And although the personal satisfaction and rewards received can make these career choices "worth it," many people are hesitant to pursue these careers because the financial benefits are often far better elsewhere. Yet these individuals who perform such an important role in our society certainly deserve a financially secure retirement - a retirement with dignity.

This part of the website addresses the opportunity public service professionals have to attain a more secure retirement future. Congress has passed special tax laws specifically designed to assist public service professionals in preparing for retirement. The result is a retirement program called a 457 Plan.

If you are a public service professional, you need to know about this simple method of keeping more of your hard-earned money through special tax savings.

The 457 Plan is a salary reduction plan similar to a 403(b). It is also known as a deferred compensation plan. Individuals participate by electing to have a certain portion of their salary deposited into an approved retirement fund vehicle, such as a fixed annuity. This monthly contribution is taken out of the pay before taxes and is excluded from the current federal and state taxable income.

In 2001, individuals could only contribute up to $8,500 into their 457 Plan annually. New IRS changes, however, have increased this annual limit to $11,000 for 2002. This limit will increase $1,000 each year until 2006, when the limit will be $15,000 annually. Then beginning in year 2007, the limit will become indexed. Also beginning in 2002, individuals who are age 50 or older may contribute an additional $1,000 annually. This additional contribution limit will also increase $1,000 annually until 2007, when it will become indexed as well.

Furthermore, there is a catch-up provision for individuals who are at least age 50 and have not taken full advantage of the contribution limits in the past. During the last three years of employment, the catch-up provision allows an employee to contribute up to $22,000.00, depending on how much they have contributed in the past. The maximum amount allowed is calculated by subtracting the actual amount contributed from that which could have been contributed in previous years. (The catch-up limits will reset if the employee leaves the job and begins employment with another eligible employer.)

In addition to the catch-up provision, people are also now allowed to contribute up to 100% of their pay (less FICA, Medicare, etc.,) as long as the total pay falls within the applicable limits. This option can be very attractive to an individual whose income is not needed to provide for the household.

Because the funds contributed to a 457 Plan are not included when calculating current taxable income, depending on the amount contributed, this plan could lower an individual's annual taxable income enough to cause him or her to fall into a lower tax bracket. In some cases, an individual may actually increase his or her annual net income by contributing to a 457 Plan.

As a result of the tax savings linked to 457 Plans, many people have discovered they are able to adequately save for their future retirement with only a minimum reduction in their take-home pay. Consider the value of contributing a portion of an individual's monthly pay to a 457 Plan before taxes are taken out. A person in the 28% tax bracket who chooses to contribute $1,000 to his 457 Plan would save $385.80 in federal and state taxes. He is putting away $1,000 for his future retirement, but because of the 457 Plan tax savings, his true "out-of-pocket" expenditure is only $614.20. This means that an individual could contribute $12,000 a year to his 457 Plan, yet only reduce his annual take-home pay by $6,285.45. It's like being given a free $5,714.55 every year toward retirement!

By contributing annually to a 457 Plan, an individual takes advantage of not only tax savings but also tax-deferred growth. Internal Revenue Code Section 72(e) states that interest earned in a retirement vehicle, such as a fixed annuity, is not taxable to the owner until it is withdrawn. As long as the funds remain within the retirement vehicle, the interest can accumulate completely tax deferred. This means that an individual can earn interest not only on the money he or she deposits into a 457 Plan, but also earn interest on the interest and interest on the money that normally would be paid in taxes.

This triple advantage of tax deferral found in 457 vehicles like fixed annuities can have a major impact on the ultimate value of a 457 Plan. For example, let's look at the retirement savings accounts of a woman named Mary and a man named John. Both of these individuals are in a 28% tax bracket, and both are earning a 5% return on their money.

Each year, Mary deposits $12,000 into a Certificate of Deposit, (a CD), and at the end of the year she must pay taxes on all the interest earned in her CD. At the end of 20 years, Mary's retirement account balance would equal $348,472.07. John, however, chose to deposit $12,000 a year into a fixed annuity. Because he benefits from tax-deferred growth, John does not have to pay any taxes at the end of the year, but is able to leave all of his earnings in his annuity to earn even more interest. At the end of 20 years, John's retirement account balance would equal $405,804.55. That is $57,332.48 more than Mary would have, simply because John chose to take advantage of tax-deferred growth with a fixed annuity. It is true that John will have to pay taxes on funds withdrawn from his 457 Plan, but it is very likely that he will be in a lower tax bracket when he begins using these funds. Plus, by withdrawing his retirement account balance systematically over time, he would continue to benefit from tax-deferred growth. Not only does the 457 Plan offer the benefits of tax savings and deferred growth, but also other unique benefits as well. For example, normally if money is withdrawn from a retirement account before the individual is at least 59 ½, the IRS imposes a 10% tax penalty*. With the 457 Plan, however, this 59 ½, 10% rule does not apply. (To qualify for a penalty-free withdrawal before age 59 ½, an employee must first cease employment prior to the distribution. *All references to the 10% tax penalty are referring to the 10% excise tax imposed by the IRS for premature withdrawals.)   And for lower-income employees, 457 Plan contributions could potentially qualify as a 10%, 20% or 50% tax credit, depending on the individual's annual income level. Lastly, employers may compensate their employees for accumulated vacation and sick leave by contributing directly to their 457 Plans. This contribution can only be made in the year of separation, and currently the limit on this deferred compensation feature is $40,000. Consider the example of an employee who makes $50,000 a year and who has 150 days of accumulated sick leave at retirement. The annual salary divided by number of annual working days determines the amount per day that this employee is eligible to receive. In this case, the employee is entitled to receive $277.77 per unused sick leave day. Multiply $277.77 by the 150 accumulated sick leave days, and this employee is entitled to receive $41,666.67. According to the new 457 rules, $40,000 of this amount can be contributed to the employee's 457 Plan, leaving only $1,666.67 to be included in the current taxable income. Not only is this feature a benefit to the employee, it also saves the employer money on FICA, Medicare and TRS.

Furthermore, for those individuals who already have a 457 Plan, the new IRS changes give you more control over your assets. Beginning in January 2002, the IRS now allows event-driven rollovers of a 457 Plan into an IRA. Qualified events include retiring, changing employment as a federal employee to a state employee, leaving one school district to work for another, moving into the private sector, etc. By taking advantage of this tax-free rollover option, you can ensure that your assets continue to work for you.  

Piecing together a secure retirement plan can be a puzzling experience, as many options must be considered. But whether used in conjunction with another plan or used alone, the 457 Plan is one of the best retirement planning options available to public service professionals. With its special tax savings, tax-deferred growth and other unique benefits, the 457 Plan can help you enjoy the retirement lifestyle you deserve - a retirement with dignity.