In my financial planning firm I work mostly with business owners and medical professionals. A good number of my clients are employees of Providence, which is one of the major medical providers in the Pacific northwest. Providence offers its employees a very strong benefits & retirement package. Employees can contribute to a 403(b) plan on a tax-deferred or Roth basis and Providence contributes to a 401(a) plan on their behalf, depending on compensation and years of service.
Providence also offers a 457(b) plan to its employees. While it’s convenient to have another tax-deferred savings vehicle available, 457 plans come with some quirks – especially surrounding distribution options once you separate from service.
Recently, one my of my clients and I discussed the possibility of them leaving to take another job. So to wrap our heads around the ins and outs of the 457 plans, we jumped on the phone with one of Providence’s retirement plan administrators. The administrator helped to explain the unique features of the plan, which I’ll explain in this post. Hopefully this review is helpful to anyone thinking about participating in Providence’s 457 plan.
A Quick Primer on 457(b) Plans
457(b) plans are sometimes mistakenly considered an alternative to a 403(b) plan. There is actually some nuance to 457(b) plans, and much of it depends on whether the plan is sponsored by a governmental entity.
457(b) plans sponsored by governments have nearly identical rules to 403(b) plans. The contribution limits are the same, the distribution options & limitations are the same, and by and large the plans operate in the same way.
Non-governmental 457(b) plans are different, in several ways. Whereas the contribution limits are the same, the distribution options are not. For non-governmental 457(b) plans, you are not allowed to roll your balances into an IRA. Yes, you read that correctly. Whereas participants in government sponsored 457(b) plans may roll their balances into IRAs after separating from service without triggering a taxable event, participants in non-governmental plans may not.
Instead, as a participant in such a plan you’re limited to the unique distribution options of the plan. This is worth some investigation, as some plans require full distribution shortly after separating from service. There isn’t an early distribution penalty for withdrawals prior to age 59 1/2, but withdrawals are still taxed as income. Think about that for a moment. You participate in a non-governmental 457(b) plan for years, accumulating potentially hundreds of thousands of dollars in the plan. Then when you separate from service you’re forced to take everything out, and be taxed on it, in one year.
Another unique difference is creditor protection. Whereas 403(b) and 403(k) plans are held in trust, 457(b) plans are held in the name of the organization sponsoring the plan. This seems like a subtle difference, but can be impactful in the event of liquidation. If the sponsoring organization falls into bankruptcy, your assets in the plan would be exposed to creditors. The chances of this happening are probably quite small (especially for an organization like Providence), but I’m sure that’s what everyone at WorldCom and Enron thought as well.
The investment options in Providence’s 457(b) plan are quite strong, and offer a blend of actively managed and index funds. On the actively managed side, the plan offers an array of very well known funds, including American Funds EuroPacific Growth fund, and Fidelity’s Growth Company fund. The active funds in this plan are not the most expensive out there, but they are not cheap.
On the index side the plan currently offers:
- Vanguard’s Institutional Index Fund (large cap stocks)
- Vanguard’s Extended Market Index Fund (mid/small cap stocks)
- Vanguard’s Total Bond Market Index Fund
The plan also offers Vanguard’s menu of target date funds, at a cost of 0.09% per year each.
Overall, the availability of Vanguard’s funds makes this lineup pretty decent. There are several asset classes not represented though, which makes building a portfolio out of these options rather difficult. There is no representation from global bonds or real estate, and the only options for international or emerging markets stocks are the more expensive active funds.
When I have clients with assets in this plan, I typically advise them to either:
- Build a three fund portfolio out of the Vanguard index funds mentioned above, or;
- Stick to a target date fund.
Even if the target date fund you choose doesn’t have the exact allocation you’re trying to build, you can “round out” your portfolio in other accounts. Whether it’s a spouse’s 401(k), and IRA/Roth IRA, or taxable account, you can always work around a rigid target date fund if you need to. And if your other options are limited that may well be your best bet.
Like 401(k) and 403(b) plans, costs for participating in a 457 plan come from a couple different sources:
- Your portion of administration costs shared with other participants
- Expense ratios of the funds you choose to invest in
The former depends on how your plan is set up, and how much of the cost your employer decides to subsidize. The latter depends on the investments you choose.
Although I’ve had the benefit of reviewing Providence’s 457(b) plan document & list of investment options, and speak with one of their plan administrators, I’ve yet to see any breakdown of this plan’s fee levels. I’m guessing this is because 457 plans are not covered by ERISA, meaning there is probably no requirement to circulate fee disclosures.
I can tell you that based on the statements I’ve seen, the annual operating expenses appear to be somewhere around 0.40% to 0.75% of participant assets per year. Add this to the low cost of a few Vanguard funds, and this a pretty reasonable fee level for a tax deferred retirement plan.
I should also mention that Providence did settle a class action suit in 2016 for breach of fiduciary duty, for $2.25 million. The plaintiffs argued that Providence’s 403(b) plan paid unreasonable compensation to Fidelity, the plan’s recordkeeper. This is on the heels of a $352 million ERISA settlement for improperly classifying it’s pension plan as a “church plan”. Church pension plans are not subject to ERISA, and therefore do not require specific funding requirements. Providence’s pension plan was grossly underfunded at one point, and would have been forced to take a massive charge on its balance sheet by being subject to ERISA’s requirements.
Reading between the lines here, I’d guess that the organization’s 457(b) plan has undergone some recent changes as a result of these suits. While participants may not have had a case against Providence for the 457(b) plan directly (again, it’s not covered under ERISA), I wouldn’t be surprised if Providence made some changes to reduce cost as a result of the 403(b) suit.
As mentioned above, the distribution limitations are where 457 plans get sticky. Your balances in a 457 plan are NOT eligible for a rollover to an IRA. When you separate from service, you’ll need to keep your assets in the plan (subject to the plan’s unique distribution rules) or take them out, which is a taxable event.
Providence’s plan requires you to make an “election” of how you’ll withdraw the funds within 75 days of separating from service. Fail to make this election within 75 days, and Providence will cut you a check for your entire balance in the plan within 90 days after the end of the year in which your employment terminates.
If you’re an employee for a long period of time, it’s entirely possible you could build up several hundred thousand dollars in the 457(b) plan. Forget to submit a distribution election form, and that entire amount would be taxable to you as income the following year.
You have two distribution options when making this election:
- Take a lump sum payment any time between your termination date and ten years from your termination date, or;
- Annual installment payments based on your age, life expectancy, and Providence’s actuarial tables (or monthly / quarterly payments totaling the required annual amount).
The wrinkle with Providence’s plan is that you may change your election exactly one time. Not twice. Once.
The way the administrator explained it to me, if you’d like to postpone your distributions for as long as possible, your initial election would be to distribute the entire account balance exactly 10 years after your termination date. Then, a month or two before this date, you would use your opportunity to change your election, and push the date out another ten years. You’d still have a lump to deal with when this date arrives, but it’d be a little farther in the future.
I asked if it’d be permissible to wait the 20 years and then begin your annual installment payments, to which the administrator did not know. The key point here is that if you have balances in Providence’s 457 plan, you need to talk to their administrator immediately after separating from service.
Missing your 75 day window is the worst possible outcome, and the plan administrator will be able to walk you through your options.
Providence’s 457(b) plan is not bad overall. The company offers a nice low cost plan that complements its 403(b) plan well. As far as non-governmental 457(b) plans go, Providence offers a pretty good option.
As a retirement savings vehicle in general, the plan leaves a lot to be desired. The distribution options are so limited that it’s difficult for me to recommend most non-governmental 457(b) plans to my clients. For some people trying to retire & distributions before age 60, the fact that 457(b) plans aren’t qualified could be convenient, since the early withdrawal penalties won’t apply. But for most, the thought of being forced into a distribution could be gut wrenching.
If you’re a Providence employee and eligible for the plan, I’d suggest using their 403(b) plan first. Your contributions are eligible for an IRA rollover if you ever leave, and combine nicely with the 401(a) contributions Providence will make on your behalf. If you need more tax deferred savings opportunities after maxing out your 403(b), and don’t mind the distribution limitations, the plan could be a good fit. It doesn’t cost much to participate in, and your investment options are solid.
What do you think?
Have the 457(b) limitations deterred you from using Providence’s plan?
Why or why not?