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457(b) FAQs
     
 
  What is a 457(b) plan?
A 457(b) plan is a non-qualified tax-deferred compensation plan that works very much like other retirement plans such as the 403(b) and 401(k). Created in 1978 the name refers to the relevant section [457] in the Internal Revenue Code that governs the plan. Two main types of 457 plans exist: governmental and tax-exempt 457(b) plans. This FAQ section will focus on governmental 457(b) plans.
 
Who is eligible to contribute to a 457(b) plan?
Several plans exist:
  Public plans — State and local government plans.
Local and state governments are eligible to establish a 457(b) plan for their employees. This type of 457(b) covers employees of a state (including the District of Columbia), a political subdivision of a state, any agency or instrumentality of a state, or political subdivision of a state. These types of employees can include: local and state government workers, fire fighters, police personnel, and public school employees.
 
  Private plans — Non-governmental tax-exempt entity plans.
Tax-exempt organizations that are non-governmental (hospitals, charitable organizations, unions, among others) must generally limit participation to a select group of management or highly compensated (also known as "top hat") employees. This is due to the rules under Title I of the Employee Retirement Income Security Act of 1974 (ERISA). ERISA generally requires that a private retirement plan providing benefits to employees be funded by a trust or annuity contract. The rules, however, require that private 457(b) plans be unfunded in order to obtain tax benefits. Therefore, a plan will violate ERISA unless an exception applies. If a tax-exempt employer limits participation to a select group of management or highly compensated employees (or "top hat" group) then it is exempt from most ERISA requirements.
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Note: Public governmental 457 plans, on the other hand, are required to be funded. As required by IRC section 457(g), those funds must be held in trust for the exclusive benefit of plan participants and their beneficiaries.
 
  How does a governmental 457(b) plan work?
Employees set aside money for retirement on a pretax basis through a salary deferral agreement with their employer. Under this arrangement, the employee agrees to take a reduction in salary. The money reduced is directed into an investment company offered by the employer. The 457(b) contributions grow tax free until withdrawal at retirement or termination of employment.
 
Why Contribute to a 457(b) plan?
  reduce taxable income
  save for retirement
  contributions and earnings grow tax-deferred
  ability to contribute to a 403(b) [or a 401(k)] as well (if offered by employer)
  portability — public (governmental) plan money can be moved into a new employer's 457(b), 403(b) or 401(k) if the plan accepts such transfers, or into an IRA.
 
  How much can be contributed to a governmental 457(b) plan?
For 2008, workers are able to contribute the lesser of:
  1. the employee elective deferral limit of $15,500, or
  2. up to 100% of includable compensation (must be less than the elective deferral limit).
 
  What are the catch-up provisions in a governmental 457(b) plan?
If you are age 50 or older in year 2008, you may contribute an additional $5,000 above the 2008 elective deferral limit of $15,500. Employers are not required to offer this provision. This catch-up option is only available in public (governmental) 457(b) plans.
 
The 457(b) plan contains a special "catch-up" provision called the "final three year" provision for those approaching retirement (assuming they haven't contributed the maximum amount in prior years). This provision, which used to limit participants to an additional $15,000 over a 3-year period, now permits up to 200% of the elective deferral limit, or $31,000 in 2008 This "catch-up" provision kicks in during the three years prior to "normal" retirement age (as defined in the plan). Example: If a worker is to reach "normal" retirement age in 2012, he or she can take advantage of the "final three year" provision in years 2009, 2010, and 2011. Employers are not required to offer this provision. Participants who take advantage of the "final three year" provision cannot also take advantage of the "Age 50 catch-up" provision.
Note: to determine the underutilized amounts in prior years all of the prior coordination rules apply.
 
Are all employees eligible to contribute to a governmental 457(b) plan?
Unlike the 403(b) plan, there is no universal accessibility under the 457(b). This means that employers are not required to make the plan available to all employees. However, any individual who performs service for the employer, including independent contractors, are eligible to participate in the plan. Your employer's plan document should spell out the specific rules for contribution.
 
Can an employee contribute to a 457(b) and a 403(b)?
Yes. The 457(b) plan has traditionally covered state and local government employees, which included some teachers. In the past, teachers who wished to contribute to both plans were limited to the total aggregate amount of the 457(b) (only $8,500). The Economic Growth and Tax-Relief Reconciliation Act of 2001 (EGTRRA) repealed coordination of contributions between 457(b) plans and 403(b) plans [and 457(b) plans and 401(k) plans]. This means that employees with enough includable compensation can contribute the maximum elective deferral limit to both a 403(b) and a 457(b) [and a 457(b) and a 401(k)]. For 2008, this is $15,500 for a whopping total of $31,000. Participants eligible for catch-up provisions can include even more. Check with your employer and your vendor for more details. Note: Not all employers offer both a 457(b) plan and a 403(b) [or a 457(b) plan and a 401(k) plan], nor are they required to do so.
 
Are loans available in governmental 457(b) plans?
Proposed regulations would permit plan sponsors to offer loans, but those regulations have not officially gone into effect. However, the IRS says you can rely on these proposed regulations until the final ones are issued. Loans from a governmental entity are allowed within the parameters set forth in the proposed regulations. Generally, as long as the provisions of IRC 72(p) regarding loans are met, loans are allowed. The loan must provide for reasonable interest, secured by the account. Finally, the plan document must contain a loan provision.
 
How can participants in governmental 457(b) plans be sure their assets are protected?
Section 1448 of the Small Business Jobs Protection Act of 1996 (SBJPA) added 457(g) of the Code, which requires that 457(b) plan maintained by state or local government employers hold all plan assets and income in trust, or in custodial accounts or annuity contracts (described in 401(f) of the Code), for the exclusive benefit of their participants and beneficiaries.
 
Is there a special tax credit for low-income savers?
Yes. Eligible savers will receive a tax credit of up to 50 percent on up to $2,000 in contributions to an IRA, 403(b), 457, SIMPLE or 401(k) plan. Joint filers whose adjusted gross income (AGI) is less than $30,000 are eligible for the full 50 percent credit; joint filers with AGI between $30,000 and $32,500 are eligible for a 20 percent credit; and joint filers with an AGI between $32,500 and $50,000 are eligible for a 10 percent credit. Eligibility for single filers is one-half the threshold for joint filers. For example a single earner with an AGI less than $15,000 would be eligible for the full 50 percent tax credit. This provision is set to expire in 2006.
 
What are an employee's options when switching jobs?
  Public plans — State and local government plans.
457(b) money can be moved into your new employer's 457(b), 403(b) or 401(k) if the plan accepts such transfers, or into a Rollover IRA. Public (governmental) plan 457(b) money is not subject to the age 59 1/2 withdrawal rule, so money can be withdrawn (subject to income tax on the full amount) without incurring a 10% early withdrawal penalty. Another option when switching jobs is to leave the money where it is, if the plan allows.
 
  Private plans — Non-governmental tax-exempt entity plans.
457(b) can be moved to another tax-exempt organization's 457(b) if the plan accepts such transfers, but it may not be rolled into an IRA or another type of employer-sponsored retirement plan.
 
  Can governmental 457(b) money be withdrawn in the case of "extreme financial hardship" or "unforeseeable emergency"?
Generally funds may be withdrawn in the case of "extreme financial hardship" or in the event of an "unforeseeable emergency." This right is subject to the employer's plan rules specified in the plan document. An unforeseeable emergency must be defined in the plan as (1) a severe financial hardship of the participant that results from illnesses or accidents of the participant, their spouse or a dependent, (2) the loss of the participant's property due to casualty, or (3) other similar extraordinary and unforeseeable circumstances that arise as a result of events beyond the participant's control. Examples of extraordinary and unforeseeable circumstances include the imminent foreclosure of, or eviction from, a primary residence or the need to pay for medical or funeral expenses. However, educational expenses are not unforeseen, so are not included.
 
When must governmental 457(b) money be withdrawn?
Generally, withdrawals must begin at age 70 1/2. Withdrawal options will vary by employer. Consult your employers plan document for details.
 
Will participation in a governmental 457(b) affect Social Security Benefits?
No. Salary reduction contributions to a 457(b) reduce taxable compensation for federal (and in most instances, state) income tax purposes only. Those contributions do not reduce wages for the purpose of determining FICA taxes or determining Social Security benefits. However, 457(b) distributions must be included as ordinary income, which may have an affect on the taxation of Social Security benefits.
 
What happens to 457(b) money at death?
Designated beneficiary(ies) will be paid survivor benefits due at death. If you are married, provisions under your employer's plan may require that your spouse be designated as the account's primary beneficiary, for at least a portion of the benefit.
 
What if my employer doesn't offer a 457(b) plan?
If you work for a 457(b)-eligible employer, lobby the powers that be to add one. If you work for an organization that allows contributions to a 403(b) plan [or a 401(k) plan], point out the ability to contribute to both a 403(b) and a 457(b) plan [or the ability to contribute to both a 457(b) and a 401(k) plan].
 
Governmental 457(b) plan advantage: no early withdrawal penalty at retirement or upon termination of employment.
A big advantage to the 457(b) plan is that it is not subject to the age 59 1/2 withdrawal rule. This means there is no 10% penalty for early withdrawal at retirement or upon termination of employment. [Note: This benefit applies only to public (governmental) plans. Private plan participants generally will pay federal income taxes when funds are made available to them. They may, however, defer receiving funds and instead be taxed when they actually take distribution].
 
Also, note that if you roll governmental 457(b) money into a 403(b), 401(k), IRA or any other plan [other than a 457(b) plan], you will lose this no early withdrawal penalty benefit. Conversely, if you roll 403(b) money into a 457(b) plan you do not avoid the 10% early withdrawal penalty. The plan provider or sponsor has to account for this money separately. As in all cases, you cannot roll over money unless the plan sponsor and product provider allow for it.
 
Other 457(b) points of note
  Unlike the 403(b) plan, the employer must create a plan document detailing the specific rules of the plan.
 
  Your employer's plan document will be the best source of information for your particular situation.
 
  A 457(b) plan must be held in a trust for the exclusive benefit of the plan's participants and beneficiaries. Section 457(g)(3) of the IRC allows public (governmental) plans to use qualifying annuity contracts and/or custodial accounts in lieu of, or in addition to, a trust to satisfy this requirement.
 
  Where can I get additional 457(b) plan questions answered?
Post a question on our 403(b)/457(b) message board. To post, click "New Topic" and post away. It's that easy!
 
Some information on this section was provided by Chuck Yanikoski, President, Still River Retirement Planning Software.
 

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