By M. Kristi Cook, TGPC
403(b) and 457(b) plans are essentially the same marketplace and client base with the same issues. So it’s easy to use the skills you’ve learned in one to master the other.
In our marketplace, there are several types of plans available for accumulation of retirement funds or deferral of current compensation. While we’re most familiar with 403(b) plans, there are many opportunities for savvy financial advisors who understand how to work with 457(b) plans.
The first step in preparing for success when working with 457(b) plans is understanding that different rules apply based on the type of employer sponsoring the 457(b) plan. Plans sponsored by governmental employers are similar to retirement plans and have provisions that 403(b) advisors are more familiar with, such as rollovers, aged 50+ catch-ups on deferrals, loans and correction of excess contributions by refunding the excess. 457(b) plans sponsored by tax-exempt organizations, however, are not permitted to include these features and may be more restrictive than 403(b) advisors are aware. Thus, advisors are first cautioned to learn the rules applicable to the plans offered in the marketplace(s) in which the advisors intend to succeed. NTSAA’s publication The Source, 403(b) & 457(b) Plans, 3rd Edition is an excellent resource for this purpose and can be ordered online by clicking this link.
Assuming that you’ve mastered the rules and selected the marketplace(s) in which you want to work, you should consider the following opportunities that are unique to 457(b) plans:
1.) Younger employees. Because the IRC §72(t) early distribution tax does not apply to 457(b) plans, younger employees are more willing to make 457(b) contributions since future withdrawals would not be subject to the mandatory 10 penalty tax. If they leave their employer at any age, there is no penalty tax.
2.) Early retirees. Similarly, 457(b) plans are excellent vessels for early retirement plan contributions where payments are distributed before age 59½. Retirees would have access to their incentive funds without a penalty tax reduction.
3.) Double deferrals. Because the contribution limits in 457(b) plans are technically not subject to the contribution limitations of IRC §402(g), participants may defer the full deferral limits in the 457(b) plan ($16,500). If the participant is also eligible to participate in a 403(b) plan, the individual may contribute the full deferral limit into the 403(b) plan ($16,500), for a total of $33,000 in 2011. There is no offset on the contribution limits between 457(b) plans and any retirement plan.
4.) Double catch-up for governmental plans. If the individual is a participant in a governmental 457(b) plan, then the aged 50+ catchup is also available in the 457(b) plan and also in any other type of plan the employer may sponsor, such as a 403(b) or 401(k) plan.
To illustrate how this may work, assume that the superintendent of Lucky School District wants to maximize her deferrals in 2011. She’s 52 years of age and her salary for 2011 is $180,000. The district’s plan document permits aged 50+ catch-up contributions, but does not permit the 15 years of service catch-up. What is the most she can defer into the district’s 403(b) and 457(b) plans in 2011?
Since she’s at least aged 50, she can defer $22,000 ($16,500 + $5,500) into her 403(b) account under the district’s 403(b) plan. Because there’s no offset rule between 457(b) plans and retirement plans, she can defer the same amount into her account under the district’s 457(b) plan for a total of $44,000 in deferrals in 2011. Note that aged 50+ catch-up contributions are not available in 457(b) plans sponsored by tax-exempt organizations (nongovernmental).
5.) Discriminatory benefits permitted. Contributions to 457(b) plans are not subject to nondiscrimination testing. Therefore, employers may make contributions for selected employees without violating discrimination standards. In fact, 457(b) plans of tax-exempt organizations must discriminate in favor of key management personnel and highly compensated employees, making 457(b) plans an excellent tool for providing special benefits to this select group of employees.
A special provision under ERISA requires tax-exempt employers sponsoring 457(b) plans to exclude all employees except those included in a “top hat” group. Accordingly, where the employer’s regular retirement program may not provide a sufficient benefit to executives and selected management staff, a 457(b) plan may be used to provide a discretionary or discriminatory supplemental benefit without violating nondiscrimination testing standards.
6.) Roth contributions. The Small Business Jobs Act of 2010 permitted governmental 457(b) plans to include Roth contributions beginning on January 1, 2011. Similarly, Roth conversion features may also be included in a 457(b) plan, although the conversion features may not yet be included in many documents as employers await further IRS guidance.
Like the Roth opportunities in a 403(b) or 401(k) plan, participants may make Roth contributions without regard to their annual compensation, and participants may contribute pre-tax and Roth 457(b) contributions that, in the aggregate, do not exceed the annual contribution limits described in items 3 and 4 above ($16,500 for 2011 + aged 50+ catch-up for governmental plans). Many participants are making pre-tax contributions in one type of plan and Roth contributions into the other type of plan because there are no offset rules between 457(b) plans and other types of retirement plans.
Once you’ve identified your marketplace and gained the basic technical skills necessary to be competent in it, you need to identify which products you plan to use and understand how they work so you can figure out which opportunities offer the best chance for success. You can use your experience mastering 403(b) relationships to find and develop 457(b) opportunities. It’s the same marketplace, the same client base, and they have the same issues. You now have an additional option and answer.
M. Kristi Cook, TGPC, is an attorney specializing in benefit programs for tax-exempt and governmental employers. She works in Jenkintown, Pa.