Retirement Plans, 457 Plan

What is a Section 457 plan? A Section 457 plan is a long-term retirement, deferred-compensation plan that’s available only to state and local government employees and tax-exempt organizations. The relevant rules are found in Section 457 of the Internal Revenue Code. These plans allow employees to defer up to 25 percent of their compensation to their retirement fund, but the maximum that can be deferred in any one year is $14,000 in 2005(this amount is indexed). Contributions to a 457 plan are made with before-tax dollars by payroll deduction, which lowers the worker’s gross pay and thus reduces the annual amount of taxes owed to the IRS. Earnings on the contributed amount grow tax-deferred until withdrawals begin. Who can participate in a Section 457 deferred compensation plan? A Section 457 deferred retirement and compensation program is one of the most flexible retirement programs available. However, it is only offered to state and municipal employees and employees of nonprofit organizations. If you qualify, you should seriously consider participating in a Section 457 plan. Contributing to a Section 457 plans is a great way to reduce your annual income tax bill and an even better way to grow your retirement fund on a tax-deferred basis. The plans also have relatively liberal withdrawal rules. And certainly, you should take part in a Section 457 if you are not eligible for a tax deductible individual retirement plan (IRA) or similar program. Who owns the assets in a Section 457 plan? Section 457 plans are unique: They are long-term, non-qualified deferred-compensation programs that are available only to state and local government employees and tax-exempt organizations. They’re also subject to some unique provisions and risks. All the assets in a 457 plan are owned by the entity that offers the plan, but the assets of tax-exempt organizations are subject to seizure by creditors. Assets of Section 457 plans established by state and local governments have to be held in trust, which protects them from creditors and money-hungry bureaucrats. Each worker has a segregated account and can direct his or her account balance into any approved investment option. When can employee distributions from a 457 plan begin? Withdrawal regulations make Section 457 plans unique among public pension plans. Because the 457 is not a qualified retirement plan, participants may receive distributions regardless of age without penalty since there is no "premature distribution" penalty, as there is with a 401(k) or regular IRA account when funds are withdrawn prior to age 59 1/2. Of course, taxes are due upon receipt of the funds. When must distributions from a Section 457 plan be made? Distributions from a Section 457 plan must begin no later than an employee’s reaching the age of 70 1/2. These distributions are subject to the minimum required distribution rules. These rules require the account balance to be distributed over the life expectancy of the participant. Once payments begin, they must be in equal dollar amounts and be made at least annually. Upon termination of employment, the employee has 60 days to make an irrevocable election identifying when distributions will begin. If no election is made, the employee is considered in "constructive receipt" of the funds and the entire account balance becomes taxable regardless of whether the employee actually received the money. How are Section 457 plan distributions taxed to me? Distributions from a Section 457 plan -- the long-term retirement, deferred-compensation plan that’s available only to state and local government employees and tax-exempt organizations -- are taxed as ordinary income when the worker receives them. The good news is that, unlike most other plans, penalty-free distributions can be made from a Section 457 plan upon termination of employment -- whether voluntary or involuntary -- and regardless of the worker’s age. Distributions can also be made in the event of an unforeseeable emergency through a "hardship withdrawal." Can my Section 457 plan account balance be rolled over into an IRA? Section 457 plans are nonqualified,as a result, funds cannot be rolled over into an Individual Retirement Account (IRA). Proceeds from a Section 457 may only be transferred to another such plan. If you have a Section 457 plan and are leaving your government job to work in private industry, you have two choices. First, you can take the plan’s balance in a lump sum and pay ordinary income taxes on the distribution. Or, you can leave the balance with your previous employer until a predetermined date. If you choose to leave the Section 457 plan where it is, you avoid current income taxes and the balance will continue to grow tax-deferred. You can continue to manage the investments just as if you were still employed, but you cannot make any additional contributions. Beginning in 2002, participants may roll their 457 plan distributions to any other tax favored plan including IRAs and if the plan documents allow it, qualified plans, other 457 plans or TSAs. What is the catch-up provision in a Section 457 plan? Unlike most other retirement plans, Section 457 plans have a "catch-up" provision that allows workers within three years of retirement to make larger contributions to supplement the smaller contributions they may have made earlier. In essence, the catch-up provision waives the standard annual limits on contributions. Instead, during the three years preceding retirement, the worker is allowed to contribute up to $15,000 annually into a Section 457 plan. To qualify, the employee must have contributed less than the maximum in previous years. A year-by-year calculation must be completed to determine the exact amount of catch up an employee is entitled to make. HIGHLIGHTS OF 457 RETIREMENT PLANS