The Internal Revenue Code (IRC) 457 allows local and state government employees and employees of tax-exempt, non-governmental entities to defer income taxation on retirement savings. To quality, tax-exempt organizations must fall under the auspices of IRC 501. IRC 457s provide advantages, namely that retirement contributions and earnings are tax-deferred and reduce taxable income. Early withdrawal options and penalties vary by age and circumstance.
The IRC 457 program was established in 1978. IRC 457 plans are similar to other retirement savings plans, such as the 401(k) and 403(b). Plans allow employees to set aside pre-tax money for retirement through a salary deferral program. This both reduces employees’ taxable income and allows retirement funds to grow on a tax-deferred basis. Usually, withdrawal must start at age 70 1/2.
Public and Private
IRC 457 plans are classified as public or private. Public plans apply to government employees, such as police or public school workers. Public plans must be funded through a trust. Private plans apply to tax-exempt organizations, such as nonprofits or unions, but not all employees are eligible to contribute. In order to remain in line with both the tax code and the Employee Retirement Income Security Act (ERISA), private 457 plans can only be offered to a limited group of employees, usually upper management or the most highly compensated.
The IRC 457 public plan offers some early withdrawal advantages. Public plans are not subject to the age 59 1/2 withdrawal rule, so circumstances such as retirement or job termination won’t lead to a 10 percent penalty. Unlike the public program, those who participate in private IRC 457 plans usually must pay federal income taxes upon early withdrawal. If participants choose to defer receiving funds, they can delay taxes until they receive distribution.
If plan participants roll 457 funds into other retirement plans, such as IRAs, 401(k), or 403(b), the no early withdrawal penalty does not also roll over, but is lost. Similarly, if 403(b) funds are rolled into a 457 account, the 403(b) money is subject to the 10 percent early withdrawal penalty. As of the time of publication, public plans may also allow roll-over to and from Roth accounts.
Though each IRC 457 plans’ specifics is determined by the employer’s rules, 457 funds can usually be withdrawn in the case of an unforeseen emergency or extreme financial hardship. Such cases must be caused by events not within the plan participant’s control, such as financial hardship stemming from an illness or accident, or the loss of property. Examples include a foreclosure on a primary residence or medical expenses, but do not include foreseeable circumstances, such as education costs.
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