However, amounts in plans organized under Internal Revenue Code (IRC) section 457(b) (hereinafter referred to as 457 plans) bear additional risk because salary deferrals to 457 plans are assets of the sponsoring employer that may be used for nonplan purposes and which are subject in the event of bankruptcy to the claims of general creditors. Federal income tax is postponed until employees begin to receive their account balances, usually at retirement or when they are no longer employed by the plan’s sponsor. With the enactment of the Tax Reform Act of 1986,state and local government employers who had not previously established 401(k) plans were prohibited from establishing new 401(k) plans, but existing plans could continue. Despite concerns raised by representatives of state and local governments, among others, the rationale for this exclusion was that allowing public employees to have access to both 401(k) plans and 457 plans would be “inappropriately duplicative.”
Only employees of and independent contractors providing service to state and local government and tax-exempt organizations may participate in 457 plans. Provisions of 457 Plans Disadvantage Participants

Section 457 plans are substantially different from 401(k) and 403(b) plans. The plan accounts can only be transferred to another eligible 457 plan if the new government employer will accept the transfer. Amounts deferred under section 457 cannot be rolled over to an IRA and have tax deferred on the distribution as can 401(k) and 403(b) plan funds. In contrast, separating participants in 401(k) and 403(b) plans are not required to declare a date for benefits to begin. The maximum total deferral a participant can make to a 401(k) or 403(b) plan is governed by the maximum deferral allowed under section 457 when a participant actually makes deferrals under a 457 plan. Further, those deferred amount limits are not indexed for inflation.
Why GAO Did This Study

Pursuant to a congressional request, GAO reviewed the status of public pension funding, focusing on how plans established under Internal Revenue Code (IRC) section 457 differ from plans created under IRC sections 401(k) and 403(b).

What GAO Found

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.