457(b) Plans – Deferred Compensation Plans for Government Employees
posted by Fisher 401(k) February 28, 2020
What is a 457(b) plan?
A governmental 457(b) plan is a nonqualified deferred compensation plan for employees of a state or local government or its agencies.
457(b) vs 401(k)
A governmental 457(b) plan operates like a 401(k) plan. Both employers and employees can contribute to the plan, although neither is required to contribute. Employees contribute a portion of their paychecks, typically on a pre-tax basis, although 457(b) plans may also allow for after-tax Roth contributions. Employee contributions vest immediately, while employers may set a vesting schedule for their contributions. The investment earnings on those contributions grow tax deferred. Pre-tax contributions will be taxable to the employee when distributed from the plan, along with the investment earnings. In the case of Roth contributions, however, distributions may be tax free if certain requirements are met.
457(b) plan contribution limit
Total contributions to a 457(b) plan cannot exceed the lesser of 100% of an employee’s compensation or the 2020 salary deferral limit of $19,500. Employees age 50 or older may contribute an additional amount up to $6,500. Plans may also permit special catch-up contributions that allow a participant to make additional contributions for 3 years prior to reaching the “normal retirement age” specified in the plan. The participant may contribute the lesser of twice the annual limit ($39,000 in 2020) or the basic annual limit plus the basic limit not used in prior years.
Individuals who participate in a governmental 457(b) plan may also contribute to an employer-sponsored retirement plan of a different employer, with each plan having separate limits on the amount the employer and employee can put it. Contributing to both can double an employee’s tax-deferred retirement savings and reduce an employee’s taxable income.
457(b) plan withdrawal rules
When employees leave a 457(b) plan employer, they can roll over their plan assets to a different retirement plan or take a lump-sum payment. The rollover rules are the same for a 457(b), 401(k), 401(a) and 403(b).
Governmental 457(b) plan distributions are not subject to the 10% early distribution tax. They are, however, subject to the required minimum distribution (RMD) rules.
Benefits of a 457(b) plan
Establishing a 457(b) plan allows governmental employers to provide the same retirement savings opportunity as private, for-profit businesses. The ability to provide similar retirement benefits as private industry employers may help governmental employers compete for talented employees. A governmental 457(b) plan may also permit employees to make two types of catch-up contributions and allow employees to purchase service credits in a defined benefit plan.