Congress is looking into suggestions to unify various types of deferred compensation plans (Section 457 plans, Section 403(b) plans and Section 401(k) plans into one type of plan. Two approaches are to incorporate all existing plans under Section 401(k) or to establish an entirely new code section that permits transfers between these plans or an individual retirement account (IRA). The advantages cited for making such changes focus on administrative ease for employers, increased portability among plans, and simplicity in the Internal Revenue Code (IRC).
Employer-sponsored deferred compensation plans allow employees to save for retirement by making pre-tax contributions to the plan on a salary reduction basis. In turn, employee contributions are set aside on behalf of the employee or his or her beneficiary and distributed upon separation from service, retirement, or death. In most cases, these savings plans allow participants to choose from among several investment options and to periodically transfer accumulated assets among investment vehicles.
There are important differences between the three types of plans that reflect the needs of those participating in the plans. These include contribution limits, nondiscrimination testing requirements, loan provisions, withdrawal options, distribution options, and reporting requirements. The history of each of these plans provides insight into the basic needs being met by each type of plan:
- Section 457 Plans. Originally, state and local governments relied on private letter rulings to adopt a deferred compensation plan. Many of the provisions of these early plans were codified with the enactment of Section 457 in the Revenue Act of 1978. Section 457 plans are non-qualified, giving employers somewhat more flexibility in plan design, but must meet a separate set of requirements under the IRC to retain the tax deferral feature for participants.
- Section 403(b) Plans. These plans may only be offered to public school teachers and certain other categories of employees in education-related positions. Although employers had been able to purchase annuities for these employees on a tax-deferred basis since 1942, Section 403(b) plans were established in the Technical Amendments Act of 1958. As with Section 457 plans, the subsequent rules placed on Section 403(b) plans, including allowing investments in mutual funds, reflect the needs of this specific group of employers and employees.
- Section 401(k) Plans. The most widely available deferred compensation plans are Section 401(k) plans. These plans were created in the Revenue Act of 1978 and can be offered by any private-sector and not-for-profit employer. State and local governments may not maintain Section 401(k) arrangements unless they were adopted before May 6, 1986.
The Government Finance Officers Association (GFOA) supports federal and state policies that promote increased retirement savings and the preservation of these savings. GFOA recognizes the need for federal tax-law changes that are intended to improve portability among employer-sponsored deferred compensation plans. Such legislation, however, should focus on the preservation of retirement assets and permit state and local employers to continue to provide retirement programs that meet their employees' needs. Changes to these plans should be driven by a national retirement policy that promotes increased retirement savings and provides for adequate transition time and employee education, while not causing undue disruption to the administration and design of current plans.
- Publication date: June 1997