Section 457 of the IRS Code provides rules that allow certain federally tax exempt governmental organizations to sponsor a non-qualified plan whereby employees can defer a portion of their compensation for the future (i.e. retirement). This is a significant benefit opportunity that should be utilized to the maximum by all eligible people.
The types of governmental organizations include a state, city, township, state agencies or political subdivision of a state such as a school district and any organization exempt from federal income tax except for a church or synagogue or any organizations they control. Non-profit educational organizations are eligible for Tax Sheltered Annuities - a similar type of deferred retirement plan.
EMPLOYEE CONTRIBUTIONS
Contributions are generally made through payroll deduction on a before-tax basis although the amount of employee social security taxes (FICA), which must be withheld, are not affected. For years beginning after December 31, 2001, a participant may defer no more than the lesser of (1) 100% of includable compensation; or (2) the applicable dollar limit. The dollar limit is $12,000 in 2003, $13,000 in 2004, $14,000 in 2005, and $15,000 in 2006. Cost-of-living adjustments will be made in $500 increments thereafter.
For years beginning before January 1, 2002, a participant could defer no more than the lesser of (1) 33 1/3% of includable compensation; or (2) $8,500 (in 2001, as indexed) under an eligible 457 plan.
Also for years beginning after December 31, 2001, the contribution limits under IRC Section 457 no longer need to be coordinated with the limits on elective deferrals under IRC Sections 401(k) and 403(b).
CATCH-UP PROVISIONS
For years beginning after December 31, 2001 a new catch-up rule applies for eligible 457 plans of governmental employers. Additional contributions are allowed for participants who have attained age 50 by the end of the plan year. This additional amount is the lesser of (1) the applicable dollar amount; or (2) the participant’s compensation, reduced by the amount of any other elective deferrals that the participant made for that year.
The applicable dollar amount for eligible 457 plans is as follows:
2003 - $2,000
2004 - $3,000
2005 - $4,000
2006 - $5,000
For years beginning after 2006, the $5,000 limit will be indexed for inflation.
The new catch-up rule does not apply during a participant’s last three years before retirement. During those years, the limit on deferrals is increased to the lesser of (1) twice the amount of the regularly applicable dollar limit; or (2) the sum of: (a) the otherwise applicable limit for the year, plus (b) the amount by which the applicable limit in preceding years exceeded the participant’s actual deferral for those years.
FUND ACCUMULATIONS
The investment choices available vary with each employer and generally include a choice between various mutual funds, annuities and/or bank account options. Specific information should be obtained from each employer. All plan contributions grow tax deferred until withdrawn.
WITHDRAWING THE BENEFITS
Withdrawals from the plan cannot be made unless an employee is age 70 ½, separates from service, dies, or has an “unforeseen emergency.” This means an employee must take the funds when they quit and will be taxed on the account value at that time unless they roll the 457 amount over to another 457 deferred compensation plan or other qualified plan at a new employer.
Distributions must begin no later than April 1st of the calendar year after the year in which the plan participant attains age 70 ½. Minimum distributions must be made under the same rules of Code Section 401(a)(9) that apply to other retirement plans or annuities.
EMERGENCY WITHDRAWALS
IRS regulations define an “unforeseen emergency” as a severe financial hardship resulting from a sudden event beyond the control of the participant. This might include an unexpected illness or accident of the participant or a dependent. It could also include a loss of property due to a casualty such as a fire or tornado. The purchase of a residence or college education of children is not considered an unforeseen emergency.
SURVIVOR BENEFITS
Distributions at death are made to beneficiaries designated by the plan participant. Distributions at death are also taxable to the beneficiary, just as they would have been to the employee during retirement.
Source: Tax Facts 2007, National Underwriter Company
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