457(b)

If you work for a state or local government or for a tax-exempt organization, you may be able to participate in a section 457 deferred compensation plan. Created in 1978, a 457(b) plan is a non-qualified tax-deferred compensation plan similar to qualified plans such as the 401(k) and 403-b. The 457 plan may be available as an additional voluntary retirement savings vehicle for state or local government or tax-exempt organization employers also offering a public employees pension system. Or they can be offered as a supplemental retirement option for those state or local government or tax-exempt organization employers offering a 401-k or 403-b plan.

Although 457 plans rarely provide an employer matching contribution, withdrawals after retirement are qualified for an exemption to the 10% early withdrawal penalty for eligible employees retired prior to age 59 and 1/2. This feature can make contributing to a 457 plan of special interest to public employees with a full retirement option prior to age 59 and 1/2 (such as many public safety officers.)

As always, costs matter, so before investing evaluate the fees and expenses of the investment options available in the 457 plan you are considering. Each plan chooses which investment alternatives to offer eligible employees, so fund choices and associated fees and expenses can vary.

Types of 457 plans
There are two basic types of 457 plans:
 *  Government Plans: Local and state governments are eligible to establish a 457(b) plan for their employees. This type of 457(b) covers employees of a state (including the District of Columbia), a political subdivision of a state, any agency or instrumentality of a state, or political subdivision of a state. These types of employees can include: local and state government workers, fire fighters, police personnel, and public school employees. Section 1448 of the Small Business Jobs Protection Act of 1996 (SBJPA) added 457(g) of the Code, which requires that 457(b) plan maintained by state or local government employers hold all plan assets and income in trust, or in custodial accounts or annuity contracts (described in 401(f) of the Code), for the exclusive benefit of their participants and beneficiaries. Contributions to the 457-b plan qualify for the savers credit.
 * Non-Government Plans: Tax-exempt organizations that are non-governmental (hospitals, charitable organizations, unions, among others) must generally limit participation to a select group of management or highly compensated employees. This is due to the rules under Title I of the Employee Retirement Income Security Act of 1974 (ERISA). ERISA generally requires that a private retirement plan providing benefits to employees be funded by a trust or annuity contract. The rules, however, require that private 457(b) plans be unfunded in order to obtain tax benefits. Therefore, a plan will violate ERISA unless an exception applies. . This provision means that the 457 plan assets are the property of the sponsoring employer and are subject to the employer's general creditors, until paid out to plan participants.

Each 457 plan is required to have a written plan document. It is essential to refer to this document for the details on how your 457 plan operates, including the investment options offered by the plan, fees and expenses, and specific withdrawal options.

Contributions
For 2009 you can contribute as much as 100% of your compensation up to $16,500 to a 457-b plan. If you are covered by a government (not private employer) plan and are 50 years of age or older, you can contribute an extra $5,500 a year. Since the passage of the Economic Growth and Tax-Relief Reconciliation Act of 2001 (EGTRRA), participants have been able to invest the maximum allowable contribution in both a 457 plan and a 401(k) or 403(b) plan. The combined maximum contribution for 2009 is thus $33,000 for younger participants and $ 44,000 for participants 50 years or older.

Catch Up Provision
The 457(b) plan often contains a special "catch-up" provision called the "final three year" provision for those approaching retirement (assuming they haven't contributed the maximum amount in prior years). Employers are not required to offer this provision. For those that do, the "catch-up" provision kicks in during the three years prior to "normal" retirement age (as defined in the plan). This provision, now permits up to 200% of the elective deferral limit, or $33,000 in 2009.

Example: Victor will reach "normal" retirement age in 2012; under his plan he can take advantage of the "final three year" provision in years 2009, 2010, and 2011. If Victor takes advantage of this provision he cannot also take advantage of the "Age 50 catch-up" provision. Note: to determine the underutilized amounts in prior years all of the prior coordination rules apply.

Investment Options
457-b plans can be funded with:
 * Group Fixed and Variable Annuities
 * Retail Mutual Funds
 * Bank Instruments
 * A combination of all three

Withdrawals

 * MRD Suspended for 2009
 * "If you're over age 70½, you won't have to take required minimum distributions (RMDs) in 2009 from your tax-deferred retirement accounts under new legislation signed by President Bush.
 * The 2009 RMD suspension applies to traditional IRAs,  401(k)s,  403(b)s, and other defined contribution plans. The suspension also applies to investors under age 70½ with  inherited IRAs or inherited retirement plan accounts that would otherwise be subject to RMDs."--Vanguard News release, December 23, 2008

Government 457-b plans are subject to income tax upon withdrawal but are not subject to the 10% early withdrawal penalty. Funds can be withdrawn at retirement, upon severance from the employer, upon death, upon disability, and under stringent hardship withdrawal rules. Funds must be withdrawn at age 70 and 1/2 (unless you are still working) and are subject to the Minimum Required Distribution rules. Different rules apply if you work for a tax-exempt organization ( you must see the employer plan document for the details.)

Hardship Withdrawals
The IRS has strict guidelines for allowable hardship withdrawals:

Under a 457(b) plan, a hardship distribution can only occur when the participant is faced with an unforeseeable emergency. (Code § 457(d)(1)(iii))

An unforeseeable emergency is a severe financial hardship resulting from an illness or accident, loss of property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant or beneficiary. Examples of events that may be considered unforeseeable emergencies include imminent foreclosure on, or eviction from, the employee's home, medical expenses, and funeral expenses. Generally, the purchase of a home and the payment of college tuition are not unforeseeable emergencies. (Reg. § 1.457-6(c)(2)(i))

Whether a participant or beneficiary is faced with an unforeseeable emergency depends on the facts and circumstances. However, a distribution is not on account of an unforeseeable emergency to the extent that the emergency can be relieved through reimbursement or compensation from insurance, liquidation of the participant's assets, or cessation of deferrals under the plan. (Reg. § 1.457-6(c)(2)(ii))

A distribution on account of an unforeseeable emergency must not exceed the amount reasonably necessary to satisfy the emergency need. (Reg. § 1.457-6(c)(2)(iii)).

Rollovers
An employer is not required to accept rollover contributions, so it is necessary to check a 457-b plan's written document for its rules on plan rollovers. Rollover provisions are more liberal for a government 457-b plan than for non-government 457 plans. A government 457-b plan can be rolled over to another employer's 457 plan, a 401-k plan, a 403-b plan or a rollover traditional IRA. However, assets transferred out of the 457 into a non 457 plan will lose the exemption to the early withdrawal penalty that 457 plans enjoy. Likewise, if you roll non 457 plan assets into an employer provided 457 plan, these assets do not gain exemption from the early withdrawal penalty.

Non-government 457 plans can only be rolled over to another non government 457 plan.

New provisions
Proposed provisions which would create 457 plan loans and a 457 Roth plan are, at present, uncertain.

Links

 * IRS IRC 457(b) Deferred Compensation Plans
 * 457(b)wise
 * CCH How a 457 Plan Works
 * 457 Savings Calculator
 * Comparison of the 457 and 401(k) Plans