On August 12, 2004, IRS issued Revenue Procedure 2004-56 which provided model amendments that were able to be used by a State or local government employer to amend its 457(b) to reflect the new final regulations as well as EGTRRA. The Procedure required employers to restate their plan no later than 12/31/2005, in order to be in compliance. Caution should be taken in using the Model amendments issued in 2004 as the IRS Model Language was more restrictive than the final regulations. In some cases, the language actually caused the plan to be in violation of the established operational procedures for years after 2001.  Because of the restrictions in the language, PenServ recommends that employers consult with their legal counsel or a consulting firm draft to ensure the plan satisfies the regulations as well as their needs.

Contribution Limitations for years beginning before January 1, 2002:

Generally, for years beginning before January 1, 2002, employees were permitted to make salary deferral contributions up to the lesser of 33 1/3% of the individual’s includible compensation or $7,500, subject to cost of living adjustments. For 1998 and 1999, the maximum deferral amount increased to $8,000, and for 2000 and 2001 the maximum was $8,500.

“Includible compensation” generally referred to taxable compensation. Therefore it did not include any salary reduction contributions made to the 457(b) plan.

A special "catch-up" rule applied to the 3 years proceeding the year the participant attained normal retirement age under the plan. The maximum salary reduction for these 3 years may be as much as $15,000.

Contribution Limitations for years beginning after December 31, 2001:

After December 31, 2001, the elective deferral limit for §457(b) Plans increased from the 2001limit of $8,500 to the following: 

Year	Deferral Limit
2002	$11,000
2003	$12,000
2004	$13,000
2005	$14,000
2006	$15,000
2007	$15,500
2008	$15,500

After 2006, the elective deferral dollar limit increased for Cost of Living Adjustments in increments of $500 per year.

The special “catch-up” rule maximum for years after 2001 has increased by doubling the normal deferral limit applicable in the 3 years prior to your normal retirement age. However, if you are age 50 or older, see the coordination rule discussed below.

Combining 457 and 403(b) Contributions

If the employer also maintains another plan, such as a 403(b), participant contributions under the 457 plan are generally not reduced. For example, if an employee participates in both a 457 and a 403(b) maintained by the employer, the individual may defer up to $15,500 into the 457 and an additional $15,500 into a 403(b), (assuming the participant’s wages were at least $31,000 for the year). The special 457(b) Catch-up is a true catch-up; in other words, the employee must determine the difference between how much he or she was entitled to contribute for past years and compare that to the amount actually contributed for the past years.

 “Age 50 Catch-up” Provision

If a participant attains the age of 50 or older by the end of the tax year, and works for a state or local government employer, such participant may defer an additional amount into the 457(b) Plan. However, if the participant is also eligible to contribute under the “special” catch-up for the 3 years prior to the participant’s normal retirement age, the catch-up deferral cannot exceed the greater of:

1. The Age 50 Catch-up for the year; or
2. The amount eligible under the 3-Year “special” Catch-up.

Age 50 catch-up contributions are not subject to any other limitation. The allowable amount of the catch-up depends on the year contributions are applied based on the following schedule:

Year	Catch-Up Amount
2002	$1,000
2003	$2,000
2004	$3,000
2005	$4,000
2006	$5,000
2007	$5,000
2008	$5,000

 

 

 

 

 

After 2006, the Catch-up deferral dollar limit will be increased for Cost of Living Adjustments in increments of $500.

NOTE

The age 50 catch-up contribution is not available for employees employed by tax-exempt organizations.

Typically, the only contributions made to a 457(b) plan are employee deferrals. Although employer contributions are permitted, those amounts are applied to the maximum contribution permitted and it is uncommon for employers to make contributions to these plans.

Roth Elective Deferrals are not permitted under a 457(b) plan.

Generally, participants may not withdraw from a 457(b) account prior to attaining age 70 1/2 unless the following circumstances apply:

• Severance from Employment;

• Incurring an "unforeseeable emergency";

• Death; or

• Plan termination by the employer.

Normal distributions may begin after the later of severance from employment or after attaining the normal retirement age. The participant may elect to receive a distribution in a single sum

payment or in installments (such as monthly or quarterly payments). Participants may elect a rollover to another eligible plan that accepts such rollovers.   If the employer’s plan allows employees to defer payment from the 457(b) account after severance from employment, minimum distributions must begin when the individual attains the age of 70 ½.

Special rules apply when changing employers

If an individual changes employers and the new employer also maintains a 457(b) plan, a transfer may be arranged from the prior employer's plan to the new plan. Both employers must be in the same State and both plans must be maintained by the same type of employer. For example, if the current employer is a local government, transfers may only be made to another state or local government’s plan, not to a tax-exempt employer’s plan. Participants should confirm with their employer(s) to determine if such transfers are permitted under both plans.

Rollovers from a 4057(b) Plan

After December 31, 2001, distributions from a state or local government 457(b) plan may be rolled over to an IRA or another employer plan that accepts such rollovers. Beginning in 2002, very complex 2002 rules became effective for these rollovers and participants are urged to first check with a qualified tax professional prior to receiving a 457(b) plan distribution. Theses rules were again modified and beginning after December 31, 2006, a non-spouse beneficiary may rollover a distribution to an “inherited IRA”.

Taxation of Distributions

Distributions from a 457(b) will be treated as ordinary income for the year the funds are distributed or made available to the participant or beneficiary. If payments are taken in installments, only the amount withdrawn is taxed. The remainder of the account will continue to grow tax-deferred until distributed. If the distribution is rolled over to an eligible plan the amount will not be taxed until a distribution occurs from the rollover account. Unlike IRAs and other employer plans, the distribution is not subject to the 10% premature distribution tax if the participant is under age 59 ½.

Employees may receive a distribution from a 457(b) plan while still employed, but only limited circumstances.  This includes:

• Unforeseeable Emergency Distributions;
• A one time in-service distribution of a low balance; and
• Qualified Hurricane Distributions.

Unforeseeable Emergencies

The term unforeseeable emergency is defined as a severe financial hardship to the participant, resulting from a sudden and unexpected illness or accident to the participant, or a dependent of the Participant. It also includes any loss of the participant's property due to casualty or other event beyond the participant's control.

A distribution may not be made to the extent that relief is available through insurance or other reimbursement, reasonable liquidation of other of the participant's assets, or cessation of plan deferrals.

Final regulations confirm that the purchase of a home or payment of tuition are not financial hardships and therefore, are not considered unforeseeable emergencies.

The 2002 final regulations did expand the definition of Unforeseeable Emergency to include:

• Imminent foreclosure of, or eviction from, a participant’s or beneficiary’s primary residence;
• The need to pay for medical expenses (including non-refundable deductibles and prescription medicine);
• The need to pay funeral expenses for a family member; and
• On account of financial hardship of a participant or beneficiary.

In addition, the final regulations added a definition of “family member” for purposes of the unforeseeable emergency rule to include the participant’s spouse or a dependent of the participant.

Under the Pension Protection Act of 2006, a Participant’s beneficiary may also qualify for an unforeseeable emergency effective for distribution made after 12/31/06.  

A one time in-service distributions of a small balance

Effective for tax years beginning after 12/31/96, certain "in-service" distributions are permitted to be made from 457(b) plans. This type of distribution is permitted without the existence of a financial hardship.

In-service distributions are not treated as "made available" if:

1. the total amount payable doesn't exceed $5,000;
2. the amount is payable only if no amount has been deferred under the plan with respect to the account for the two-year period ending on the date of distribution;
3. the amount is payable only if there has been no prior distribution under this cash-out rule; and
4. only one such in-service distribution is given to each participant.

Note: For Plan Years beginning after 8/5/97, the $3,500 was increased to $5,000.

Below we have reprinted the most frequently asked Questions and Answers to assist Plan Participants in understanding their 457(b) Plan benefits. 

What is a 457(b) Plan?           

A 457(b) plan is a nonqualified deferred compensation plan that may be established by a state, political subdivision of a state (including cities, counties, boroughs, and school districts). A 457(b) plan may also be adopted by certain tax-exempt organizations where only highly compensated employees are participating. These plans are also referred to “eligible 457(b) plans”.

How much may I contribute to my Plan?

The elective deferral limit for §457(b) Plans increased from its 2001limit of $8,500 to the following:

Year	Increased Deferral Limit
2002	$11,000
2003	$12,000
2004	$13,000
2005	$14,000
2006	$15,000
2007	$15,500
2008	$15,500

After 2006, the elective deferral dollar limit will then be increased for Cost of Living Adjustments in increments of $500.

The special “catch-up” rule maximum for years after 2001 has increased by doubling the normal deferral limit applicable in the 3 years prior to your normal retirement age. However, if you are age 50 or older, see the coordination in Q & A 3 below.

If your employer also maintains another plan, such as a 403(b), your contributions under the 457 plan are generally not reduced. For example, if you participate in both a 457 and a 403(b) of your employer, for calendar year 2008 you may defer from your salary up to $15,500 into the 457 and an additional $15,500 into a 403(b), assuming your salary is at least $31,000 for the year. The special 457(b) Catch-up is a true catch-up, in other words you must determine the difference between how much you were entitled to contribute for past years and how much you actually contributed for those past years.

If I am age 50 or older by 12/31 of any year, can I contribute under the new “Age 50 Catch-up” provision?

            Yes. If you will attain the age of 50 or older by the end of the tax year, and you work for a state or local government employer, you may defer an additional amount into the 457(b) Plan. However, if you are also eligible to contribute under the “special” catch-up for the 3 years prior to your normal retirement age, you may only defer the greater of:

1. The amount of the Age 50 Catch-up for the year; or
2. The amount eligible under the 3-Year “special” Catch-up.

Age 50 catch-up contributions are not subject to any other limitations. The allowable amount of your catch-up depends on the year you are contributing for as follows:

Year	Catch-Up Amount
2002	$1,000
2003	$2,000
2004	$3,000
2005	$4,000
2006	$5,000
2007	$5,000
2008	$5,000

After 2006, the Catch-up deferral dollar limit will then be increased for COLAs (Cost of Living Adjustments) in increments of $500.

When can I withdraw from my 457(b) plan account?

Generally, you may not withdraw from your 457(b) account prior to attaining age 70 1/2 except for the following reasons:

• Severance from Employment;
• Incurring an "unforeseeable emergency";
• Death; or
• Plan termination by your employer.

How may I take distributions from the Plan?

            Distributions may begin after the later of severance from employment or after attaining the normal retirement age. You may elect to receive your distributions in a single sum payment or in installments such as monthly or quarterly payments. You also may elect a rollover to another eligible plan. If your employer’s plan permits you may delay receiving your 457(b) account after severance from employment, but you must begin to receive minimum distributions once you attain the age of 70 ½.  

What happens if I change employers?

            If your new employer also maintains a 457(b) plan, you may arrange a transfer from your prior employer's plan to the new plan. Your employers must be in the same State and both plans must be maintained by the same type of employer. For example, if your current employer is a local government, you may only transfer to another state or local government’s plan, not to a tax-exempt employer’s plan. Check with your employer(s) to make sure such transfers are permitted under both plans.

Can I rollover my 457(b) plan distribution to an IRA?

            Yes. For distributions made after December 31, 2001, amounts you receive from a state or local government 457(b) plan may be rolled over to an IRA or another employer plan that accepts rollover. Due to the eligible rollover rules becoming very complex beginning in 2002, you should first check with your tax advisor prior to receiving a distribution from your 457(b) plan. Beginning in 2007, a non-spouse beneficiary may roll to an “inherited IRA”.

How will I be taxed on the income I receive at retirement?

Distributions will be treated as ordinary income for the year in which the funds are distributed or made available to you. If payments are taken in installments, only the amount withdrawn is taxed. The remainder of your account will continue to grow tax-deferred until distributed. If you rollover your distribution to an eligible plan you will not be taxed until a distribution occurs from the rollover account. Unlike IRAs and other employer plans, your distribution is not subject to the 10% premature distribution tax if you are under age 59 ½.

Transfers Permitted After 2001 to Purchase Service Credits

Governmental 457(b) plans may permit employees to transfer amounts to governmental Defined Benefit Plans to purchase service credits. No distributable event is required for such transfers, and there are no reporting requirements.  These transfers were required to be made within the same state, until the final regulations were issued in 2004.

The Pension Protection Act of 2006 expanded the permissive service credit rules to include service credit relating to benefits to which the participant is “not otherwise entitled” under the governmental plan. Specifically, this includes credit for periods where no performance of service was provided, such as a sabbatical. 

The new law also clarifies that “participants” are eligible for credits, as opposed to “current employees”. This provision is retroactive to years beginning after 12/31/97.

Important Tax Credits are Available for Certain Participants who Defer

Effective for tax years beginning after 12/31/01, certain individuals may receive a tax credit for a percentage of contributions made to a traditional IRA, Roth IRA, and elective deferrals made to a 457(b), 403(b) and 401(k) plan. The eligibility requirements are as follows:

• Individual must be 18 years of age or older.
• May not be a full time student or be claimed as a dependent on another taxpayer’s tax return.
• The amount of the credit is reduced by any distribution taken from the plan (or account) during the same year as the credit.
• Credit rates are based on AGI levels as outlined below (Updated for 2008 cost-of-living adjustments).

Joint Filers	Heads of Household	All other Filers*	Credit Rate
$0- $30,999.99	$0-$23,249.99	$0-$14,999.99	50%
$31,000-$33,999.99	$23,250 - $25,499.99	$15,000 - $16,999.99	20%
$34,000 - $51,999.99	$25,500 - $38,999.99	$17,000 - $25,999.99	10%
Over $52,000	Over $39,000	Over $ 26,000	0%

*This column includes single filers and married filers filing separately

Congress created Internal Revenue Code Section 457 in 1978 in order to provide certainty with respect to unfunded deferred compensation plans maintained by state and local governments and to preclude the application of the constructive receipt of contributions under such plans. TRA '86 extended the limitations and restrictions applicable to unfunded deferred compensation plans of state and local governments to unfunded deferred compensation plans maintained by nongovernmental tax-exempt organizations. Plans established under Section 457(b) are also referred to as "eligible deferred compensation plans".

The Economic Growth Tax Relief & Reconciliation Act of 2001 (EGTRRA) made major changes to 457 plans effective with the 2002 tax year. Most of the changes affected governmental 457(b) plans. For example, rollovers are now permitted to traditional IRAs, reporting is done on a Form 1099-R, the required minimum distribution rules at 70 ½ and death apply, and so on.

On May 8, 2002, the IRS issued proposed regulations under section 457 of the Code that were subsequently finalized in 2004. These regulations focus on 457(b) plans for state and local governments and tax-exempt organizations. The regulations are effective for years beginning

after December 31, 2001; however, adoption of plan amendments for 457 plans was not required until the end of the 2005 Plan Year.

Loss of Deferred Status

If the 457(b) plan fails to satisfy the regulatory requirements, it will be treated as an ineligible plan as of the first day of the plan year which begins more than 180 days after the employer receives written notification of the plan's inconsistency, unless the inconsistency is cured before that time. 

Establishing the Eligible 457(b) Plan

Once an eligible employer has decided to establish a 457 plan, various steps must be taken to adopt the plan. The first step is to determine if any constraints exist under the State law.

The plan provisions that are adopted must meet the requirements of Section 457(b) of the Code and the regulations thereunder.  The employer should also arrange for administration of a governmental 457(b) plan including:

1. Accounting for investments;
2. accounting for each participant's interest;
3. reporting distributions on Form 1099-R (for distributions after 12/31/01); and
4. providing the 402(f) Notice to participants who receive a distribution from the plan after 12/31/01.

In addition to the 457(b) plan itself, the following forms, policies and procedures should be drafted for the employer:

1. An Election to Participate and Defer Compensation Form;
2. A Beneficiary Designation Form;
3. A Distribution Request Form;
4. Loan Policies, if applicable;
5. Unforeseeable Emergency Procedure;
6. QDRO policies and procedures;
7. 402(f) Rollover Notice; and
8. Required Minimum Distribution Calculation/Forms

Like other retirement plans it is important for the Employer, or their third party administrator to keep track of the different sources of money in the 457(b) governmental Plan. The types of monies that may be contributed or transferred or rolled over into the plan include:

• Salary Deferral contributions (limited to $15,500 for 2008, unless a catch-up rule applies);
• Employer non-elective and/or employer match (counted as part of the $15,500 indicated above);
• Transfer contributions from other 457(b) Plans; and
• Rollovers from other Plans. 

Rollovers to a Governmental 457(b) Plan

A governmental 457(b) plan may accept rollovers from other plans (IRA, QP, 403(b), another 457(b)), but only if the amounts are separately accounted for. The final regulations allow a 457(b) plan to maintain a single rollover account for all types of rollovers into the 457(b) plan. In the alternative, a 457 plan may choose to establish 3 accounts – one for the deferral amounts under the 457 plan, one for rollovers from other 457 plans, and another for the rollover amounts from a QP, IRA and 403(b) plan. The final regulations also allow the plan to indicate “ordering rules” for purposes of distributions. 

Are Participant Directed Investment Permitted?

Participants may investments under the plan if the plan permits. The plan may also provide for the selection of investment types for the investment of deferred amounts both before and after payments have begun.

Participant direction is a permissive feature; however, for a state or local government employer's eligible plan, many state laws require participant-directed investments.

Fiduciaries of 457(g) trusts are not subject to ERISA. Governmental plans are not subject to any of the provisions of Title I of ERISA.  The identity and conduct of any plan fiduciaries are governed solely by state law (including the trust document).

What Types of Investments are Permitted?

For a 457(b) deferred compensation plan of a nongovernmental employer (a tax-exempt employer), any investment the employer permits can be used for the plan. For a 457(b) deferred compensation plan of a state or local government employer, state law will regulate what investments may be held for the plan. Frequently, the types of permitted investments are specified by the state's enabling statute. Unlike past years, it is rare for a state to limit the types of investments permitted.

Loss of Deferred Status

If the 457(b) plan fails to satisfy the regulatory requirements, it will be treated as an ineligible plan (457(f)) as of the first day of the plan year which begins more than 180 days after the employer receives written notification of the plan's inconsistency, unless the inconsistency is cured before that time. This means that the assets will be immediately taxed in most cases to the participants under the Plan.

Correction under the IRS’ EPCRS

In 2004, the preamble to the 457 plan regulations requested comments on how the correction procedures currently in place for qualified plans and 403(b) may be expanded to cover 457(b) plans. To date this has not been done, however until such time that the EPCRS is updated to cover 457(b) plan failures, the IRS has indicated that they will accept submissions of failures outside of EPCRS on a provisional basis based on the same criteria as EPCRS for an other