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Copyright 2009, The National Underwriter Company 1
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
What is it?
A plan designed to comply with IRS Code Section 457, which provides rules for all nonqualified deferred compensation plans of
- governmental units
- governmental agencies
- non-church controlled tax exempt organizations
Copyright 2009, The National Underwriter Company 2
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
When is it indicated?
When
- governmental units
- governmental agencies
- non-church controlled tax exempt organizations
want employees to have a deferred compensation plan
Copyright 2009, The National Underwriter Company 3
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: What employers are covered by Section 457?
1. a state, a political subdivision of a state, and any agency or instrumentality of a state or political subdivision of a state
2. any organization exempt from federal income tax, except for a church or synagogue or an organization controlled by a church or synagogue
Copyright 2009, The National Underwriter Company 4
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Limit on Amount Deferred
Eligible Section 457 plans
– plans include limits on the amounts deferred
– typically cover broad class of employees
– eligible for favorable tax treatment
Copyright 2009, The National Underwriter Company 5
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Limit on Amount Deferred
Ineligible Section 457 plans
– plans provide greater deferral levels than annual dollar limit
– generally designed for executives
– taxed in first year in which no longer ‘substantial risk of forfeiture’
– generally taxable in full no later than the year of the executive’s retirement
Copyright 2009, The National Underwriter Company 6
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Basic limit
for eligible plan, amount deferred annually by participant cannot exceed 100% compensation
Or applicable dollar amount:
2006 $15,000
2007 $15,500
2008 $15,500
2009 $16,500
Copyright 2009, The National Underwriter Company 7
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Limit on Amount Deferred
• Section 457 plans allow ‘double dipping’
salary reduction contributions do not reduce contributions to any other type of salary reduction plans, e.g. Section 403(b) or Section 401(k) plans
• 100% of compensation limit applies to gross compensation before salary reductions
Copyright 2009, The National Underwriter Company 8
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Limit on Amount Deferred
50 or over catch-up provisions
governmental employees can have an additional salary reduction contribution
2006 $5,000
2007 $5,000
2008 $5,000
2009 $5,500
Copyright 2009, The National Underwriter Company 9
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Limit on Amount Deferred
50 or over catch-up provisions (cont’d)
– cannot exceed the excess of the participant’s compensation over all regular elective deferrals
– Section 415 limits (annual additions to participant’s account cannot exceed the lesser of $49,000 (2009) or 100% of compensation) does not limit use of the 50-or-over catch-up
Copyright 2009, The National Underwriter Company 10
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Timing of Salary Reduction Elections
Employee generally must elect to defer compensation under agreement made before compensation earned
e.g. if paid monthly, must enter agreement to defer compensation at beginning of the month
Copyright 2009, The National Underwriter Company 11
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Distribution Requirements
Plan distributions cannot be made before:
1. calendar year in which the participant attains age 70½
2. severance from employment
3. ‘unforeseen emergency’ as defined in regulations
Copyright 2009, The National Underwriter Company 12
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Distribution Requirements
Additional issues:
– in certain situations, participant can receive involuntary cash-out of $5,000
– participant can make on-time election to defer commencement of distributions
Copyright 2009, The National Underwriter Company 13
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Distribution Requirements
Additional issues:
– must comply with minimum distribution rules
– Qualified Domestic Relations Orders follow qualified plan rules
Copyright 2009, The National Underwriter Company 14
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Coverage and Eligibility
Section 457 plans have no specific coverage requirements
– governmental organization can offer to any one or more employees or employee groups
– most private non-governmental organizations may be subject to ERISA eligibility rules
• can avoid if utilize ERISA exemptions
Copyright 2009, The National Underwriter Company 15
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Funding
Nongovernmental tax-exempt organizations
– cannot be funded
– can ‘finance’ the plan with insurance or annuity contracts
– ‘no funding’ of Sec. 457 conflicts with ERISA
Copyright 2009, The National Underwriter Company 16
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Design Features: Funding
Governmental organizations
– - governmental plans MUST be funded
– - plan assets must be in trusts or custodial accounts
Copyright 2009, The National Underwriter Company 17
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Tax Implications
1. sponsoring employer does not pay income tax
2. limited nonrefundable tax credit available to some lower income tax payers
3. if plan permits voluntary employee contributions to ‘deemed’ IRA, amounts so contributed will reduce limit for other traditional or Roth IRA contributions
Copyright 2009, The National Underwriter Company 18
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Tax Implications
4. benefits are taxable
– governmental plan distributions included in income when paid
– non-governmental or tax exempt plan distributions included in income when paid or otherwise made available
Copyright 2009, The National Underwriter Company 19
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Tax Implications
5. Sec. 457 plan distributions no eligible for 10-year averaging for lump sum distributions
6. in certain situations, plan participants can exclude from income amounts directly transferred from a Sec. 457 plan to governmental defined benefit plan
7. certain rollovers permitted
Sec. 457 IRA
Sec. 457 Sec. 457
Copyright 2009, The National Underwriter Company 20
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
ERISA Requirements
Governmental employers and church-related organization are NOT subject to ERISA
Tax-exempt private employers have difficulty with ERISA funding requirements
Copyright 2009, The National Underwriter Company 21
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Alternatives
Tax-exempt employers can adopt
qualified pension and profit sharing plans
Sec. 403(b) plans
Sec. 401(k) plans
SIMPLE IRA
SIMPLE 401(k)
Governmental employers can adopt
governmental pension plans
Copyright 2009, The National Underwriter Company 22
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
True or False?
1. Beth Shalom Synagogue can have a Section 457 plan.
2. Contribution to one Section 457 plan will reduce contributions to a second Section 457 plan.
3. Contribution to a Section 457 plan will reduce contributions to other types of salary reduction plans such as Sec. 401(k) or Sec. 403(b) plans
Copyright 2009, The National Underwriter Company 23
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
True or False?
4. Participants in a Sec. 457 plan in a private tax exempt organization aged 50 and over are eligible for an additional ‘catch-up’ contribution.
5. A nongovernmental tax-exempt organization can use a trust fund to finance a Sec. 457 plan.
6. Funds can be withdrawn from a Sec. 457 plan prior to time for normal distribution to pay for purchase of residence or child’s college education.
Copyright 2009, The National Underwriter Company 24
Section 457 Plan Chapter 27Employee Benefit & Retirement Planning
Discussion Question
How can a governmental or tax-exempt employer provide a substantial deferred compensation benefit for an executive or key employee for whom the annual dollar limit would be inadequate?
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