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What is a Section 457 Plan?
A Section 457 Plan is a tax-deferred retirement savings program for public-sector employees. It offers an alternative to a Traditional IRA. The plan offers participants a variety of investment choices from an array of sub-accounts of mutual funds.
These investments are subject to market risks. However, participants in a governmental 457 can roll their funds over to a traditional IRA. However, if you are an employee of a non-governmental entity, you will have to make a distribution, which can wipe out as much as 40% of your savings.
Tax-deferred Retirement Savings Program for Public Sector Employees
Section 457 plans, a tax-deferred retirement savings plan for public sector employees, allow participants to make extra contributions before their average retirement age. Under these plans, workers can start contributing money up to three years before they reach the average retirement age.
A 457 plan is similar to a 401(k) plan, where employees can invest a particular portion of their salary. This way, the money grows tax-deferred over time. However, there are a few differences between a 457 plan and a 401(k).
Depending on the employer, employees may be eligible to contribute as little as 2% of their pre-tax pay. The Township matches the rest of the employee’s contributions. In addition to tax-deferred retirement savings, employees can take advantage of hands-on financial planning from retirement professionals with this program.
Currently, there are two types of Section 457 plans for public sector employees. One is the Deferred Compensation 457 Plan. This program is voluntary and is offered by the state’s departments and agencies. Participants pay a minimum contribution of $10 per pay period.
Another tax-deferred retirement savings plan for public sector employees is the 403(b). Public educational institutions and specific nonprofit organizations often offer this plan. While it has many similarities with the 401(k) plan, it offers limited investment choices.
The Section 457 Plan allows public sector employees to make salary contributions tax-deferred. As with 401(k) plans, earnings accumulate tax deferred until withdrawn. However, there are essential differences between a Section 457 Plan and a 401(k) plan. Both plans have different rules for early withdrawal.
Non-qualified Deferred Compensation Plan
A non-qualified deferred compensation plan is a flexible way to reward key employees. It can be set up to allow employees to contribute annually or over the years. These types of plans are subject to specific rules, including vesting. In addition, they are not assignable.
First, an employer needs to identify its key people. These employees have critical relationships with clients and customers and possess deep operational, sales, and marketing knowledge.
Evaluating these individuals and understanding their needs and interests is imperative to structure a non-qualified deferred compensation plan properly.
The non-qualified deferred compensation plan is a retirement plan funded by an employer and employee. This plan has two parts: a contractual agreement between the employer and the employee and an available asset reserve to cover plan costs.
Life insurance is also funded through a non-qualified deferred compensation plan. Two types of non-qualified deferred compensation plans allow life insurance funding: corporate-owned life insurance and supplemental executive retirement plans. These are very similar to defined benefit pension plans.
While some exceptions exist, the IRS generally allows an employer to terminate a non-qualified deferred compensation plan for many reasons. These include a corporation changing control, a new incentive plan, or any other reason.
However, employers cannot terminate a deferred compensation plan based on financial loss. Before terminating a deferred compensation plan, an employer should consult with a labor attorney and complete the required paperwork. The plan administrator will then send a notification to the IRS.
Non-qualified deferred compensation plans are not protected against creditors in case of a company’s bankruptcy. Employees concerned about the company’s health may be hesitant to participate in NQDC plans. In addition, the Tax Cuts and Jobs Act of 2017 changed a few rules regarding nonqualified deferred compensation plans.
Required Minimum Distribution Rules
If you are a government or non-profit employee, you probably have a Section 457 plan. This plan allows you to save money in a retirement account without paying taxes or penalties for early withdrawal.
However, you must take a required minimum distribution at age 72. A Section 457 plan differs from a 401(k) or 403(b) plan because the assets are not held in a trust.
You must calculate your RMD for each separately if you have several IRAs. However, if you have a 403(b) account, you can take a total distribution from one account. For a 401(k) plan, the rules are similar. In addition, you can take a total distribution from one account if you so choose.
For those who have made contributions before 1987, you may be able to delay the RMD deadline. This option is helpful for those who contributed to their 403(b) plan before that year.
To calculate your RMD, divide your prior December 31 balance by a life expectancy factor. The IRS publishes Life expectancy factors in 590-B, and you can choose which is appropriate for your situation.
RMDs are required by the IRS and must be taken after reaching age 70 1/2. RMDs can be delayed by a year or two, but you must take them no later than April 1 of the year you turn 70 1/2. If you do not follow these rules, you’ll have to take two RMDs in the same year.
Contribution Limits
Contribution limits of Section 457 (Section 401(k)) plan are set by the Internal Revenue Service. In 2020, employees may contribute up to $19,500, but that amount will increase to $20,500 by 2022. Employers must match employee contributions at least 50% of the amount of the employee’s compensation.
Section 457 plans offer tax advantages. They let participants defer their income tax-free until retirement. Contribution limits are lower than those in 401(k) and 403(b) plans. In addition, they allow participants to contribute up to $7,500 annually. The current section 457 limit is $6,500 for individuals over 50.
The limit of a 457(b) plan depends on the employer’s match, so employee contributions may be reduced if the company wishes to meet specific nondiscrimination requirements. Depending on the plan, a person may be eligible to make catch-up contributions.
If an employee has a Section 457(b) plan, he or she can transfer those funds to a new employer or a traditional IRA.
Employees of tax-exempt organizations may be eligible to transfer their money into designated Roth accounts. In addition, government 457(b) plans may permit designated Roth contributions and in-plan rollovers to designated Roth accounts.
If an employee reaches age 50 and is eligible for a 457(b) plan, they may take advantage of a special catch-up provision.
The catch-up provision allows people 50 years old to make additional contributions to a deferred comp account. However, participants may not take advantage of both provisions within the same calendar year.
Withdrawals from a Section 457(b) plan can be complicated. While an individual may be eligible to withdraw funds early without penalty if there is an unforeseen emergency, he or she must still pay income taxes on that amount.
Coordination of Benefits Limitation
The PPACA makes coordinating benefits easier for employees and employers. The new law makes it easier for participants to transfer money from one plan to another and reduces the number of restrictions on distributions.
For example, it eliminates the user fee for requesting a pension plan. The PPACA also allows a hardship exception for a Section 457 plan’s 60-day rule. Finally, it allows employers to require at least one employee to make a minimum distribution.