Untitled Document

Commentary

403(b) Plan and 457 Plan: Perfect Together
Sample Article from the Winter 2003 Edition of 403(b) Perspectives Newsletter
Rev. 03-28-03

As a result of recent changes in the tax law made by EGTRRA, many 403(b) plan sponsors are supplementing their existing tax sheltered annuity plans with 457 plans. The results are significant tax savings and retirement accumulation opportunities for employees who participate in the two plans. What's more, the IRS released regulations with respect to 457 plans giving practitioners much needed guidance with respect to 457 plan design and administration. As a result, 457 plans have become more attractive than ever before. McKay Hochman makes it easy for you to get involved in the 457 market by offering an eligible 457 plan document, governmental and non-governmental adoption agreements and administrative forms including a Summary Plan Description and required registration materials. A 457 plan is a non-qualified, tax-deferred plan of deferred compensation. There are two general categories of 457 plans: eligible plans as described in Code Section 457(b) and ineligible plans as described in Code Section 457(f). Eligible 457 plans can only be sponsored by “eligible employers”. For this purpose, the term eligible employer is limited to governmental entities and not-for-profit organizations. Both governmental and tax-exempt 457 plan sponsors are governed by Code Section 457(b) however, the rules for governmental 457 plans are more restrictive and tend to more closely mirror the rules that apply to qualified retirement plans. Many of the recent changes to the tax law (for example the increased portability) apply only to governmental 457 plans. The Economic Growth and Tax-Relief Reconciliation Act of 2001 (EGTRRA) made several changes to the rules governing eligible 457 plans. The most significant of these changes is that Employees can contribute the maximum elective deferral limit to both a 457 plan as well as a 403(b) [or 401(k)] program. Section 457 plans have many other attractive design features. For example:
	»	Special catch-up provisions apply to 457 plans that permit the employee to double-up deferrals in the three years before retirement. This special catch-up rule is designed to permit an employee to make-up for years during which he or she did not maximize deferrals. It applies in addition to the otherwise applicable catch-up provision that would apply to a 403(b) plan, although a participant can not use both the special 457 catch-up and the otherwise applicable EGTRRA catch-up in the 457 plan within the same plan year. The participant could however use the 457 catch-up in the 457 plan and the EGTRRA catch-up in a 403(b) plan.
	»	Special catch-up provisions apply to 457 plans that permit the employee to double-up deferrals in the three years before retirement. This special catch-up rule is designed to permit an employee to make-up for years during which he or she did not maximize deferrals. It applies in addition to the otherwise applicable catch-up provision that would apply to a 403(b) plan, although a participant can not use both the special 457 catch-up and the otherwise applicable EGTRRA catch-up in the 457 plan within the same plan year. The participant could however use the 457 catch-up in the 457 plan and the EGTRRA catch-up in a 403(b) plan.
	»	457 plan withdrawals are available at any time after severance from employment with special rules in the case of financial emergencies. Code Section 457 refers to these as “unforeseeable emergencies” and limits distributions of this nature to severe financial hardships resulting from a sudden unexpected illness or accident of the Participant or a dependent of the Participant, loss of the Participant's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant. This definition is far more restrictive than the standard 401(k) hardship definition.
	»	457 plans are exempt from the 10% premature distribution penalty for distributions made prior to age 59-1/2.
	»	In governmental 457 plans, distributions can be rolled over to an IRA, another 457, a 403(b) program or a 401(a)/(k) plan of a new employer.
	»	457 plans offer broader eligible participation definition that includes non-traditional employees and independent contractors.
	»	There are no coverage or nondiscrimination rules with respect to 457 plans. This allows the plan sponsor to design the plan to benefit certain targeted employees.
Unlike 403(b) plans that are often designed as individual arrangements between the investment company and the plan participant, 457 plans are employer sponsored. This means that in order for employees to take advantage of the additional deferral opportunities, the employer must adopt a 457 plan. The rules that apply to governmental 457 plans differ from those that apply to tax-exempt employers. For example, governmental plans are required to maintain assets in a trust. In addition, the more liberal rollover rules that permit portability between all types of retirement plans that was added by EGTRRA only apply to governmental 457 plans and while the new 457 regulations permit plan loans in 457 plans, according to the new regulations, this appears only to apply to governmental 457 plans. Tax-exempt 457 plans have to be designed in a manner that avoids the plan from being subject to ERISA. As a result, tax-exempt 457 plans are prohibited from holding the assets in trust and must limit participation to a select group of management and highly compensated employees. In a tax-exempt 457 plan the funds remain part of employer's general assets and are subject to the claims of the employer's general creditors. A rabbi trust could be used for funding purposes provided the funds remained subject to the Employer's general creditors. Section 457 plans offer many attractive design opportunities especially when used as a supplemental plan. The combination of employee deferrals and employer contributions is limited to the lesser of the applicable 402(g) limit ($12,000 for 2003) or 100% of compensation. For example, if a plan was drafted to include these special catch-up rules and a worker was going to attain normal retirement age in 2009, he or she would be able to take advantage of the special catch-up rules in 2006, 2007, and 2008 provided the employee had underutilized the ability to defer in prior years. Section 457 plan administration is relatively minimal. Contributions and distributions must be processed. Governmental plans are exempt from ERISA's reporting and disclosure obligations, tax exempt plans are exempt from reporting and disclosure provided they register the plan at the plan's inception. In general, this involves obtaining a Top Hat Plan Exemption from the Pension and Welfare Benefits Administration as required by DOL Reg § 2520.104-23(c). The plan administrator obtains the exemption on behalf of plan merely by filing a notice specifically stating that it is intended that the plan qualify for ERISA's limited reporting and disclosure requirements. The notice should include the employer's name and address; the employer's identification number (EIN) and a statement that the employer maintains this plan primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. The group for whom the plan is intended to benefit should be identified as well as the number of employees covered. While a timely notice will exempt the plan for all future reporting and disclosure, the plan sponsor must make plan records available for inspection by the PWBA. The timing of this notification should be within 120 days of the date the plan is adopted. Section 457 plans are a very attractive design opportunity for the not-for-profit and governmental sectors of the marketplace. It is likely that a good portion of your existing 403(b) clients will want to consider adopting a supplemental 457 plan.

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