Deferred compensation is a type of retirement plan that public employees can participate in. Public employees typically work for school districts and government agencies that receive income from tax revenue. Public and private employers may also offer 401(k) retirement plans. Each plan is subject to different tax and contribution regulations, which the Internal Revenue Service determines. Rollovers occur when a plan participant transfers money from one type of retirement plan to another.
Deferred Compensation Plans
Deferred compensation plans are officially known as 457(b) plans. Current regulations stipulate that only firms that are tax-exempt, or state and local government agencies, can establish a 457(b). Employers often contribute a percentage of their employees' salaries to deferred compensation plans through payroll deductions. The annual contribution limit is $16,500 as of 2011. Any contributions made to a 457(b) plan are not taxed at the time of deduction. Interest that an employee earns on contributions are also not taxed until funds are withdrawn.
While 401(k) plans are popular with private sector employers, the IRS penalizes participants for withdrawing funds prior to the age of 59 1/2. The government allows exceptions in the case of documented financial hardship and certain types of loans against the balance, as long as the principal and interest is paid back. When an employee terminates the relationship with his employer, he can choose to convert his 401(k) plan into an IRA, cash out his balance, or roll the funds over to another 401(k) plan.
Public employees who leave their employers may be eligible to roll funds from their 475(b) plans into 401(k) or IRA plans. Funds rolled over from one eligible retirement plan to another are not included in an individual's yearly gross income. The transfer of funds must occur between plan administrators, and each plan must agree to keep official records of the transfer. To qualify as a rollover, the employee must not receive a check for the funds or physically deposit the withdrawn funds with the new plan.
Restrictions and Consequences
Rollover funds can be subject to the restrictions and tax laws of the new retirement plan. Funds rolled from a deferred compensation plan to a 401(k) can lose their ability to be withdrawn at any time without an additional 10 percent tax penalty. Rollovers from a deferred compensation plan can also affect the amount of future contributions an employee is able to make to his 401(k) plan.
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