Updated July 17, 2023
Introduction of 457 Plan
457 plan (also known as a defined contribution retirement plan) is a government-approved & recognized program for retirement benefits of only the eligible employees, wherein an employee makes a fixed contribution during his tenure of employment. Such contribution grows each year with the compounding effect of interest, along with the feature that contributions to such plans are also not taxed.
Explanation
- Everyone wants to save for his future. But due to the hustle of daily work, it may not be possible for a few employees to take out time & invest in a plan that will financially support them at retirement.
- Thus, the government usually comes out with a compulsory investment plan wherein a fixed amount is saved from the earning source, i.e., salary. Such deductions help employees to focus on their expenditures easily.
- So, 457 plans revolve around saving through deduction from salary income per month.
- The plan is offered by state & local governments to their employees and employees of the non-profit organization. Only such employees are eligible to participate in the 457 plan.
- The contributions made are accumulated throughout employment to become massive at the end of tenure.
- Such a plan has an added feature of tax. The withdrawals from the plan at the time of retirement are not taxed. Such exemption forms a retirement-gift gesture from the government.
- Many issues can be addressed with the 457 plan, but we will consider the same in the later part of the article.
Features of 457 Plan
“Feature” means a distinctive attribute or aspect of something. It may be good or bad. So, features suggest specifying the attribute, whether positive or negative. Every plan has some features, and so does; we have an ample number of features plans as follows:
- It is said that the 457 plan has a tax advantage of its own. The contributions made by an employee are not taxed. However, if the same is withdrawn, it is taxable.
- There may be circumstances that the whole of the salary of a person is wholly saved due to his other income. In such a scenario, such an employee can contribute up to 100% of his salary subject to the condition that such contribution should not exceed the applicable dollar limit.
- In exceptional circumstances, employees can make double contributions to get maximum benefits.
- One of the best features is that even non-federal employees can invest in the said plan. Moreover, employees of non-profit organizations are also given the liberty to invest in the said plan.
- The plan allows employees to choose the appropriate investment fund where they want to invest into.
- Also, such plans have the flexibility to transfer the plan from one employer to another. This flexibility happens to be another added feature of the 457 plans.
How Does It Work?
- The eligible employees set aside a specific amount out of their salary periodically to contribute to the plan.
- Employees are offered two plans for 457(b) and 457(f). The maximum contribution limits are annual. Employees cannot contribute over and above the said limits.
- After the contributions are made, the same is transferred to the retirement account of the government.
- The said money grows with the compounding of interest rates. Moreover, such compounding of income is not taxed.
Types of 457 Plan
The different types of 457 plans are explained as follows:
1. 457(b)
- This is a simple & most common 457 plan used across the country.
- Employees of state government, as well as local government, can take advantage of such a plan.
- Moreover, employees of the non-profit organization are also eligible for the plan.
- The revised contribution limit is $ 19500 per employee per annum. This limit is applicable for 2020, with a slight increase of $ 500 compared to 2019. In exceptional cases, this limit is doubled, i.e., $ 39000 per employee per annum. Such an exception is called a double catch-up of the provision of the government. So, a doubling of limits is allowed for employees serving the last three years of their employment service.
2. 457(f)
- This particular plan allowed the government to select non-government employees who have been highly compensated.
- It is easy to administer compared to 457(b) & incurs a lower cost of administration.
- Even employers can contribute to the plan.
- Even in this plan, the employees can contribute up to 100% of their inflow through salary, subject to the maximum cap imposed by the government.
- Further, executives face the risk of a substantial risk of forfeiture.
457 Plan Limits
- As said earlier, the basic limit is $ 19500 per employee per year from 2020, compared to $ 19000 for 2019.
- Thus, the plain text of IRS reads as 100% salary contribution subject to the maximum of the specified limit.
- However, if the age of state or local government employees is 50 or more, they are allowed for catch-up provisions. In such catch-up provisions, the employees are permitted to contribute up to $ 6000 over & above the average annual limit.
- If an employee serves the last three years of employment, he is allowed to contribute double the annual contribution limit.
Advantages of 457 Plan
Some of the advantages are given below:
- The plan’s benefits are extended even to non-federal employees of the country.
- It’s your hard-earned money. So, there is no absolute restriction on withdrawing money at a time during the year. Thus, there is no penalty for early withdrawal as such.
- The plan has a particular focus on employees who are near their retirement age.
- The focus of the government is more & more savings. Thus, the contributions are not taxed.
- This serves the purpose of securing a better future.
- Employees can contribute up to 100% of their salary to the plan.
- One of the best things about 457 plans is the portability of the plan. This means you can transfer your retirement account to the new employer if you have to change the job.
- 457 plans also cover employees of local governments and highly compensated employees.
Disadvantages of 457 Plan
Some of the disadvantages are given below:
- We know there is a dollar cap on the contribution limit for 457 plans. The disadvantage is that the said upper limit also includes the employer’s contribution.
- Since such contributions are compulsory, the real disposable income of employees is reduced currently.
- The withdrawals are allowed only for emergencies which the employees to explain.
- Such plans are non-qualified plans.
Conclusion
The more you invest, the more money flows to the future. Such accumulated money is saved for the future. Also, the government does not tax the contributions made. This makes even the taxation part flexible with time. Thus, tax is deferred through the allowed parameters of government. The said plan is called a non-qualified plan & hence, income retirement income security is not covered here. Thus, such a plan is best suited for employees who have planned for their retirement journey.
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