457 plan
Encyclopedia
The 457 plan is a type of non-qualified tax advantage
d deferred-compensation retirement plan that is available for government
al 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 that unlike with a 401(k) plan, there is no 10% penalty for withdrawal before the age of 59½ (although the withdrawal is subject to ordinary income
taxation). Also 457 plans (both governmental and non-governmental) can allow independent contractor
s to participate in the plan where 401(k) and 403(b) plans cannot.
(EGTRRA) made a number of changes in how governmental 457 plans are treated, the most notable of which is that the coordination of benefits limitation was removed. This allows a person whose 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 $16,500 for 2009 into their 401(k) and also the maximum $16,500 into their 457 plan. If that person's age is at least 50 at the end of the current tax year, they can contribute the additional catch up amount into each plan also, meaning an additional $5,500 into the 401(k) and another $5,500 into their governmental 457 (catch-up contributions are not provided for non-governmental 457 plans). The total would then be $44,000 deferred instead of the $22,000 that would have been allowed if the coordination of benefits provision had not been repealed in regard to the governmental 457 plan.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-deferred plans. However, the total combined annual contribution to 401(k) and 403(b) plans is subject to the $16,500 limit and $5,500 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.
age (and perhaps eligible retirement at any age). This second catch-up option is equal to the full employee deferral limit or another $16,500 for 2009. Thus, a person over 50 within 3 years of retirement and who has both a 457 and a 401(k) could defer a total of $52,500 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.
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 creditor
s of the employer in legal
or bankruptcy
proceedings.
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).
Tax advantage
Tax advantage refers to the economic bonus which applies to certain accounts or investments that are, by statute, tax-reduced, tax-deferred, or tax-free...
d deferred-compensation retirement plan that is available for government
Government
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
al and certain non-governmental employers in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
. The employer provides the plan and the employee defers compensation
Deferred compensation
Deferred compensation is an arrangement in which a portion of an employee's income is paid out at a date after which that income is actually earned. Examples of deferred compensation include pensions, retirement plans, and stock options...
into it on a pre-tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
basis. For the most part the plan operates similarly to a 401(k)
401(k)
A 401 is a type of retirement savings account in the United States, which takes its name from subsection of the Internal Revenue Code . A contributor can begin to withdraw funds after reaching the age of 59 1/2 years...
or 403(b)
403(b)
A 403 plan, also known as a tax-sheltered annuity, is a tax-advantaged retirement savings plan available for public education organizations, some non-profit employers , cooperative hospital service organizations, and self-employed ministers in the United States...
plan most people are familiar with in the US. The key difference is that unlike with a 401(k) plan, there is no 10% penalty for withdrawal before the age of 59½ (although the withdrawal is subject to ordinary income
Ordinary income
Under the United States Internal Revenue Code, the type of income is defined by its character. Ordinary income is usually characterized as income other than capital gain...
taxation). Also 457 plans (both governmental and non-governmental) can allow independent contractor
Independent contractor
An independent contractor is a natural person, business, or corporation that provides goods or services to another entity under terms specified in a contract or within a verbal agreement. Unlike an employee, an independent contractor does not work regularly for an employer but works as and when...
s to participate in the plan where 401(k) and 403(b) plans cannot.
Changes within The Small Business Jobs Act of 2010
Participants in section 457 plans are allowed to treat elective deferrals as Roth contributions.Changes with EGTRRA 2001
The Economic Growth and Tax Relief Reconciliation Act of 2001Economic Growth and Tax Relief Reconciliation Act of 2001
The Economic Growth and Tax Relief Reconciliation Act of 2001 , was a sweeping piece of tax legislation in the United States by President George W. Bush...
(EGTRRA) made a number of changes in how governmental 457 plans are treated, the most notable of which is that the coordination of benefits limitation was removed. This allows a person whose employer has a 401(k)
401(k)
A 401 is a type of retirement savings account in the United States, which takes its name from subsection of the Internal Revenue Code . A contributor can begin to withdraw funds after reaching the age of 59 1/2 years...
or 403(b)
403(b)
A 403 plan, also known as a tax-sheltered annuity, is a tax-advantaged retirement savings plan available for public education organizations, some non-profit employers , cooperative hospital service organizations, and self-employed ministers in the United States...
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 $16,500 for 2009 into their 401(k) and also the maximum $16,500 into their 457 plan. If that person's age is at least 50 at the end of the current tax year, they can contribute the additional catch up amount into each plan also, meaning an additional $5,500 into the 401(k) and another $5,500 into their governmental 457 (catch-up contributions are not provided for non-governmental 457 plans). The total would then be $44,000 deferred instead of the $22,000 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-deferred plans. However, the total combined annual contribution to 401(k) and 403(b) plans is subject to the $16,500 limit and $5,500 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
Individual Retirement Account
An individual retirement arrangement is the blanket term for a form of retirement plan that provides tax advantages for retirement savings in the United States...
. 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 $5,500 that can be contributed as noted above. This option for making catch-up contributions is only available under governmental 457 plans. The second option is much more complicated and is available under both governmental and non-governmental plans. It can be elected by an employee who is within 3 years of normal retirementRetirement
Retirement is the point where a person stops employment completely. A person may also semi-retire by reducing work hours.Many people choose to retire when they are eligible for private or public pension benefits, although some are forced to retire when physical conditions don't allow the person to...
age (and perhaps eligible retirement at any age). This second catch-up option is equal to the full employee deferral limit or another $16,500 for 2009. Thus, a person over 50 within 3 years of retirement and who has both a 457 and a 401(k) could defer a total of $52,500 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). ERISAEmployee Retirement Income Security Act
The Employee Retirement Income Security Act of 1974 is an American federal statute that establishes minimum standards for pension plans in private industry and provides for extensive rules on the federal income tax effects of transactions associated with employee benefit plans...
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 creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
s of the employer in legal
Law
Law is a system of rules and guidelines which are enforced through social institutions to govern behavior, wherever possible. It shapes politics, economics and society in numerous ways and serves as a social mediator of relations between people. Contract law regulates everything from buying a bus...
or bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
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
Rabbi trust
In the United States a Rabbi trust is a type of trust used by businesses or other entities to defer the taxability to the person or entity receiving such payments as employee compensation or purchase payments in the acquisition of another business....
, 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
Revenue Ruling
Revenue Rulings are public administrative rulings by the Internal Revenue Service of the United States federal government that apply the law to particular factual situations. A revenue ruling can be relied upon as precedent by all taxpayers....
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
Enron
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. Before its bankruptcy on December 2, 2001, Enron employed approximately 22,000 staff and was one of the world's leading electricity, natural gas, communications, and pulp and paper companies, with...
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
- IRS website page regarding 457 plans
- 403(b) and 457 Plan Feature Comparison Chart (8pp pdf file)
- IRS 403(b)/457 Online Resource Guide
- IRS Section 457 plan outline (28pp pdf file)
- Section 457 of the IRS code - From Cornell Law SchoolCornell Law SchoolCornell Law School, located in Ithaca, New York, is a graduate school of Cornell University and one of the five Ivy League law schools. The school confers three law degrees...