457(b) would, however, cause a tax revenue loss in the future
if participants took advantage of higher deferral limits. 


SUMMARY AND CONCLUSIONS AND AGENCY
COMMENTS
============================================================ Chapter 4

With enactment of IRC section 457 in 1978, the Congress specifically
authorized a tax-deferred, nonqualified, and unfunded compensation
plan to enable employees of state and local governments to provide
themselves with additional retirement income.  The Congress' action
had been prompted by proposed IRS regulations that would have
subjected all nonqualified, unfunded deferred compensation amounts to
immediate taxation.  Eight years later, in the belief that 457 and
401(k) plans offered duplicative benefits, the Congress excluded
state and local employers from establishing new 401(k) plans for
their employees. 

As a nonqualified, unfunded deferred plan, however, section 457
provides significantly less protection for plan participants compared
with qualified, funded deferred plans such as 401(k) and 403(b)
plans.  Until recently, there was little or no evidence that greater
protections were needed; however, events in Orange and Los Angeles
Counties have posed possible financial risks to participants'
deferred amounts in 457 plans that suggest greater protections may be
needed. 

Section 457 plan participants voluntarily forego current income in
order to provide for themselves in their retirement years.  Yet the
money that these participants forego is at risk.  This is because 457
plans are nonqualified, unfunded deferred plans that require that the
amounts deferred may not be set aside for the exclusive benefit of
the employee but must remain the property of the employer, subject to
the claims of the employer's general creditors.  To date, the use of
the Orange County Investment Pool to calculate how amounts deferred
under its 457 plan are to be treated as invested has resulted in
financial paper losses that ultimately may affect county employees'
retirement benefits.  Los Angeles County intended to use funds of its
plan to meet its payroll.  Under current law, potential bankruptcies
and financial difficulties of other state and local governments pose
similar risks to the salary deferrals that employees have made under
457 plans. 

Apart from the greater risk to plan participants, as compared with
other salary reduction plans, employees who participate in 457 plans
are treated differently from those in 401(k) and 403(b) plans.  For
example, as a result of IRC provisions, the maximum annual amount
that may be deferred under an eligible 457 plan is notably less than
the maximum annual amount that may be contributed to 401(k) and
403(b) plans.  Further, those deferred amount limits are not indexed
for inflation.  This is particularly noteworthy because a 457 plan is
often the only deferred compensation plan available to most state and
local employees to supplement their regular government pension. 

Other disadvantages occur because of differences between
nonqualified, unfunded and qualified, funded plans.  For example,
participants who leave employment before retirement have limited
portability for their funds.  Participants transferring to another
state or local government may transfer account balances in a 457 plan
to another 457 plan only if their new employer will accept that
transfer and their old employer permits transfers.  In lieu of such a
transfer, participants leaving state or local government who choose
to withdraw their 457 plan amounts are subject to immediate taxation. 
No legal barrier exists under the principles of constructive receipt
and economic benefit for raising the limits that participants could
defer or for indexing the limits for inflation.  However, changes to
portability would not comport with these two principles. 

Given the risk of financial loss associated with deferrals under 457
plans, imposing a rabbi trust requirement, where a plan sponsor could
not use such amounts for its own interest, would not be successful in
fully assuring the security of these funds for plan participants. 
Such a trust requirement would not preclude a bankruptcy court from
securing such funds for the general creditors of the state or local
government employer.  Moreover, a trust may not be successful in
barring an employer's creditors access to these funds, for example,
if an employer experiences a temporary liquidity shortfall or
financial insolvency.  Thus, the existence of a rabbi trust would not
have eliminated the risks posed by events in Orange County and may
not have eliminated risks of nonplan use in Los Angeles County. 
However, under the tax theories that drive section 457 and other
nonqualified, unfunded deferred compensation plans, any trust that
would not subject its assets to the claims of the employer's
creditors and would provide the participant an unconditional and
irrevocable right to receive the deferred amounts in it would create
an immediate--not a deferred--tax liability for the employee.  The
complexity of IRC makes amending section 457 very difficult, as
proposed in H.R.  2491, for example, because of the many ways section
457 dovetails with other provisions. 


   AGENCY COMMENTS AND OUR
   EVALUATION
---------------------------------------------------------- Chapter 4:1

SEC provided written comments on a draft of this report (see app. 
I).  SEC found the report informative and said that it would serve as
a reference for SEC staff as they consider section 457 issues.  SEC
said it agreed with our recommendation that the Congress amend IRC
section 401(k) to permit state and local governments to establish
401(k) plans.  We did not recommend that the Congress make such an
amendment; rather we concluded that addressing all the problems with
section 457 plans that we identified merely by amending IRC section
457 would be difficult.  SEC added that if the Congress proceeds with
legislation relating to public plans, it should consider statutory
changes to clarify the status of 457 plans under federal securities
laws.  SEC said all qualified plans are now exempt from SEC
regulation.  Those governmental plans, as defined in IRC section
414(d), that are established for the employees' exclusive benefit and
which cannot be used by the employer for other purposes (exclusivity
and impossibility requirements) are exempt.  SEC staff told us that
they have received numerous inquiries with respect to whether 457
plans also may be considered exempt under federal securities laws,
although IRC prevents 457 plans from meeting the exclusivity and
impossibility requirements.  SEC also noted some technical changes
that we incorporated into our report where appropriate. 

IRS also provided written comments on a draft of this report (see
app.  II).  IRS made several general comments primarily concerning
technical terms.  IRS pointed out the distinction between the
tax-favored status of 401(k) plans and the tax-deferred status of 457
plans.  We clarified these differences throughout the report.  IRS
emphasized the fact that 457 plan deferrals may be treated as
invested in a certain way, but in fact there is no requirement to
invest such amounts.  As a result, if the sponsor becomes insolvent,
the rights of participants in a 457 plan are no greater than other
general, unsecured creditors.  IRS also pointed out that most state
and local governments have basic pension plans for employees and 457
plans are additional plans.  We refer to them as supplemental plans
to reflect this relationship.  IRS suggested that we should clarify
that only state and local governments can offer nonqualified plans to
their rank-and-file employees, which we did.  IRS clarified some
features of rabbi trusts that we did not include in the report,
though the major feature of a rabbi trust--the inability of the
sponsor to have access to the assets therein--is the focus of chapter
3.  IRS also made technical comments that we incorporated into our
report where appropriate. 




(See figure in printed edition.)Appendix I
COMMENTS FROM THE SECURITIES AND
EXCHANGE COMMISSION
============================================================ Chapter 4



(See figure in printed edition.)


The following are GAO's comments on the SEC letter dated February 16,
1996. 


   GAO COMMENTS
---------------------------------------------------------- Chapter 4:2

1.  Deferrals under section 457 could be at risk of loss in the event
of a sponsor's insolvency, and our review and IRS officials'
statements led us to conclude that fixing this problem, as the
Congress proposed to do, cannot easily be accomplished merely by
amending section 457.  While some of the disadvantages of section 457
plans, such as lower deferral limits, indexing of the limits, and
imposing a rabbi trust requirement (which is a grantor trust owned by
the employer) could be altered by legislation without contradicting
tax principles, other changes, such as a funded trust whose assets
are set aside from the claims of the employer's creditors and are
held for the exclusive benefit of participants, portability, and the
date of benefit receipt, could not be accomplished within the context
of nonqualified plans. 

SEC recommended that the Congress make statutory changes to clarify
the status of 457 plans under federal securities laws, if it proceeds
with legislation relating to these plans.  We do not comment on this
recommendation in this report, as it is outside the scope of our
review. 

2.  SEC also made technical comments on the draft of this report that
clarified its role with respect to 457 plans, which we incorporated. 




(See figure in printed edition.)Appendix II
COMMENTS FROM THE INTERNAL REVENUE
SERVICE
============================================================ Chapter 4



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on the IRS letter dated March 1,
1996. 


   GAO COMMENTS
---------------------------------------------------------- Chapter 4:3

1.  We have included appendix I with the IRS letter.  We agree that
certain terms pertaining to supplemental qualified (tax-favored) and
nonqualified, unfunded (tax-deferred) plans can cause confusion.  We
have altered the text throughout the report to reflect this
distinction and other "terms of art." We also made other IRS
technical markups to the draft as appropriate. 

2.  We recognize that most state and local government employers offer
a basic qualified, funded pension plan and that section 457 plans
operate in addition to the basic plan.  We call these plans
supplemental plans and include 401(k) and 403(b) plans in the same
category as nearly all these plans in the state and local sector are
in addition to a basic plan. 


GAO CONTACT AND STAFF
ACKNOWLEDGMENTS
========================================================= Appendix III

GAO CONTACT

Donald C.  Snyder, Assistant Director, (202) 512-7204

STAFF ACKNOWLEDGMENTS

Dea M.  Crittenden was the Evaluator-in-Charge on this project.  The
following individuals also made important contributions to this
report:  Cynthia L.  Giacona-Wilson participated in all phases of the
project including project planning, data gathering and analysis, and
report writing; Endel P.  Kaseoru assisted with data gathering and
drafting the report; and Dayna K.  Shah, Stefanie G.  Weldon, and
Roger J.  Thomas provided legal counsel.  Also assisting in various
phases of the project were Nancy L.  Crothers, Donald P.  Ingersoll,
and Kenneth J.  Bombara. 


*** End of document. ***