New tax law a boon to those in state's 457 retirement plan

PERSONAL FINANCE

September 09, 2001|By EILEEN AMBROSE

ELISABETH Plitt had been waiting for just the kind of pension reform included in the new tax law.

Up until the law was signed in June, the Pasadena resident followed the debate over pension changes and e-mailed congressmen and senators for updates.

Plitt, who retired in July as a budget analyst for Maryland's Department of Labor, Licensing and Regulation, was hoping for more flexibility when taking distributions from the state's 457 retirement plan, which is like a 401(k).

Plitt will get her wish next year, when many of the changes in the new tax law take place. Not only will the plan provide more flexibility for retirees and others leaving a job, but it will allow remaining workers to set aside more money for retirement.

"I'm delighted to see what has happened," said Plitt, who delayed withdrawals from her 457 account while waiting for the law to change. "I can transfer [the account] into a 401[k] or self-directed IRA or whatever. I don't know yet. I might leave it where it is."

The changes will affect thousands of state and local government workers in Maryland covered by a 457 plan, including firefighters, police officers, legislators and college professors. Some tax-exempt organizations, such as hospitals and foundations, also offer 457 plans to top management.

A 457 plan works much like a 401(k). Workers invest pretax dollars in the plan, and later pay income tax on the money when it's withdrawn.

The 457 plan has some perks a 401(k) doesn't. But a 457 also has some additional restrictions, which the new law lifts.

"The overall thrust of the change is to make 457 plans ... more like their counterpart plans in private industry," said John Barry, Maryland assistant attorney general.

Of course, like all changes in the new law, these, too, will disappear in 2011 unless Congress acts. Most experts expect changes to the 457 will be permanent, Barry said.

Among the changes:

Portability. Now, when workers leave their jobs, they can't roll their 457 account into an individual retirement account, a typical move for those with 401(k)s.

Unless departing workers opt for a lump-sum distribution, they face the difficult choice of when to take future distributions and by how much each year. For the most part the decision can't be changed, although people could delay for one time the starting date of distributions.

"It's fairly rare that people know precisely how much they want and need each year," Barry said.

For instance, retirees a decade or so ago may have made conservative choices so their money would last and find themselves stuck with small withdrawals even though their accounts mushroomed in the bull market, said Michael Halpin, deputy executive director of the Maryland Teachers and State Employees Supplemental Retirement plans.

"They were living on store-brand groceries when they had filet mignon money in their plan," he said.

The new law changes this.

Beginning next year, workers leaving a job will be able to roll their account into an IRA, giving them more control over distributions and investments. (The 457 rollover provisions won't apply to workers at tax-exempt organizations, Barry said.)

They also will be able to roll the account into a 401(k) or a nonprofit's 403(b) plan, if the plans permit it. Likewise, they can roll a 401(k) and 403(b) account into a 457.

Retirees also will be able to revise their distribution elections beginning next year, provided the plan permits, Barry said.

Warning: Workers leaving a job can take a distribution from the 457 account without worrying about paying a 10 percent penalty for early withdrawals. But once a 457 is rolled over into another retirement account, say, an IRA, that money becomes subject to the new account's rules, experts said.

In this case, 457 money rolled into an IRA and withdrawn before age 59 1/2 would be subject to the IRA's early withdrawal penalty.

"You are moving it from a safe zone to a danger zone," said John McFadden, a tax professor at the American College in Pennsylvania.

And there's no escaping the early withdrawal penalty on 401(k) or 403(b) money by rolling it into a 457 account, according to the IRS.

Increased contributions. "At long last, the 457 participant will have the same contribution limit as those members of 401(k) plans. They were quite a few thousand dollars behind," Halpin said.

Currently, the maximum annual 457 contribution is $8,500, compared with $10,500 for a 401(k) and 403(b). Next year, the top limit for all three plans will be $11,000. Thereafter, the ceiling rises $1,000 a year to $15,000 in 2006.

Some workers with a 457 account also may have a 401(k) and/or a 403(b). Beginning next year, those workers can set aside up to $11,000 in a 457, plus make the maximum contribution in the other plan for a total of $22,000.

Catch-up provisions. A 457 plan already could allow older workers to make catch-up contributions. But the tax law permits another catch-up option and boosts contributions under the old one.

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