FINAL 457
REGULATIONS HIGHLIGHT DIFFERENCES
IN GOVERNMENTS AND
TAX-EXEMPTS
Prepared
By: Patricia K. Keesler
Benefits
Law Group
Atlanta, Georgia
On July 11, 2003, the Internal Revenue Service issued final regulations on deferred compensation plans of state and local governments and tax-exempt entities. These regulations incorporate all the legislative changes made to Section 457 of the Internal Revenue Code since the Tax Reform Act of 1986. The regulations also highlight the differences between deferred compensation plans sponsored by state and local governments and deferred compensation plans sponsored by tax-exempt entities. This article will examine both the differences and similarities in those plans.
Both government entities and tax-exempt employers are eligible to provide section 457(b) plans to employees to enable them to defer a portion of their pay until a later date. The money grows on a tax-deferred basis. State and local governments may offer section 457(b) plans to all employees and all plan assets must be placed in trust. Section 457(b) plans sponsored by tax-exempt entities, however, may be offered only to upper management and highly paid employees and plan assets may not be set aside in a trust. Those assets must remain as general assets of the employer, subject to the creditors in the event of bankruptcy.
While the increased limits on deferrals apply to plans sponsored by both governments and tax-exempt entities ($12,000 in 2003) the catch-up contribution rules for employees who are age 50 or older enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) do not apply to participants in plans sponsored by tax-exempt entities. On the other hand, the “other” pre-EGTRAA catch-up contribution, for participants who are within 3 years of retirement, applies to plans sponsored by both governments and tax-exempt entities. (In the case of government plan, however, the two catch up provisions cannot be used in the same year.)
The final regulations include a self-correction mechanism for excess deferrals under section 457(b). Under the proposed regulations, only government plans could self-correct excess deferrals by distributing them. Excess deferrals under plans sponsored by tax-exempt entities would have resulted in the plan being treated as an ineligible section 457(f) plan, which could require immediate taxation of all amounts in the account of the participant with the excess. However, the final regulations extend self-correction to excess deferrals of plans sponsored by tax-exempt entities so long as any excess is distributed by April 15 th of the year following the year of the excess.
New rules related to plan distributions enacted under EGTRRA apply exclusively to government-sponsored 457 plans. Distributions from government-sponsored plans are treated similarly to distributions from 401(k) plans and can be rolled into an IRA or other qualified plan. Distributions from plans sponsored by tax-exempt entities are still treated as W-2 compensation and cannot be rolled into an IRA or other qualified plan.
The most appealing aspect of section 457(b) plans since the EGTRAA changes were enacted applies equally to government and tax-exempt sponsored plans. That is, there is no required coordination of the deferral limits between section 457(b) plans the 401(k) or 403(b) plans. Therefore, both governments and tax-exempt entities can offer a section 401(k) or 403(b) plan (as appropriate) in addition to a 457(b) plan, thus enabling an employee to defer up to the limit under both plans. In 2003 that means a total of $24,000 deferral is possible for employees under age 50.