State and Local Government 401(k) Plans
Provisions in the House- and Senate-passed pension bills
March 2006
Permits state and local government to maintain a 401(k) plan and provides for coordination of contribution limits with 457 plans. Making 401(k) plans available to the public sector could put pressure on employers to provide yet another optional retirement plan (ORP) to their employees. State and local plan administrators would need to learn new rules and establish new system components to accommodate a 401(k) plan, which has more restrictive rules than 457 plans. For example, state and local government employees who opt for a 401(k) plan would not have the exemption from the 10 percent penalty (provided for in a 457 plan) on withdrawals prior to age 59 ½. It also could place a burden on administrators to explain to employees the differences between a 401(k) plan and a 457 plan. If enacted, the provision has the potential to reduce 457 contributions due to the required coordination of contribution limits with 401(k) plans. The coordination rules in the proposal do not apply to pre-1986 grandfathered 401(k) plans.
At the state level in particular, some groups are concerned that 401(k) plans could make it easier to eventually supplant the state DB plans. They recognize that 457 plans have played an important role as a supplemental and portable partner with existing defined benefit plans. In a similar vein, some are concerned that if states are initially offered the option of a 401(k) plan, it could make it easier for Congress to later mandate a 401(k)-like replacement (ERSAs; see “Savings & Retirement Issues in Administration’s FY 2007 Budget Proposal”) for existing state and local government plans. ICMA-RC, and other state and local government organizations, do not believe the addition of new 401(k) plans into the governmental market will be beneficial to state and local employees and employers.