The Uniqueness of 457 Deferred Compensation Plans
A deferred compensation plan is a type of retirement savings vehicle that is available for government employees. These plans are also known as 457 plans because that is the section of the IRS code that establishes them. All contributions to these plans are done at the discretion of the employee through payroll deferrals. Employee deferrals are the sole source of funding for these accounts. Pre-tax contributions will grow on a tax deferred basis similar to a 401k and are subject to the same maximum contribution limit of $19,000 (plus $6,000 if the employee is over age 50) for 2019. Roth contributions effective January 1, 2011 are also allowed to 457 plans. In addition, once retired, 457 plans can also be rolled into other types of retirement plans such as IRAs but that is where most mistakes happen with deferred compensation plans.
Deferred compensation plans have different features from traditional retirement accounts like IRA’s or 401K’s. The most significant difference is that deferred compensation plans have no 10% penalty for early withdrawal regardless of age. Consequently, you can take distributions from a deferred compensation account and simply pay only the applicable taxes. This is a major advantage and incentive for employees to put some of their paycheck into such accounts over their working years. Having a deferred compensation account gives one a resource to use in retirement without having to worry about an extra 10% tax penalty. In addition, access to the monies in your deferred compensation account is usually available within less than a month after your final day of work. This feature particularly helps retirees under the FRS Investment Plan who have timing issues in accessing their monies.
One of the biggest mistakes retirees can make is to roll their deferred compensation account over to an IRA. Once that money is in an IRA, then the rules of an IRA, particularly those that impose a 10% tax penalty, apply. FRS members should only roll their deferred compensation accounts over once they have passed age 59 ½ when there is no risk of any penalty regardless of the type of account their money is in.