457 Plan

A 457 plan is a type of non-qualified, tax-advantaged deferred-compensation retirement plan that is available for governmental and certain non-governmental employers in the United States. These plans are named after the Internal Revenue Code (IRC) section 457 that dictates their operation. Participants can defer compensation from their employer for retirement savings purposes, which can help in reducing taxable income and allowing savings to grow tax-deferred until they are withdrawn.

History and Background

The 457 plan was established under the Revenue Act of 1978 and has undergone several legislative changes since then. It was initially implemented to provide a retirement savings option primarily for state and local government employees. Over the years, enhancements and clarifying regulations have expanded participation eligibility and improved plan features.

Eligibility and Participation

Governmental 457 Plans

Governmental 457 plans are open to employees of state and local governments, as well as certain non-governmental organizations that are tax-exempt under IRC Section 501. This includes public schools and universities. Examples of eligible employees include police officers, firefighters, and public administrators.

Non-Governmental 457 Plans

Non-governmental 457 plans are typically offered by tax-exempt organizations like charitable organizations, unions, and certain hospital systems. However, these plans have stricter regulations and are limited in scope as compared to governmental 457 plans. Participants usually include higher-ranking officials and key employees due to Non-discrimination rules.

Contribution Limits

Annual Contribution Limits

For the year 2023, the maximum contribution limit for a 457 plan is $22,500. This limit is adjusted annually based on cost-of-living adjustments. Employees over the age of 50 can make additional catch-up contributions amounting to $7,500, making the total possible contribution $30,000 per year.

Special Catch-Up Contributions

Unique to 457 plans is a “special catch-up” provision for participants who are within three years of normal retirement age. This provision allows those participants to contribute up to twice the annual limit or the standard limit plus unused contribution amounts from prior years, whichever is less.

Tax Treatment

Pre-Tax Contributions

Contributions to a 457 plan are made on a pre-tax basis, reducing the participant’s current taxable income. Taxes on contributions and investment earnings are deferred until the funds are withdrawn.

Roth 457 Contributions

Some 457 plans offer a Roth option, allowing participants to make post-tax contributions. This means contributions are taxed at the time they are made, but qualified withdrawals are tax-free.

Withdrawals and Distributions

Qualifying Events

Distribution from a 457 plan can generally be taken without penalty upon separation from service, reaching the age of 70½, or facing an unforeseeable emergency. Unlike 401(k) and 403(b) plans, 457 plans are not subject to the 10% early withdrawal penalty for distributions taken before the age of 59½.

Required Minimum Distributions (RMDs)

Participants must begin taking required minimum distributions (RMDs) by April 1 of the year following the year they turn 72, similar to other retirement plans.

Withdrawal Options

Participants can choose from various distribution options including lump-sum payments, annuities, and periodic payments at retirement. Withdrawals are subject to ordinary income taxes.

Investment Options

457 plans typically offer a range of investment options including mutual funds, annuities, and sometimes individual securities. The investment choices vary depending on the specific plan and the plan provider. Many plans offer a diversified range of options to suit different risk tolerances and retirement goals.

Managed Accounts

Some 457 plans provide managed account services where investment decisions are made by professional investment managers. These accounts often come with additional fees but are beneficial for participants who prefer expert management of their retirement funds.

Advantages and Disadvantages

Advantages

• Tax Deferral: Contributions and earnings grow tax-deferred until withdrawal.
• No Early Withdrawal Penalty: Distributions are not subject to the 10% early withdrawal penalty typically seen in other retirement plans.
• Contribution Flexibility: Special catch-up contributions allow for increased savings close to retirement.

Disadvantages

• Limited Portability: Non-governmental 457 plans can be less portable compared to 401(k) or 403(b) plans because they are not easily rolled over into IRAs.
• Investment Restrictions: Investment options may be more limited compared to other types of retirement accounts.
• Creditor Risk: Assets in non-governmental 457 plans may be subject to claims by the general creditors of the employer in case of employer bankruptcy.

Plan Providers

Various financial institutions and companies provide 457 plan administration services. Prominent providers include TIAA, Nationwide, and Voya Financial. These organizations offer plan setup, investment management, and compliance services.

Example Providers:

• TIAA: tiaa.org
• Nationwide: nationwide.com
• Voya Financial: voya.com

Conclusion

457 plans offer valuable retirement savings opportunities for employees of governmental and certain non-governmental organizations. With tax advantages, flexible contribution options, and various investment choices, these plans are an integral part of retirement planning for eligible participants. Understanding the nuances of 457 plans can help participants maximize their retirement savings and achieve financial security in retirement.