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.
The FRS Investment Plan option started in 2002. The Investment Plan is a defined contribution plan in which employer contributions are a set amount as defined by law. The period of time in which the Investment Plan monies actually become yours or vest is only one year. The 3% employee contribution is still required but those monies go directly to your own personal Investment Plan account rather than to the general FRS fund. The amount of your retirement income depends directly on the performance of your Investment Plan account balance. Unlike the FRS Pension Plan, there is no fixed benefit level at retirement with the Investment Plan.
The Investment Plan is funded through defined employer contribution rates based upon your salary and your FRS membership class. The contribution rates are currently at 6% for regular class and 15% for special risk class which include the mandatory 3% employee contribution. These contributions are made every pay period to your own personal Investment Plan account. Prior to July 1, 2012, these contributions were 30% higher but this reduction occurred to level the Investment Plan benefits with prior cuts that were made in 2011 to the FRS Pension Plan benefits. Regardless, it is disappointing to have any cuts to contribution rates especially in this time of stagnant salaries.
In addition, these cuts in the contribution rates often mean that the timing of any decision to switch from the Pension Plan to the Investment Plan should be carefully considered. The second choice service on www.myfrs.com allows you to calculate different scenarios for when your lump sum balance is maximized. Often this occurs after you have completed your required years of service for full retirement (i.e. 25 years as special risk and 30 years as regular class for those hired prior to July 1, 2011). After that, if you are still working, the lump sum benefit amount does not increase that much at all. The other alternative is to choose the Investment Plan at the inception of your career with the state. We often see examples where this leads to a greater amount of money than the lump sum amount available on a subsequent conversion from the Pension Plan.
The Investment Plan contributions are sent to your personal account within the FRS Investment Plan. Within this account, there are only 21 different investment choices (10 of which are target date funds) to invest your contributions. While these choices are somewhat limited in number, there are some worthwhile investment options. We monitor the performance of the investment options we recommend within the FRS Investment Plan and let you know if any changes are warranted through our regular correspondence. Remember the overall balance in one’s FRS Investment Plan account is solely dependent on how your underlying investments perform.
In addition, when you retire, this account needs to follow a growth and income approach to provide you with a monthly retirement benefit like what you would have gotten under the Pension Plan. This means that you cannot treat the Investment Plan like a cookie jar in retirement by taking chunks out of the balance. The objective with the Investment Plan balance is to generate a regular monthly income by using a diversified and properly allocated investment approach. This is where our firm provides its greatest assistance to state employees by working together at retirement to establish a financial plan for the rest of their lives.
In summary, the Investment Plan provides you an option to personally control your retirement monies. Your years of FRS service are represented entirely in a cash value lump sum. The beneficiaries of this lump sum can be your spouse or children when you pass. However, this lump sum must be used to generate your retirement income. It does not come with any guaranteed benefit like the Pension Plan. For a more complete description of the FRS Investment Plan, please refer to the Summary Plan Description of the FRS Investment Plan prepared by the State of Florida Division of Retirement located within www.myfrs.com.
For a complete comparison of the advantages and disadvantages of these FRS options, please refer to FRS Plans Advantages and Disadvantages prepared by the State of Florida Division of Retirement at www.myfrs.com. In addition, we are here to meet with state employees at any time at no charge to discuss these options.