457 Plans: Pitfalls Tax Exempts Should Avoid

Running any employee benefit plan entails following certain rules—and it is always possible that at some point, a mistake will be made in running a plan. An expert offers his observations regarding mistakes that tax-exempt organizations (EOs) make with their 457(b) plans. 

In a recent entry in the Trucker Huss “The Benefit of Benefits” blog, Scott E. Galbreath discusses common mistakes he has encountered in 457 plans EOs sponsor.

Confusion    

Galbreath says he found that confusion can result in EOs adopting the wrong kind of 457 plan. 

For instance, some set up a plan appropriate for a state and local government plan. This is a mistake, he says, because such a plan includes provisions that a 457(b) plan for an EO cannot include, such as: 

• coverage of all employees;
• holding assets for the exclusive benefit of employees; and
• allowing : 
  • catch-up contributions; 
  • participant loans;
  • in-service distributions;
  • Roth deferrals; and 
  • rollovers to and from other types of plans.

Galbreath also has seen confusion regarding which kind of 457 a tax-exempt EO should establish,and points out the differences between 457(b) and 457(f) plans. The key differences he identifies are that:

• With a 457(b), there is generally an annual limit on contributions; also, participants are not taxed on contributions until the benefits are paid or otherwise made available.
• With a 457(f), there is no annual limit on contributions, and contributions are taxable when no longer subject to a substantial risk of forfeiture (or vested) regardless of when benefits are paid. 

Top Hat Plan Requirements

EO 457 plans must be top hat plans and cannot cover all employees; however, Galbreath says that EOs sometimes attempt to include employees who are ineligible to participate in the plan. Another mistake he has encountered is EOs failing to file a top hat statement with the Department of Labor, which they must do in order to not be required to file the Form 5500 annually. 

Monthly Elective Deferral Rule

Galbreath notes that while SECURE 2.0 eliminated the monthly elective deferral rule for state and local governmental 457 plans, it did not do so for EO 457(b) plans. Under that rule, in order for a participant’s deferral election in an EO’s 457(b) plan for a given month to be valid, he or she must make it in writing before the beginning of a month. 

Excess Contributions

Galbreath says that another mistake he has encountered is contributing too much to a 457(b) plan. He stresses that EOs with 457(b) plans should remember the rules concerning annual contribution limits. He also reminds that unvested employer contributions do not count against the 457(b) annual limit until they vest, and that, if a vested account balance exceeds the annual limit for that year, a correction must be made in order for the 457(b) to not be taxed as a 457(f) plan.