What Is a 457(b) Deferred Compensation Plan?
A 457(b) Deferred Compensation plan is an employer sponsored plan that allows employees to deduct pre-tax dollars from their paychecks and contribute the monies into a retirement savings plan. The 457(b) plans pre-tax status is similar to the traditionally offered 403(b) retirement savings plan. 457(b) plans are eligible governmental supplemental retirement plans and as such, are not subject to qualified plan distribution rules.
Plans of deferred compensation described in IRC section 457 are available for certain state and local governments and non-governmental entities tax exempt under IRC 501. They can be either eligible plans under IRC 457(b) or ineligible plans under IRC 457(f). Plans eligible under 457(b) allow employees of sponsoring organizations to defer income taxation on retirement savings into future years. Ineligible plans may trigger different tax treatment under IRC 457(f).
Who can establish a 457(b) plan?
The organization must be a state or local government or a tax-exempt organization under IRC 501(c).
How do 457(b) plans work?
Employers or employees through salary reductions contribute up to the IRC 402(g) limit, $18,000 in 2016 on behalf of participants under the plan.
What are the advantages of participating in a 457(b) plan?
There are significant tax advantages for participants in a 457(b) plan:
- Contributions to a 457(b) plan are tax-deferred.
- Liquidity at any age; only qualifying event is separation from service
457 Plan Unforeseeable Emergency Rules
First and foremost, tax deferred savings plans such as 403(b)s, 401(k)s and 457s are designed to allow employees to save money for retirement while employed. They are considered long term investments and the IRS have imposed restrictions in the form of stiff penalties to discourage employees from accessing the funds in the account before retirement which are commonly called an “early or premature distribution”.
Generally, benefits cannot be made available to a participant unless the participant has experienced one of the following events:
- Severance from employment
- Attainment of age 70 ½
- The plan is terminated, or
- An unforeseeable emergency
Note that an “unforeseeable emergency” under 457 Plan is very different than a “financial hardship” under 403(b). By its very terms, the emergency must be unexpected and unanticipated. College tuition or the purchase of a new home are neither unexpected, nor unanticipated and would not be acceptable reason for distribution from a 457 Plan.
The IRS defines an “unforeseeable emergency” to be a severe financial hardship to the participant resulting from at least one of the following:
- A sudden and unexpected illness or accident experienced by the participant or participant’s dependents;
- A casualty loss to the participant’s property not otherwise covered by insurance;
- Imminent foreclosure of or eviction from participant’s primary residence;
- Medical expenses not reimbursed from other sources;
- Funeral expenses of a family member or;
- Any other extraordinary AND unforeseeable circumstances that arise as a result of events beyond the participant’s control.
Proper documentation and Plan Administrator approval are required for 457 unforeseeable emergency distributions.