457 Plans: Employee Deferred Compensation for Government and Tax-Exempt Organizations
While there are several different retirement plans available to businesses, government (state & local) and tax-exempt organizations have an additional option: 457(b) Employee Deferred Compensation plans. These plans are similar to 401(k) and 403(b) plans in that contributions are exempt from federal and state income taxes. Another similarity is the tax-deferred growth of all earnings within the 457 plan. But how do 457 plans differ from 401(k) and 403(b) plans?
One major difference is the absence of the 10% early withdrawal penalty. Money deferred into a 457(b) plan can be withdrawn once the employee separates from service regardless of age, but these withdrawals are still subject to taxation as ordinary income in the year they are made.
As with 401(k) and 403(b) plans, both the employee and employer can make contributions to 457 plans with similar limitations. Contributions are limited to $15,500 for 2007, and employees over the age of 50 may defer an additional $5,000 per year as a “catch-up” contribution. But unlike 401(k) and 403(b) plans, where employer contributions or matches do not count toward the employee’s deferral limit of $15,500, 457(b) plan contribution limits apply to both employee and employer contributions. Total contributions from both employee and employer cannot exceed $15,500.
In addition, there are different rules that apply to government offices and tax-exempt businesses. While government organizations that adopt a 457(b) plan must make employee deferrals available to all employees, tax-exempt organizations organized under the 501(c) tax code are only allowed to offer key employees 457s known as “Top Hat” 457 plans.
What are Top Hat 457 plans?
Top Hat 457 plans have become very popular with tax-exempt businesses as a means to increase or replace the retirement benefits of key employees. Top Hat 457 plans are not subject to ERISA discrimination testing associated with other types of retirement plans such as 401(k) and 403(b). In fact, Top Hat 457 plans must be limited to a number of key or highly-compensated employees.
Top Hat 457 plans can allow the employer to make contributions to key employees who are otherwise limited or ineligible to receive employer contributions or matching contributions into the organization’s 401(k)/403(b). The employer is not required to offer a 457 to all key employees and it can choose the key employees to be included in the program.
What are paired plans?
Pairing plans can increase the allowable contribution amounts for eligible organizations that currently have a 401(k)/403(b) and also adopt a 457 plan. Employees pairing plans would be able to contribute the maximum to a 401(k)/403(b) ($15,500, plus $5,000 catch-up) and also be able to contribute the maximum deferral into a 457(b) ($15,500 plus $5,000 catch-up). The total deferral amount for 2007 can be as high as $41,000.
For further information on 457 plans, visit the following links:
IRS 403(b)/457 plan comparison chart
To find out if a 457 plan is right for your organization, call our offices at 919-913-0235.
Questions or comments about this article? Email us at comments@hcwbenefits.com.
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January 5, 2007
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