7.22 Government and Exempt Organization Deferred Pay Plans

Federal government civilian employees may make tax-deferred salary-reduction contributions to the Federal Thrift Savings Plan. Employees of state and local governments and of tax-exempt organizations may be able to make tax-free salary-reduction contributions to a Section 457 deferred compensation plan.

Federal Thrift Savings Plan.

Federal employees may elect to make salary-reduction deferrals to the Thrift Savings Plan up to the elective deferral limit for 401(k) plans (7.17). Deferrals are not taxed until distributed from the plan. The deferred amount is counted as wages for purposes of computing Social Security taxes and benefits.

Distributions from the Thrift Savings Plan are generally fully taxable. However, lump-sum distributions are eligible for tax-free rollover treatment (7.7) and employees born before January 2, 1936 are eligible for special averaging (7.4). If you receive a distribution before age 59½, you are subject to the 10% penalty for early distributions unless an exception applies (7.15).

Section 457 plans.

State and local governments and tax-exempt organizations other than churches may set up Section 457 deferred compensation plans. Employees may annually defer compensation up to the 401(k) elective deferrable limit (7.17). Employees in state and local government 457 plans who are 50 years of age or older may be permitted by the plan to defer an additional “catch-up” amount (7.17).

The plan also may provide for an increased deferral limit in the last three years before reaching normal retirement age. During this three-year period, the plan may allow deferrals up to double the regular annual limit, or, if less, the total of the regular annual limit plus any unused regular deferral limits in prior years.

Deferred compensation (and allocable income) under a Section 457 plan of a tax-exempt employer (non-governmental) is not taxed until paid or otherwise made available. Amounts deferred (and earnings) under state or local government 457 plans are taxed only when paid.

Distributions to employees or beneficiaries generally may not be made before the year the employee turns age 70½, has a severance from employment, or faces an “unforeseeable” emergency, assuming the plan allows payment in cases of emergency. Under IRS regulations, an unforeseeable emergency generally means severe financial hardship resulting from a sudden illness or accident of the employee or a dependent, or loss of property due to a casualty. If the employee can obtain funds by ceasing deferrals to the plan or by liquidating assets without causing himself or herself severe financial hardship, payment from the plan is not allowed. The regulations specifically prohibit payments from the plan to purchase a home or pay for a child’s college tuition.

Caution

Unforeseen Emergency Distributions

If you can show severe financial hardship arising from a sudden illness or accident, or loss of property due to events beyond your control, and you are unable to obtain funds elsewhere, you may make a withdrawal from your employer’s Section 457 plan. However, the need to buy a home or pay college expenses does not qualify as an unforeseeable emergency.

- - - - - - - - - -

Eligible rollover distributions (7.7) from a governmental 457 plan (but not a nongovernmental plan) may be rolled over tax free to a traditional IRA, another governmental 457 plan, a qualified plan, or a 403(b) plan. An eligible distribution from a governmental 457 plan may also be rolled over to a Roth IRA, subject to the conditions for a taxable conversion (7.8). If a rollover from a governmental 457 plan is made to a qualified plan, special averaging (7.4) and capital gain treatment (7.5) will not be allowed for a lump-sum distribution from the qualified plan even if such treatment would otherwise be available. Rollovers of eligible distributions may also be made to governmental 457 plans.

As discussed in 7.20, a governmental 457 plan may allow you to make an in-plan rollover to a designated Roth IRA within the same plan.

See 7.13 for required distribution starting dates after age 70½ and minimum payout rules.

Note: Check with your employer for other details on Section 457 contributions and distribution rules.