Governmental 457(b) Plan

Terrence Abiola, 54, is a county civil engineer who has deferred salary into his employer governmental 457(b) plan for eighteen years. He is considering retiring at 56 and drawing on the balance. His adviser is comparing that plan with the 401(k) Terrence holds from a prior private-sector employer. Which statement is accurate?

1. A.Both plans impose the 10% penalty on any distribution before age 59 1/2 unless he takes substantially equal periodic payments72(t) is a genuine route to penalty-free access, but it is unnecessary for the 457(b), which carries no early distribution penalty after separation.
2. B.Distributions from the governmental 457(b) escape both the penalty and ordinary income tax, since contributions were made from already-taxed salaryDeferrals into a traditional 457(b) are pretax. Distributions are fully taxable as ordinary income; only the penalty is absent.
3. C.Distributions from the governmental 457(b) after separation avoid the 10% early distribution penalty at any age, which is not true of the 401(k)Correct. The exemption from the early distribution penalty is a defining feature of governmental 457(b) plans and does not depend on reaching a particular age.
4. D.The 457(b) is subject to the penalty but the 401(k) is not, because governmental plans follow the same distribution rules as IRAsReversed, and the premise is wrong. Governmental 457(b) plans do not follow IRA distribution rules, and IRAs have no separation-from-service exception at all.

Why: A distinctive feature of a governmental 457(b) plan is that distributions after separation from service are not subject to the 10% early distribution penalty, regardless of the participant age. The 401(k) is different: the separation-from-service exception generally requires separation in or after the year the participant turns 55. So at 56 the 457(b) balance is penalty-free because of the plan type, and the 401(k) is penalty-free because he cleared the age 55 threshold - but the reasons differ, and at 52 only the 457(b) would qualify.

A 52-year-old public school administrator is choosing between deferring into her employer 403(b) plan and its governmental 457(b) plan. If there is a meaningful chance she will separate from service at 55 and need the money, an important distinction is that a governmental 457(b):

1. A.Requires no minimum distributions during the participant lifetimeGovernmental 457(b) plans are subject to required minimum distribution rules like other employer plans.
2. B.Permits tax-free distributions of both contributions and earnings after separation from serviceDistributions are still ordinary income. Escaping the penalty is not the same as escaping income tax.
3. C.Allows contributions that are excluded from Social Security and Medicare taxesSalary deferrals into these plans remain subject to FICA. Only federal income tax is deferred.
4. D.Is not subject to the 10% early-withdrawal penalty on distributions after separation from service, regardless of her ageCorrect. This penalty exemption is the defining planning advantage of a governmental 457(b) for someone who may need access before 59 1/2.

Why: Distributions from a governmental 457(b) plan after separation from service are not subject to the 10% early-withdrawal penalty, regardless of age. Distributions from a 403(b) or 401(k) generally are penalized before 59 1/2, subject to exceptions such as separation from service at or after age 55. Both plans defer income tax on contributions and both are subject to ordinary income tax on distribution.

Ardmore County employs Solveig Brandt, age 61, in its public works department and sponsors a governmental 457(b) plan. Solveig intends to retire at the plan's stated normal retirement age of 64 and has underused her deferral limit in several prior years. The plan offers both the age-50 catch-up and the special final-three-year catch-up. Assume the basic annual elective deferral limit is 24,000 dollars. Which statement is correct?

1. A.She may use the age-50 catch-up and the special final-three-year catch-up in the same year, deferring the basic limit plus both add-ons.Wrong. The two catch-ups may not be combined in the same taxable year in a 457(b) plan; the participant uses the larger of the two.
2. B.In each of the three years before her normal retirement age she may defer up to twice the basic limit, but only to the extent of prior unused deferrals, and she may not also use the age-50 catch-up in that same year.Correct. Twice the basic limit is the ceiling, the excess above the basic limit is limited to prior underutilized deferrals, and the age-50 catch-up is off the table in any year the special catch-up is used.
3. C.The special final-three-year catch-up is available only in the single year in which she actually separates from service.Wrong. It is available in each of the three taxable years ending before the plan's normal retirement age, not only in the separation year.
4. D.Because she is already past age 50, the special final-three-year catch-up is unavailable and she is limited to the age-50 catch-up.Wrong. Age 50 does not disqualify a participant from the special catch-up; the two simply cannot be used together in one year.

Why: A governmental 457(b) plan may offer two catch-up features, but they cannot be stacked. In each of the three taxable years ending before the participant reaches the plan's normal retirement age, the special catch-up permits deferrals of up to twice the basic limit, and the extra amount is limited to the deferrals the participant failed to use in prior years. In a year the special catch-up is used, the age-50 catch-up is unavailable; the participant uses whichever produces the larger deferral.