4. Government 457 Plans Flashcards
Section 457 plan
NQ deferred compensation plan that permits salary reduction contributions for state and local government and tax-exempt employers
-plans that include limits on the amounts deferred are subject to favorable tax treatment
Deferrals are placed in investments outlets that may include insurance. Deferred amounts ad earnings are distributed upon retirement, death, termination of employment, or if elected, the calendar year in which the participant attains age 73.
Employers who can use the Section 457 plan
-State and local government employers: state, political subdivision of state, or an agency of a state/political subdivision eg school district/sewage authority
-Tax-exempt employers- any org exempt from federal income tax/not controlled by church/synagogue
Eligible plans
The amount deferred annually by an employee cannot exceed the lesser of 100% of the employee’s compensation or $22,500 in 2023. Adjusted for COL increases in increments of $500, don’t need to be coordinated with other plans such as 401(k) and 403(b) plans
Ineligible/forfeitable plans are those providing greater deferral (for executives). Additional deferred amount is taxed in the first taxable year in which there is no substantial risk of forfeiture
Catch up contributions
-Participants in a governmental employer or a non-church-controlled tax-exempt organization who are 50+ : eligible for an additional salary reduction catch-up contribution of $7,500 (2023).
-catch up for any years since 1/1/79 during three years before retirement age
- contribution ceiling can be increased in each of the last three years before the normal retirement age to the lesser of:
-2x the dollar limit for the year, or
-regular limit of the lesser of the dollar limit for the year or 100% of taxable compensation, plus the total amount of deferral not used in prior years.
-All elective deferrals must be aggregated in applying the applicable limit EXCEPT deferrals into a Section 457 plan.
eg if Section 415 limit reached for qualified plans, can still make elective deferrals in 457 plan
Distribution requirements
Cannot be made before:
-< 73,
-Severance from employment,
- “unforeseeable emergency,” as defined in the regulations, or
- death or disability of the plan participant.
can elect to receive an involuntary cashout of up to $5,000 from account under a tax-exempt non-governmental organization’s plan if:
- No amount has been deferred by the participant for two years, and
- There has been no prior distribution.
Must be transferred to individual retirement plan
Min distributions must be made under 401(a)(9) @73
since 12/31/01 can take out for QDRO
- severance from employment/ ceases to be employed by the employer sponsoring the plan
-unforeseeable emergency:
-sudden and unexpected illness or accident of the participant or a dependent - loss of property due to casualty, or
- similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant. (NOT tuition/residence purchase)
Coverage and eligibility requirements
most private nongovernmental tax-exempt organizations are subject to ERISA, with the exemption for unfunded plans covering select group of management/ HCE (top-hat group)
Funding regulations
Non-governmental Tax-exempt Organizations financing/informal funding via insurance/annuity contracts:
If employer purchases contracts to finance, there is no current life insurance to employees and under these conditions for employer:
-retains ownership
-sole beneficiary
- no obligation to transfer/pass through proceeds
Conflict with unfunded and ERISA requirement
Exemptions for Top-hat plans and Unfunded excess benefit plans
Tax policies
Deductibility- not applicable since employer doesn’t pay federal income taxes
Nonrefundable tax credit-voluntary contributions to a deemed IRA may count toward nonrefundable credit for lower income taxpayers
Income: Governmental plan distributions when paid; nongovernmental tax exempt when actually paid or made available. compensation deferred is included in the employee’s income in the first taxable year in which there is no substantial risk of forfeiture of the rights to the compensation
10-year averaging: not eligible for the favorable lump sum 10-year averaging treatment
Direct transfers- may exclude from income amounts directly transferred (from trustee to trustee) from a Section 457 plan to a governmental defined benefit plan and used to purchase permissive service credits
Rollovers- may rollover distributions to an IRA or other eligible plans, such as a qualified plan or an employer-sponsored tax-advantaged retirement plan under the same rules that apply to rollovers from qualified plans.
No pre 59 ½ 10% tax penalty
Alternatives
Governmental entities, like tax-exempt employers, are permitted to maintain Savings Incentive Match Plan for Employees IRA (SIMPLE IRA) plans.
Governmental employers can also adopt governmental pension plans similar to qualified private plans.
-qualified pension and profit sharing plans for employees.
-Section 403(b) plans that provide as good or even better benefits for employees when compared to a Section 457 plan.
Tax-exempt organizations, but not governmental entities, can adopt 401(k) plans.
Top Management Employees
Section 457(f): most general provision that allows escape for top management employees from the annual dollar limit: the additional deferred amount is taxed in the first taxable year in which there is no substantial risk of forfeiture, should not have rolling forfeiture
- amounts generally are taxable in full, no later than the year of the executive’s retirement.
Steps to install
- written plan containing the provisions must be adopted
-Employees elect salary reduction elections on forms - For tax-exempt private employers subject to ERISA, the same ERISA requirements applicable to nonqualified deferred compensation will apply.
Next month Sally Sharp will be quitting her job with a state government agency, Sweet60, which cares for senior citizens. She will be joining a public school as a teacher. She will be receiving the distribution from the Section 457 plan of Sweet60 upon severance of employment. If she wants to avoid paying tax on the distribution this year, what are the options available to her?
As an employee of a government agency, Sally Sharp would have to include the distributions in income when they are paid. However, this will result in it being taxed in the current year. To avoid paying tax she could directly roll over or make a direct transfer of the amount to other permitted plans or accounts. She can also use the amount to repay previously refunded contributions.
Lisa, age 40, has an eligible unforeseen financial emergency and must withdraw $30,000 from her governmental Section 457(b) plan to pay emergency expenses. If Lisa is in a 22% federal marginal income tax bracket, what is the total she will pay in income taxes and penalties?
Lisa will pay $6,600 in federal income tax. Early distributions from a governmental Section 457(b) plan are not subject to penalty.
Ted, age 54, is employed by a municipality that sponsors a government Section 457 plan with a normal retirement age of 65. His monthly salary is $7,000. Ted also works part-time for a for-profit company and earns $25,000 annually. The company sponsors a Section 401(k) plan. What is the maximum amount Ted can defer into the Section 457 plan for 2023?
Ted can contribute $30,000 to the Section 457 plan for 2023 ($22,500 regular contributions plus the $7,500 age 50+ catch-up allowance).
Ted, age 62, is employed by a municipality that sponsors a government Section 457 plan with a normal retirement age of 65. His monthly salary is $7,000. Ted also works part-time for a for-profit company and earns $25,000 annually. The company sponsors a Section 401(k) plan.
What is the maximum amount Ted can defer into the Section 457 plan for 2023?
Ted can contribute $45,000 to the Section 457 plan for 2023 under the “last 3 years rule” prior to the normal retirement age in the plan. The “last 3 years rule” allows deferrals up to two times the normal annual maximum. The age 50+ catch-up allowance may not be used in the same year the “last 3 years rule” catch-up is used.
