Do You Really Need the NYCDCP 457 Plan After 59 1/2 Years Old?
In general, the answer is no. Although, if you are over 59 ½ years old and are still working for FDNY/NYPD it may make sense to continue to contribute to the NYCDCP 457 plan. Or, if you live in New Jersey or plan to retire to New Jersey it may be more beneficial to not rollover the 457 plan to an IRA, regardless of age.
There are two main reasons why the NYCDCP 457 plan may not be needed after 59 ½:
1. Mandatory 20% federal tax withholding. The NYCDCP is required to withhold 20% federal tax on most distributions. There are a few exceptions to this rule; installment payments of 10 years or more, required minimum distributions, payments spread over your life expectancy, etc.
2. Periodic payment requirement. The NYCDCP 457 plan is subject to a periodic payment rule as it relates to the $20,000 NYS Pension and Annuity Exclusion.
Federal Tax Withholding
An IRA distribution paid to an individual is subject to 10% federal tax withholding, but the individual is permitted to elect zero federal tax withholding. As stated above, the 457 plan has mandatory 20% federal tax withholding in most cases.
The following compares a $20,000 distribution from an IRA vs. a $20,000 distribution from the 457 plan of a married 3/4 retiree (60 years old) with “negative” taxable income of $20,000. Although unusual, it is possible to have negative taxable income. The IRA retiree, knowing that he has negative taxable income, decides to withhold 0% while the 457 plan retiree is forced to withhold 20%.
IRA retiree
$20,000 distribution
Federal tax withholding = $0
Federal tax withheld = 0%
Cash received = $20,000
Federal tax owed = $0
Federal tax refund = $0
457 plan retiree
$20,000 distribution
Federal tax withholding = $4,000
Federal tax withheld = 20%
Cash received = $16,000
Federal tax owed = $0
Federal tax refund = $4,000
The following compares a $40,000 distribution from an IRA vs. a $40,000 distribution from the 457 plan of a married 3/4 retiree (60 years old) with taxable income of $40,000. The IRA retiree decides to withhold 12% while the 457 plan retiree is forced to withhold 20%.
IRA retiree
$40,000 distribution
Federal tax withholding = $4,800
Federal tax withheld = 12%
Cash received = $35,200
Federal tax owed = $0
Federal tax refund = $0
457 plan retiree
$40,000 distribution
Federal tax withholding = $8,000
Federal tax withheld = 20%
Cash received = $32,000
Federal tax owed = $0
Federal tax refund = $3,200
In both examples, the 457 plan retiree gets a refund for the excess amount of federal tax withheld. However, most retirees would rather have that $4,000 or $3,200 during the year so it can be invested or spent at the time of withdrawal. The 457 plan retiree has provided an interest free loan to the federal government.
Periodic Payment Rule 457 Plan
To take advantage of the $20,000 NYS Pension and Annuity Exclusion, the distribution must be periodic if distributed from the 457 plan. There is no periodic distribution rule if distributed from an IRA. A periodic payment is a distribution that is spread over more than one year, such as installments. Since the IRA does not have the periodic payment requirement it provides more flexibility to the retiree.
For example, an IRA retiree (over 59 ½ years old) requests a lump-sum withdrawal of $20,000 (no installments). The IRA retiree would be eligible for the $20,000 NYS Pension & Annuity Exclusion. If the 457 plan retiree were to do the same he/she would not be eligible for the $20,000 NYS Pension & Annuity Exclusion because the $20,000 was not a periodic payment.
Conclusion
The 457 account has a key advantage over other accounts in that it is liquid at retirement. There is no minimum age requirement to take a penalty free withdrawal, whereas the minimum age requirement for an IRA is 59 1/2. However, once retirees reach 59 1/2 the liquidity advantage dissipates. The IRA and the 457 are now on equal footing in terms of liquidity. In addition, the IRA is superior to the 457 in a few ways. The IRA account does not have a forced tax withholding and the 457 account is usually forced to withhold 20%. IRA account withdrawals have more flexibility with regard to the $20,000 NYS Pension & Annuity Exclusion, and do not have to be part of a periodic payment. These two key differences offer the IRA account owner the potential for superior tax planning.