457 Plans and the Economic Growth and Tax Relief Reconciliation Act of 2001
The Economic Growth and Tax Relief Reconciliation Act of 2001 (referred to herein as the “Act”) was recently enacted. The Act has changed many of the rules and limitations for plans subject to Section 457 of the Internal Revenue Code of 1986, as amended (the “Code”). This Client Alert briefly summarizes the changes made by the Act to the laws affecting 457 plans. These changes will not apply to tax, plan, or limitation years beginning after December 31, 2010.
Elective Deferral and Contribution Limits and Coordination Requirements
The Act made the following changes to the elective deferral and contribution limits and the coordination requirements of 457 plans effective for years beginning after December 31, 2001:
- The Act increased the dollar limit applicable to 457 plans to conform to the elective deferral limitations applicable to other qualified retirement plans. Accordingly, the current $8,500 limit is increased in 2002 to $11,000 and is increased in $1,000 increments each year thereafter until 2006 when the limit reaches $15,000. Thereafter, this limit is indexed for inflation in $500 increments. The limit for individuals within three years of retirement shall be twice the otherwise applicable dollar limit. For individuals who are at least age 50 by the end of the plan year, the Act has increased these limits, beginning in the 2002 tax year, by an additional $500 each year until 2006 when it reaches $2,500. However, the age 50 catch-up rule does not apply in the last three years prior to a participant’s retirement.
- The Act repealed the requirement that the maximum annual deferral amount for any 457 plan be coordinated with the deferrals made to other retirement plans. The Act eliminated the dollar-for-dollar reduction of the deferral amount.
- Currently, the maximum amount of deferred compensation under a 457 plan is the lesser of $8,500 or 33-1/3 percent of the employee’s includible compensation. The Act raised the 33-1/3 percent limit to 100 percent of the participant’s includible compensation.
In addition to modifying the rules regarding elective deferrals, contributions and coordination requirements, the Act made the following modifications to the rules regarding plan distributions:
- Currently, a 457 plan is prohibited from making deferred amounts available before the calendar year in which the participant attains age 70½, separates from service, or faces an unforeseen circumstance, such as a severe financial hardship. An unforeseen circumstance does not include a divorce. The Act has amended these rules to allow early distributions based on a qualified domestic relations order (“QDRO”) without causing the employee to be taxed on the QDRO distribution. If a distribution is made pursuant to a QDRO, then the non-employee former spouse is treated as the distributee and is taxed on the benefits effective for all transfers, distributions, and payments made after December 31, 2001.
- Prior to the Act, the “same desk rule” prevented an employee from receiving a distribution from a plan if the employee continued in the same job for a different employer following the liquidation, merger, or consolidation or outsourcing because the employee was not deemed to have separated from service. The Act has repealed the “same desk rule” and provides that employees who participate in a plan of an employer that is involved in a merger, consolidation or liquidation or outsourcing may receive a distribution from the plan in the event they terminate employment after December 31, 2001.
- Under the current law, a participant in a governmental 457 plan cannot transfer amounts from a governmental 457 plan to a defined benefit governmental plan for purposes of purchasing permissive service credits or repaying former cashouts from the governmental plan without including the amount in his or her gross income. However, the Act removes this impediment and, effective for years beginning after December 31, 2001, permits a participant to make a trustee-to-trustee transfer of amounts under a 457 plan without including the amount in gross income, if the transfer is made for the purpose of (1) purchasing permissive service credits or (2) repaying contributions and earnings with respect to a previous forfeiture of service credit.
- In addition to the foregoing, the Act repeals the special minimum distribution rules that apply to governmental 457 plans. Effective for distributions after December 31, 2001, 457 plans only need to satisfy the minimum distribution rules applicable to qualified plans under Code Section 401(a)(9). The Act amends the previous rule that amounts deferred under a governmental plan were includible in the taxpayer’s income either when the amounts are paid or when they are otherwise made available to the taxpayer, to provide that amounts deferred under a governmental plan are only includible in the taxpayer’s income when the amounts are paid. This change only applies to governmental 457 plans and not to 457 plans sponsored by tax-exempt employers.
If you have any questions about the Economic Growth and Tax Relief Reconciliation Act of 2001, please contact one of the authors listed at the top of the page.