11/18/04 - Section 457 Plans for Municipal and State Employees
By: Frank C. Armstrong, CFP, AIF
Municipal and state employees enjoy yet another variation of the defined contribution plan. But, Section 457 plans are a distinct breed of animal with individual quirks. Typically, there is no employer match or contribution, only voluntary salary deferrals.
Technically a non-qualified tax deferral program, contributions are limited to the lesser of 100% of compensation or $13,000 in 2004 rising to $15,000 in 2006. After that the amount is indexed for inflation. There are special catch up provisions for 457 plans. After age 50 the catch up amount is $3000 in 2004 increasing to $4000 in 2006.
So far, it looks pretty much like a 401(k) plan. But, here are some major differences:
- If the participant is also eligible for a 401(k) or other defined benefit plan, she is eligible to make the maximum contribution to both plans! (Prior to 2002, a dollar for dollar offset was required for any contributions to other plans.)
- For the last three years before retirement, the catch up is twice the normal requirement. So that in 2004 the total contribution limit is $26,000 increasing to $30,000 in 2006!
- Recent legislation allows for rollovers into IRA's upon termination of employment, or a rollover into another 457 plan if desired.
- These plans have another unique feature: there is no 10% early distribution penalty. This could be a very useful feature for many employees that retire early to a second career and may need to draw on the funds at some point before age 59 ½. However, if the plan is rolled over into an IRA it becomes subject to the early withdrawal penalty like any other IRA.
- Unlike 401(k) plans and other defined benefit plans loans are not allowed. However hardship withdrawals are allowed but subject to ordinary income tax.
- ERISA does not apply to 457 Plans, depriving these employees of some Federal regulatory standards and oversight enjoyed by other qualified plan participants. Fiduciary standards may be problematical in some localities, and participants should use some independent judgment before deciding to enroll. All local governments are not uniformly honest and/or competent. Enough said.
Note: There are two additional completely different Section 457 Plans that are not discussed here. Some church or non-governmental 501(c)3 organizations have non-qualified deferred compensation plans for their employees. Then there are special deferred compensation plans for highly compensated state and municipal employees. Unfortunately, all three plans are called Section 457 Plans, causing more than a little confusion because they are not similar at all.
Coming up: None of the private pension plans whether defined benefit or defined contribution plans will work unless the plan sponsors/fiduciaries do their job. There is precious little evidence that that is happening. While there are some exceptions, we also see massive failure of fiduciary standards. A huge number of private pensions are disgracefully bad, incapable of delivering retirement security or decent returns for participants. Waste, corruption, mismanagement, and failure to adhere to elementary fiduciary standards will cost American retirees trillions of dollars! That's right, trillions with a capital T!
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