457(b) retirement plans
Tax code section 457 provides rules to govern all nonqualified deferred compensation plans of governmental employees and non-church controlled tax-exempt organizations. The pension plan designed to comply with theses rules is simply referred to as a Section 457 plan. Employees are allowed to defer compensation on a pre-tax basis though payroll deductions that further allows them to defer federal and sometimes state taxes until the assets are withdrawn.
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) which was only $8,500 at the time. The Economic Growth and Tax-Relief Reconciliation Act of 2001 (EGTRRA) repealed coordination of contributions between 457(b) and 403(b) plans [and between 457(b) and 401(k) plans]. This means that participants who are eligible to contribute to both plans can contribute the maximum to both a 403(b) and a 457(b) [or to both a 457(b) and a 401(k)]. For 2007 and 2008, this is $15,500 per plan for a whopping total of $31,000. Participants eligible for catch-up provisions (over 50) can also include another $5,000. Not all employers offer both a 457(b) and a 403(b) plan [or both a 457(b) and a 401(k)], nor are they required to do so.
What are Eligible and Ineligible Plans?
Eligible Section 457 plans include limits on the amounts deferred and are subject to favorable tax treatment. Plans that provide greater deferral are generally designed for executives and are referred to as ineligible. The amount deferred annually by an employee for an eligible plan cannot exceed the lesser of 100% of the employee’s compensation or the annual maximum contribution amount.
Only eligible employers can establish a Section 457 plan. An eligible employer is defined as states, subdivisions of states, instrumentalities or political subdivisions of states, or any entity other than a governmental unit that is exempt from federal income taxes. Some governmental units that are exempt from federal income taxes include the following types of organizations:
- charitable organizations
- religious organizations
- educational organizations
- private hospitals
- private foundations
- labor unions
- trade associations
- fraternal orders
- farmers cooperatives
With a Section 457 plan, distributions cannot be made before:
- the calendar year the participant reaches age 70
- severance from employment
- an unforeseeable emergency such as a severe financial hardship, unexpected illness or accident, and so on
The qualified plan rules of Section 414(p) regarding Qualified Domestic Relations Orders apply to Section 457 plans. A plan participant may rollover distributions into an IRA or other eligible plan under the same rules that apply to rollovers from qualified plans. Participants in a 457 plan may also rollover a Section 457 plan to another Section 457 plan without incurring income tax on the amount rolled over.
Other Benefits of a Section 457 Plan
In addition to deferring the maximum allowable under the 457 plan, an employee may also defer a:
- 401(K) plan
- 403(b) plan
- SAR-SEP plan
- Simple IRA