457 plan

457 plan

The 457 plan is a type of tax advantaged defined contribution retirement plan that is available for governmental and certain non-governmental employers in the United States. The employer provides the plan and the employee defers compensation into it on a pre-tax basis. For the most part the plan operates similarly to a 401(k) or 403(b) plan most people are familiar with in the US. The key difference is unlike a 401(k) plan, there is no 10% penalty for withdrawal before the age of 59 1/2 (although the withdrawal is subject to ordinary income taxation).

Changes with EGTRRA 2001

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made a number of changes in how governmental 457 plans are treated. The most notable of which is the coordination of benefits limitation was removed. This allows a person whose governmental employer has a 401(k) or 403(b) and a 457 to defer the maximum contribution amounts to both plans instead of coordinating the total and only being able to meet a single limit amount. Thus a participant can contribute the maximum $15,500 for 2007 into their 401(k) and also the maximum $15,500 into their 457 plan. If that person is over age 50 they can contribute the additional catch up amount into each plan also, meaning an additional $5,000 into the 401(k) and another $5,000 into their governmental 457 (catch-up contributions are not provided for non-governmental 457 plans). The total would then be $41,000 deferred instead of the $20,500 that would have been allowed if the coordination of benefits provision had not been repealed in regard to the governmental 457 plan. As a result, many governmental employers have now set up 457 and 401(k) plans for their employees, and non-profit employers have set up 403(b) and 457 plans each allowing their employees to invest in both. Some state universities and school districts have access to all three tax-exempt plans. However, the total combined annual contribution to 401(k) and 403(b) plans is subject to the $15,500 limit and $5,000 catchup limit.

Other notable changes made in the EGTRRA legislation were increasing the maximum deferral amount from the approximately $8,500 that was previously allowed to the same maximum elective deferral amount that 401(k) plans and now 403(b) plans allow, and easing restrictions on some plan rollovers. Governmental 457 plans may be rolled into other types of retirement plans with few restrictions beyond the normal ones for any other type of employer provided plan, which includes separation of service or disability. This includes other 401(k) and 403(b) plans and also IRA's. IRA's have much greater flexibility in withdrawal and conversion privileges. In contrast, non-governmental 457 plans can only be rolled into another non-governmental 457 plan.

Catch-up provisions

The 457 plan allows for two types of catch-up provisions. The first is similar to other defined contribution plans and amounts to an additional $5,000 that can be contributed as noted above. The second (only available to governmental 457 plans) is much more complicated and can be elected instead by an employee that is within 3 years of normal retirement age (and perhaps eligible retirement at any age). This second catch-up option is equal to the full employee deferral limit or another $15,500 for 2007. Thus, a person over 50 within 3 years of retirement and both a 457 and a 401(k) could defer a total of $51,500 into their retirement plans by utilizing all of their catch-up provisions. The second type of catch-up provision is limited to unused deferral limits from previous years. An employee that had deferred the maximum amount of money into the 457 plan every year they were employed previously would not be able to utilize this extra catch-up.

Governmental and non-governmental plans

There are two primary types of the plans, governmental and non-governmental. Some governmental plans were under 457(g) but those plans may no longer be created. Most governmental and non-governmental plans are 457(b) plans.

Non-governmental plans

Non-governmental plans can now be set up by non-profit organizations in addition to their 403(b) plans. They may either be "eligible" plans set up under section 457(b) or "ineligible" plans set up under section 457(f). ERISA legislation has said that non-governmental plans must be limited to some group of higher compensation employees. The level of compensation required is not specified by ERISA, but it must be according to some ascertainable standard that the employer sets. The same highly compensated limit ($100,000 a year for 2006) in place for 401(k) discrimination testing would likely be acceptable, as would restricting the plan to some class of employees such as directors or officers. Because of this limitation to higher-compensation employees, 457(b) plans are often referred to as "top hat" plans.

Non-governmental 457 plans have a number of restrictions that governmental ones do not. Money deferred into non-governmental 457 plans may not be rolled into any other type of tax-deferred retirement plan. It may be rolled only into another non-governmental 457 plan. Also, money deferred into non-governmental plans is not set aside in a trust for the exclusive benefit of the employee making the deferral. The Internal Revenue Code requires that money in a non-governmental 457 plan remains the property of the employer and is thus available to general creditors of the employer in legal or bankruptcy proceedings.

457(f) (ineligible) plans

IRS code section 457(f) allows for non-governmental, non-profit organizations to set up a plan that can be tax deferred and exceed the normal defined contribution employee deferral limit. Ineligible 457 plans are made available because non-profit organizations are not allowed to have another kind of non-qualified deferred compensation plan.

Generally, these deferred amounts would be currently taxable under Section 83 of the Code, unless the employee faces a "substantial risk of forfeiture" which has been clarified by the IRS to mean that in addition to the money remaining available to general creditors of the organization or subject to not vesting if the employee does not stay with the employer for the full vesting period. When the risk of forfeiture is gone, the value of the property given to the employee ceases to be deferred from taxation and is included in current ordinary gross income.

Another plan design, the rabbi trust, gives the employee deferred money in a trust and is funded, but must be available to creditors. This is to make the employer junior to general creditors so that the employee can avoid current inclusion into income.

These general deferral of current income conditions of Section 83 (as explained in Revenue Ruling 60-31 would give the 457(f) plan the deferral of tax desired.

In 2004 Congress passed a tax act which added Section 409A to the tax code and applies to deferred nonqualified compensation which also covers some 457(f) plans. This was in response to the executive bonus plans given to key employees at Enron which allowed them early access to their deferred compensation if financial conditions of the employer deteriorated (i.e., if Enron got into trouble).

External links and references

* [http://www.irs.gov/retirement/article/0,,id=172437,00.html IRS website page regarding 457 plans]
* [http://www.irs.gov/pub/irs-pdf/p4406.pdf 403(b) and 457 Plan Feature Comparison Chart (8pp pdf file)]
* [http://www.irs.gov/retirement/article/0,,id=96315,00.html IRS 403(b)/457 Online Resource Guide]
* [http://www.irs.gov/pub/irs-tege/457_outline.pdf IRS Section 457 plan outline (28pp pdf file)] PAGE NOT FOUND ERROR
* [http://assembler.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000457----000-.html Section 457 of the IRS code] - From Cornell Law School


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