The Perks of a Government Retirement Plan
State and local government jobs may not seem like the height of glamour, but they aren't without their perks. Benefits such as pensions, plus access to tax-advantaged government retirement plans known as 457(b) plans, help make working at the county or municipal level more rewarding for local civil servants.
Employees of the federal government do not have a 457(b) plan; instead they have the thrift savings plan, which comes with its own idiosyncrasies.
A 457(b) is roughly analogous to a 401(k), but it comes with its own quirks.
"It's very similar in that you can only defer a certain dollar amount each year, and the amount you can defer is linked to the cost of living (indexes) as the 401(k) is," says Dominick Pizzano, a New Jersey-based employee benefits consultant at Milliman, an actuarial and consulting firm.
The contribution limit is $17,000 for 2012. If the plan allows it, a participant can make Roth contributions to his retirement account, paying taxes on the contribution before it goes into the account. Interest and earnings would be tax-free in retirement.
Also similar to the 401(k) is one of the catch-up provisions that allow workers older than 50 to put away extra money -- specifically an extra $5,500.
Now for the curve ball: 457(b) plans also may allow workers to squirrel away extra money starting three years before the so-called normal retirement age, which the plan specifies.
The normal retirement age can vary, but the special contributions can begin three years before that point.
"So if someone was to retire at 50, at 48 they could begin the 457 catch-up because it's three years prior to their retirement age. It's called the three-year rule," says Julia Durand, director at CalSTRS and president of the National Association of Government Defined Contribution Administrators, or NAGDCA.
Here's the deal: Employees can contribute the lesser of twice the normal elective deferral limit or the sum of the current year's ceiling plus unused portions from prior years.
Essentially, for 2012, it would be $34,000, or $17,000 plus the sum of all the money you didn't put in but could have in previous years, whichever is less.
The formula sounds a bit convoluted -- and it can be that way on the administrative end as well. That's why plan administrators sometimes choose not to offer it as a catch-up option.
"It requires information to calculate that the employers may not always have available to them. If an employee wants to participate in catch-up, they have to provide the payroll records that show they did not contribute the full amount they could have for past years," says Durand.
State and local government employers rarely provide matches to employees, but they do have the ability.
Unlike with 401(k) and 403(b) plans in which the $17,000 limit only applies to employee deferrals, if a government employer does make a contribution to a 457(b) plan, it counts toward the total allowable limit for the year.
For instance, this year if a local government employer contributes $1,000, the employee may only contribute $16,000.
However, a government employer could theoretically kick in as much as the yearly limit if it wants.
As most government employees have a pension, defined contributions plans such as 457(b)s are considered supplemental savings plans -- thus the lack of an employer match in most plans.
As employers can't lure participants into the savings plan with free money, they may sign up for services that end up costing participants a little bit more but will encourage them to save.
"The 457 plan doesn't have a match, and it doesn't really sell itself," says Andrew Ness, principal at Mercer, a human resources and investment services consulting firm.
"What is seen more commonly in the 457 market that isn't as prevalent in the 401(k) market is an onsite education representative model -- so having people physically visit to educate employees and enroll them in the plans," he says.
Bringing in representatives can drive up plan fees paid by participants. But there are other factors that influence the cost of 457 plans to workers, such as the size of the plan.
Similar to the corporate world, larger plans are able to negotiate fees more successfully than the smaller ones.
"Smaller plans usually have kind of a product in the box, and providers need to have a little bit more profit margin to service the small plan, so the fees are probably a little bit higher in those plans," says Ness.
As well, the plan administrator can make a difference.
"Some 457s offer more competitive fee structures than 401(k) plans and vice versa. It depends who's at the helm and if their fiduciary responsibilities are taken seriously," Durand says.
Withdrawals and Early Distributions
When it comes to breaking into the account early, 457(b) plans make it a little bit harder to get money out in an emergency.
"A 457 plan can only make hardship distributions if the participant has no other resources available. They would have to exhaust any monies they had in other places. Then if they took a distribution from the 457, they would have to stop making deferrals for a certain period of time," says Jimmy Williamson, CPA and former member of the American Institute of Certified Public Accountants' National CPA Financial Literacy Commission.
Also, to qualify for a hardship withdrawal, the funds must be not only for an emergency but an unforeseeable one.
"In the 401(k) plan, if you needed money to buy a house or to pay tuition for a dependent, you could do that. But in the 457 plan, those types of foreseeable withdrawals are not allowed. It has to be something catastrophic, like a fire without adequate insurance to replace your house," Pizzano says.
In this case, it's very difficult to get money out. But distributions to workers who retire early are a lot easier. Early distributions, before age 59½, from 457(b) plans are not subject to the 10% penalty.
There's a good reason for that, and it's a necessity, says Durand.
"Typically, police and fire departments were the participants in 457 plans for counties or municipalities. And typically, they would retire early on a disability," she says. If the 457 didn't have the exemption for early distribution, they would have been penalized.
That particular provision often comes under fire by those who want to make all defined contribution plans the same, according to Durand. There has been proposed legislation to combine these types of plans, but it is very complicated.
Penalty-free withdrawals before age 59½ could be a double-edged sword. Unless the money is needed, keeping it invested in a tax-sheltered account as long as possible is nearly always the best option for building wealth.
Government employees do get a few bonuses that nongovernment workers might envy, namely the pension. But when it comes to defined contribution plans, 457(b)s have more in common with their corporate counterpart, the 401(k), than differences.