A 457 plan is a retirement or pension plan that provides benefits to government employees as well as employees of tax-exempt organizations. Employees participating in 457 plans are allowed to defer their compensation on a before-tax basis through regular payroll deductions. Money placed in these accounts grows on a federally tax-free basis until withdrawn.
In this article, we're going to explain the basics of 457 retirement plans, touching on topics such as employee eligibility, contribution limits, as well as the differences between these plans and 401(k) or 403(b) plans. But first we're going to start with a brief discussion of employer eligibility.
The growing interest in 457 plans stems from the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which made a number of changes to the way these plans are treated. Employers eligible to participate in these plans include state and local government agencies that are exempt from federal income taxes, as well as other non-church organizations exempt from federal income taxes such as:
As just mentioned, there are two types of 457 plans: those for governmental agencies and those for non-governmental / tax-exempt organizations. Some government plans were established under the provisions of Section 457(g), but these types of plans can no longer be created. Most of the plans in existence today are Section 457(b) plans, and that's what we're going to discuss first in this article. We'll cover the topic briefly here, but we also have an entire publication dedicated to 457(f) plans.
Non-profit organizations are now able to provide their employees with 457 plans in addition to their traditional 403(b) plans. Such companies can establish an eligible plan under Section 457(b) or what are called "ineligible" plans under Section 457(f).
Non-governmental 457(b) plans are limited to a predefined standard group of higher compensation employees; typically directors or officers of the company. Oftentimes, this compensation limit is the same as that used for 401(k) participation testing purposes. Because these plans are usually limited to highly-compensated employees or a select group of executives, they are sometimes referred to as "top hat" plans.
The big advantage of these plans is they allow employees in their peak earning years to defer the payment of federal and state income taxes on their contributions to the plan.
Plans for non-governmental entities are much more restrictive than governmental plans. For example, money deferred into these plans cannot be rolled over into any other type of tax-deferred retirement plan; only another non-governmental 457 plan. In addition, the money placed into these accounts is not held in a trust for the sole benefit of the employee that makes the deferral. Instead the money remains the property of the employer, and therefore is available to creditors.
In 2019, the contribution limit on a 457(b) plan was $19,000, and that limit increases to $19,500 in 2020. In the years 2021 and beyond, the deferral limit on these plans can increase in $500 increments, and will be indexed for inflation. This deferral limit applies to both governmental and non-governmental 457(b) plans.
Note: Updated contribution limits are generally available in mid to late October.
Anyone that's over 50 by the end of the calendar year also qualifies for an additional catch-up contribution of $6,000 in 2019 and $6,500 in 2020. Catch-up contributions only apply to governmental plans. Non-governmental plans are not eligible to make catch-up contributions.
Finally, plan participants may also qualify for a special catch-up contribution of $19,000 in 2019 and $19,500 in 2020. This special catch-up contribution cannot be combined with the catch-up contribution for those aged 50 and over. In order to qualify for this special catch-up deferral, the accountholder must have under-contributed in prior years. Speak with the plan's administrator to verify eligibility under this special provision.
The following table compares the features such as contribution limits, transfers, distributions, and rollover rules of 457(b) plans for governmental agencies, tax-exempt organizations, and those employers offering 457(f) plans.
|Feature||457(b) Governmental||457(b) Tax Exempt||457(f) All Plan Types|
|Sponsors||State and local government||501 (c) tax exempt organizations||Government and 501(c) organizations|
|Eligible Employees||Common law employees.||Highly compensated employees.||Common law employees.|
|Contribution Limits||See information above on limits.||See information above on limits.||No limit on employee or employer contributions.|
|Special Catch Up Contributions||See information above on limits.||See information above on limits.||Catch up contributions do not apply.|
|Age 50 Catch Up contributions||See information above on limits.||See information above on limits.||Catch up contributions do not apply.|
|Distributions||Age 70 ½ minimum required distributions apply.||Age 70 ½ minimum required distributions apply.||Taxable when no substantial risk of forfeiture.|
|Rollover Rules||Subject to distribution requirements.||Does not apply.||Does not apply.|
|Transfers||Government 457(b) to government 457(b) only.||Tax exempt 457(b) to tax exempt 457(b) only.||Does not apply.|
Back in 2001 there was an important change to the coordination of benefits limits for participants of 403(b), 401(k) plans, and the 457(b). As a result of that change, the contribution limits for persons working for employers sponsoring a 401(k) or 403(b) essentially doubled if they were also eligible for a 457 plan.
That is to say, instead of being confined to a single contribution limit in each of their 401(k), 403(b) and 457(b) plans, employees are now allowed to defer the maximum contribution amounts to each plan (individually) instead of combining each plan into a single limit amount.
The 457(f) is a non-qualified deferred compensation arrangement (a non-qualified retirement plan) that provides tax-exempt or 501(c)(3) employers with an opportunity to supplement the retirement income of highly-compensated employees. Within such an arrangement, employers can contribute to this plan, and money is paid to the employee at retirement. This is why these plans are sometimes referred to as "golden handcuffs" plans, since they provide an incentive for executives to stay with the organization.
Under the provisions of Section 457(f), assets contributed by the employer remain owned by the employer until paid to the executive at retirement. This provides the promise of a future benefit to the executive, while also providing a tax shelter; since the assets are not taxable income as long as they remain the property of the employer.
As illustrated earlier, the contribution rules for a 457(f) plan are extremely generous (unlimited) as long as there is substantial risk of forfeiture. In other words, organizations can contribute as much as they want to this plan, as long as there is a mechanism in place by which the executive is at risk to lose the entire benefit.
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