Retirement Reform May Affect 457 Plans

August 2005

Much remains unclear about retirement savings legislation currently being developed on Capitol Hill. A number of bills have been proposed and more should be released after the August recess.

Supporters of public sector retirement saving legislation are carefully watching the progress of any legislation to fight off any proposed changes that would adversely affect public sector employees.

Following are key provisions that ICMA-RC and other public sector advocates are watching carefully:

• Early Withdrawal Penalty: Legislation should maintain the 457 plan exemption from the 10% excise tax penalty. Under current law, state and local government 457 (b) plans are not subject to the 10 percent early withdrawal penalty. This exemption is important because many employees currently rely upon these early withdrawals to pursue retirement or phased-retirement options and pay for health care during retirement
• Catch-up contributions: The 2001 tax reform legislation added the age-50 catch-up contribution provisions for 457 (b) participants to previously existing catch-up provisions. Public sector employees are now taking advantage of both of these provisions and it is not clear how they will be treated under new proposals.
• Distribution options: Flexible distribution options, as currently allowed under the law, should be maintained for all state and local government defined contribution plans. The current proposals do not include the most popular distribution option of systematic withdrawals (except through an annuity).
• Administrative Aspects: New federal legislation should NOT create unfunded mandates by adding to administrative costs and confusion for state and local governments.
• Mandatory Social Security: Some in Congress have raised the possibility of mandatory participation of all public employees in the Social Security system. This would be an extreme hardship on a number of states that have developed retirement programs based on previously granted exemptions from Social Security for their employees.

When Congress returns in September, there is likely to be considerable discussion and perhaps action on retirement legislation. It will be important for public sector employers to remain vigilant to ensure that any new laws do not harm the interests of public sector retirement employers, employees and retirees.