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.