Public Pensions

Section 457 Plans Pose Greater Risk Than Other Supplemental Plans Gao ID: HEHS-96-38 April 30, 1996

Millions of state and local government employees are trying to increase their future retirement benefits by deferring some of their wages to supplement pension plans, known as salary reduction arrangements or plans. The amount deferred or contributed to these plans, however, may be at risk. Recent media stories have recounted instances of imprudent investment, improper use of plan funds by sponsors, and possible seizure of plan funds by sponsoring governments' creditors. This report examines the risks of financial loss inherent in such plans and discusses whether the provisions of such plans treat participants comparably.

GAO found that: (1) most state and local government employees are covered under section 457 plans because the Tax Reform Act of 1986 prohibited state and local governments from establishing plans under sections 401(k) and 403(b); (2) section 457 plan participants risk losses if sponsoring governments go bankrupt or the deferred monies are mismanaged or lost; (3) section 457 does not require sponsoring governments to maintain deferred monies to pay future benefits; (4) section 457 plan participants risk losses because sponsoring governments may view deferred monies as available for public use; (5) while funds enrolled in section 401(k) and 403(b) plans can be transferred to investment retirement accounts (IRA) when the employee leaves state or local government employment, amounts payable from section 457 plans can only be rolled over into other section 457 plans; (6) section 457 plan participants must declare a fixed date for when they will begin receiving their benefits shortly after retiring or leaving employment; (7) according to IRS, the transfer of section 457 plan deferrals into IRA or allowing plan participants to change their distribution dates would create a taxable event or be incompatible with the plan's tax deferred condition of government ownership; (8) section 457 plans allow a lower maximum annual employee deferral and employer contribution than section 401(k) and 403(b) plans, and are not indexed; and (9) new legislation could increase the section 457 plan deferral and contribution limit and index section 457 plans to inflation.

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