Is a 457 Plan Considered a Qualified Plan?

A 457 plan is a deferred compensation retirement plan available to employees of state and local governments and certain non-profit organizations. It is considered a “non-qualified” plan, a technical definition indicating it does not adhere to the regulations of the Employee Retirement Income Security Act (ERISA). This non-qualified status results in a different set of rules governing contributions, withdrawals, and participant protections compared to more common retirement vehicles like 401(k)s.

Defining Qualified vs Non-Qualified Plans

A “qualified plan” is a retirement plan that meets the requirements of Internal Revenue Code (IRC) Section 401. These plans, such as 401(k)s, are also governed by ERISA, which establishes minimum standards for participation, vesting, and funding, and provides protections for participant assets.

In contrast, a “non-qualified plan” is a contractual agreement between an employer and an employee to pay compensation in a future year. These plans do not have to comply with ERISA rules, which provides more flexibility for the employer but offers fewer protections for the employee. The 457(b) plan falls into this category and is governed by IRC Section 457.

There are two distinct types of 457(b) plans. Governmental 457(b) plans are for employees of state and local governments. The second type is for employees of certain tax-exempt organizations under IRC Section 501. This distinction is a primary factor in determining the level of security and specific features of the plan.

Key Differences in Plan Rules and Features

The non-qualified status of a 457(b) plan creates several practical differences from qualified plans, most notably in contribution limits. An employee who has access to both a 403(b) or 401(k) and a 457(b) plan can contribute the maximum amount to each plan separately. The contribution limits for 457(b) plans are independent, allowing for a higher total retirement savings potential.

One of the features of a 457(b) plan relates to its withdrawal rules. Qualified plans, like 401(k)s, assess a 10% early withdrawal penalty on distributions taken before the participant reaches age 59½. However, funds withdrawn from a 457(b) plan after an employee separates from service are not subject to this 10% penalty, regardless of the employee’s age.

The level of creditor protection depends heavily on the type of 457(b) plan. Assets in a qualified plan are protected by ERISA and cannot be claimed by the employer’s creditors in bankruptcy. Governmental 457(b) plans offer similar security, as the assets must be held in a trust or custodial account for the exclusive benefit of participants and their beneficiaries.

For tax-exempt 457(b) plans, the situation is different. The plan assets legally remain the property of the employer until they are distributed to the employee. These funds are therefore subject to the claims of the employer’s general creditors if the organization faces bankruptcy. This means an employee could lose their deferred compensation if their non-profit employer becomes insolvent.

Rollover and Portability Rules

The rules for moving funds from a 457(b) plan are specific and depend on the plan type. An employee with a governmental 457(b) plan has flexibility upon leaving their job. They can roll over their account balance into a traditional IRA, a 401(k), a 403(b), or another governmental 457(b) plan, allowing for asset consolidation.

Once funds from a governmental 457(b) are moved into a qualified plan like a 401(k) or an IRA, they become subject to the rules of the new plan. This means the money that was previously exempt from the 10% early withdrawal penalty will now be subject to it if withdrawn before age 59½. The penalty-free withdrawal feature is lost once the funds leave the 457(b) environment.

Rollover options for tax-exempt 457(b) plans are more restrictive. Funds from a tax-exempt 457(b) plan can only be rolled over into another tax-exempt 457(b) plan. They cannot be moved into an IRA, 401(k), or governmental 457(b) plan, which is a limitation for employees of non-profit organizations.

It is also possible to roll funds from other retirement plans into a governmental 457(b) plan. These plans can accept rollovers from qualified plans like 401(k)s and 403(b)s, as well as from IRAs. However, the plan administrator must separately account for these rolled-in assets, as they retain the withdrawal restrictions of their original plan.