Introduction of 457 Plan
457 plan (also known as defined contribution retirement plan) is a government approved & recognized plan for retirement benefits of only the eligible employees, wherein a fixed contribution is made by an employee during his tenure of employment and 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 life work, it may not be possible for few employees to take out time & invest in some plan, that will financially support them at the retirement stage.
- Thus, the government normally comes out with a compulsory plan of investment wherein a fixed amount is saved from the earning source i.e. salary. Such deductions help employees to focus on their expenditure easily.
- So, 457 plans basically revolve around this concept of saving, through deduction from salary income per month.
- The plan is offered by state & local governments to their employees as well as employees of the non-profit organization. Only such employees are eligible to participate in the 457 plan.
- The contributions made are accumulated over the period of employment to become a huge amount 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.
- There are many issues that 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 distinct attribute or aspect of something. It may be good or bad. So, features basically means specify the attribute whether positive or negative. Every plan has some features and so does, we have an ample number of features plan 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 However, if the same is withdrawn, it is taxable.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 circumstances that the whole of the salary of a person is completely 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 exception circumstances, employees are allowed to 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 into the said plan.
- The plan allows employees to choose their 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?
- Basically, the eligible employees set aside a specific amount out of their salary on a periodic basis to contribute in the plan.
- Employees are offered with 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 simple & most common 457 plan used across the country.
- Employees of state government as well as local government can take advantage of such plan.
- Moreover, employees of non-profit organisation are also eligible for the plan.
- The revised contribution limit is $ 19500 per employee per annum. This limit is applicable for the year 2020 with slight increase of $ 500 as compared to the year 2019. In exception cases, this limit is doubled i.e. $ 39000 per employee per annum. Such exception is called as double catch up provision of the government. So, doubling of limits is allowed for employees who are serving the last three years of their employment service.
2. 457(f)
- This is special plan allowed for government as well only selected non-government employees, who have been high compensated.
- It is easy to administer as compared to 457(b) & incurs 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 maximum cap imposed by the government.
- Further, executive face the risk of substantial risk of forfeiture.
457 Plan Limits
- As said earlier, the basic limit is $ 19500 per employee per year from the year 2020, as compared to $ 19000 for the year 2019.
- Thus, the bare text of IRS reads as 100% of salary contribution subject to maximum of the specified limit.
- However, if the age of employee of state of local government is 50 or more, they are allowed for catch-up provisions. In such catch up provisions, the employees are allowed to contribution up to $ 6000 over & above the normal annual limit.
- In case an employee is serving the last 3 years of his employment, he is allowed to contribution double the annual limit of contribution.
Advantages of 457 Plan
Some of the advantages are given below:
- The benefits of the plan are extended even to non-federal employees of the country.
- It’s your hard-earned money. So, there is no absolute restriction on withdrawal of money at point of time during the year. Thus, there is no penalty for early withdrawal as such.
- The plan has special focus for employees who are near to their retirement age.
- The focus of government is more & more savings. Thus, the contributions are not taxed.
- This serves the purpose of securing a better future.
- Employee is even allowed to contribute up to 100% of salary to the plan.
- One of the best things about 457 plans, is portability of the plan. This means you can transfer your retirement account to the new employer in case 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 that there is a dollar-cap on the contribution limit for 457 plans. The disadvantage part is that the said upper limit includes the contribution of the employer as well.
- Since such contributions are compulsory, the real disposal income of employee is reduced currently.
- The withdrawals are allowed only for emergency situations 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 on 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 has plans ahead for their retirement journey.
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