Section 457 Plan Chapter 27 Employee Benefit & Retirement Planning Copyright 2009, The National...

Copyright 2009, The National Underwriter Company 1

Section 457 Plan Chapter 27Employee Benefit & Retirement Planning

What is it?

A plan designed to comply with IRS Code Section 457, which provides rules for all nonqualified deferred compensation plans of

- governmental units

- governmental agencies

- non-church controlled tax exempt organizations



When is it indicated?

When

- governmental units

- governmental agencies

- non-church controlled tax exempt organizations

want employees to have a deferred compensation plan



Design Features: What employers are covered by Section 457?

1. a state, a political subdivision of a state, and any agency or instrumentality of a state or political subdivision of a state

2. any organization exempt from federal income tax, except for a church or synagogue or an organization controlled by a church or synagogue



Design Features: Limit on Amount Deferred

Eligible Section 457 plans

– plans include limits on the amounts deferred

– typically cover broad class of employees

– eligible for favorable tax treatment




Ineligible Section 457 plans

– plans provide greater deferral levels than annual dollar limit

– generally designed for executives

– taxed in first year in which no longer ‘substantial risk of forfeiture’

– generally taxable in full no later than the year of the executive’s retirement



Basic limit

for eligible plan, amount deferred annually by participant cannot exceed 100% compensation

Or applicable dollar amount:

2006 $15,000

2007 $15,500

2008 $15,500

2009 $16,500




• Section 457 plans allow ‘double dipping’

salary reduction contributions do not reduce contributions to any other type of salary reduction plans, e.g. Section 403(b) or Section 401(k) plans

• 100% of compensation limit applies to gross compensation before salary reductions




50 or over catch-up provisions

governmental employees can have an additional salary reduction contribution

2006 $5,000

2007 $5,000

2008 $5,000

2009 $5,500




50 or over catch-up provisions (cont’d)

– cannot exceed the excess of the participant’s compensation over all regular elective deferrals

– Section 415 limits (annual additions to participant’s account cannot exceed the lesser of $49,000 (2009) or 100% of compensation) does not limit use of the 50-or-over catch-up



Design Features: Timing of Salary Reduction Elections

Employee generally must elect to defer compensation under agreement made before compensation earned

e.g. if paid monthly, must enter agreement to defer compensation at beginning of the month



Design Features: Distribution Requirements

Plan distributions cannot be made before:

1. calendar year in which the participant attains age 70½

2. severance from employment

3. ‘unforeseen emergency’ as defined in regulations




Additional issues:

– in certain situations, participant can receive involuntary cash-out of $5,000

– participant can make on-time election to defer commencement of distributions




Additional issues:

– must comply with minimum distribution rules

– Qualified Domestic Relations Orders follow qualified plan rules



Design Features: Coverage and Eligibility

Section 457 plans have no specific coverage requirements

– governmental organization can offer to any one or more employees or employee groups

– most private non-governmental organizations may be subject to ERISA eligibility rules

• can avoid if utilize ERISA exemptions



Design Features: Funding

Nongovernmental tax-exempt organizations

– cannot be funded

– can ‘finance’ the plan with insurance or annuity contracts

– ‘no funding’ of Sec. 457 conflicts with ERISA



Design Features: Funding

Governmental organizations

– - governmental plans MUST be funded

– - plan assets must be in trusts or custodial accounts



Tax Implications

1. sponsoring employer does not pay income tax

2. limited nonrefundable tax credit available to some lower income tax payers

3. if plan permits voluntary employee contributions to ‘deemed’ IRA, amounts so contributed will reduce limit for other traditional or Roth IRA contributions



Tax Implications

4. benefits are taxable

– governmental plan distributions included in income when paid

– non-governmental or tax exempt plan distributions included in income when paid or otherwise made available



Tax Implications

5. Sec. 457 plan distributions no eligible for 10-year averaging for lump sum distributions

6. in certain situations, plan participants can exclude from income amounts directly transferred from a Sec. 457 plan to governmental defined benefit plan

7. certain rollovers permitted

Sec. 457 IRA

Sec. 457 Sec. 457



ERISA Requirements

Governmental employers and church-related organization are NOT subject to ERISA

Tax-exempt private employers have difficulty with ERISA funding requirements



Alternatives

Tax-exempt employers can adopt

qualified pension and profit sharing plans

Sec. 403(b) plans

Sec. 401(k) plans

SIMPLE IRA

SIMPLE 401(k)

Governmental employers can adopt

governmental pension plans



True or False?

1. Beth Shalom Synagogue can have a Section 457 plan.

2. Contribution to one Section 457 plan will reduce contributions to a second Section 457 plan.

3. Contribution to a Section 457 plan will reduce contributions to other types of salary reduction plans such as Sec. 401(k) or Sec. 403(b) plans



True or False?

4. Participants in a Sec. 457 plan in a private tax exempt organization aged 50 and over are eligible for an additional ‘catch-up’ contribution.

5. A nongovernmental tax-exempt organization can use a trust fund to finance a Sec. 457 plan.

6. Funds can be withdrawn from a Sec. 457 plan prior to time for normal distribution to pay for purchase of residence or child’s college education.



Discussion Question

How can a governmental or tax-exempt employer provide a substantial deferred compensation benefit for an executive or key employee for whom the annual dollar limit would be inadequate?

Section 457 Plan Chapter 27 Employee Benefit & Retirement Planning Copyright 2009, The National...

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