Oct 4, 2009


These plans are primarily used by government employers. Government employers may have qualified plans for employees, except that they are not eligible to adopt 401(k) plans. And, only a very limited category of government employers (public schools) can adopt 403(b) plans. Thus, the opportunity to offer employees a plan of the salary savings type is very limited. Section 457 provides the only alternative in designing a salary savings arrangement for most government employers. Plans designed under this Code provision are not qualified plans; moreover the rules are in many cases very different from those. The rules were enacted by Congress primarily to forestall perceived abuses in retirement plans of government employers rather than to benefit government employees, so they are somewhat lacking in flexibility or generosity.

Eligible Employers

Section 457 applies to government employers and to employers that are exempt from federal income tax. However, these plans are not much used by private tax-exempt organizations because better alternatives such as 401(k) plans are available.

Limit on Amount

The amount deferred annually by an employee under these plans cannot exceed the lesser of $7,500 or one-third of the employee's taxable compensation, reduced by any salary reductions under a Section 403(b) plan or SIMPLE. The $7,500 limit is indexed for inflation (2000: $8,000). This ceiling can be increased in each of the last three years before normal retirement age, to the lesser of $15,000 or the regular ceiling plus the total amount of potential deferral that was not used in prior years. If an individual has more than one employer, the total deferred for all employers must not exceed these limits.

Other Rules

  • Elections to defer compensation under Section 457 are made monthly, under an agreement entered into before the beginning of the month.

  • For government employers, employee salary deferrals must be placed in a trust fund or custodial account. However, for private tax-exempt employers, the plan cannot be funded—all deferred compensation and income therefrom remains the property of the employer.

  • Plan distributions cannot be made before separation from service or "unforeseeable emergency."

  • Plan distributions must meet the minimum distribution rules of Section 401(a)(9) regarding beginning date (April 1 after age 70½ or retirement).

  • A special incidental death benefit provision applies—the participant must expect to receive at least two-thirds of the total payout where there is a survivor annuity.

  • Plan distributions are taxable in full when received. They are not eligible for five- or ten-year averaging and cannot be rolled over into an IRA.

  • There are no specific coverage requirements—the plan can be offered to all employees, or any group of employees, even a single employee. However, for a tax-exempt organization (but not for a government organization) the participation, fiduciary, and other ERISA rules may apply.

If the state or local government employer or tax-exempt employer has a nonqualified deferred-compensation plan that does not comply with Section 457—for example, one that exceeds the limits—then it is treated for tax purposes as a funded plan, whether or not it is actually funded. This means that the deferred amount is includable in the participant's income when there is no substantial risk of forfeiture. This does, however, provide some opportunity for governments and tax-exempts to design plans for top executives above the $7,500 limit by including forfeiture provisions.


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