Public Employee Deferred Compensation
— What Is It?

By DAVID ZAHLLER

With so many financial obligations competing for employees' paychecks, it is becoming harder for them to save enough money to maintain, after retirement, the sort of lifestyle they developed as active members of the work force.

Even pensions may be inadequate tomorrow for employees who retire today. The National Center for Policy Analysis conducted a study of retired persons filing income tax returns. It showed that 38% of the income of those retirees comes from pensions and Social Security benefits, while 45% comes from personal savings.

Chris Martin, Finance Director in Ogle County, Illinois, knows about retirement. Chris serves as an Executive Trustee of the Illinois Municipal Retirement Fund (IMRF), which is the pension fund for 120,000 active and 43,000 retired employees for 2,500 units of government in the State of Illinois.

"All workers need to prepare early for retirement. The IMRF pension plan and social security coupled with an employer offered deferred compensation plan could easily provide the replacement income necessary for a worry-free retirement."

Concerned public officials across the country are turning to 457 deferred compensation plans as a workable solution to this problem. It is a highly effective means for employees to supplement their retirement income.

The concept of deferred compensation is not new. It started in the 1930s with the implementation of the first corporate pension plans; an opportunity to save pre-tax dollars during peak earning years to supplement retirement income. In the 1950s, public school teachers successfully lobbied for TSAs (Tax Sheltered Annuities) which allowed them to build supplemental retirement funds.

As a result of effective lobbying efforts by various interest groups, Congress passed the Tax Reform Act of 1978 which gives local government (state, county, city, township) employees the right to participate in a public employee deferred compensation plan if their employer chooses to make one available to them. The Internal Revenue Code which all plans must comply with is Section 457, thus the title 457 deferred compensation plans.

These plans allow participants to defer the lesser of 33 1/3% of includible income (usually 25% of taxable income) or $7,500 per year. Taxes on the deferred amount and on earnings don't come due until those dollars are actually received.

Deferred Compensation has virtually no effect on Social Security or IMRF benefits, either during accumulation or during withdrawal of accumulated funds. As the funds are drawn out they are taxed as ordinary

August 1990 / Illinois Municipal Review / Page 11

income according to your tax bracket at that time. In Illinois, these distributions are treated the same as your state pensions and therefore will not be subject to Illinois state income tax.

HERE'S HOW DEFERRED COMPENSATION WORKS:

Deferred compensation is payroll deducted pre-tax savings program. Typically the minimum deferral amount can be as low as $20.00 per month. However, as an example based on a $50.00 per check deferral and the 15% tax bracket:

$50.00 deposited into your account =
$41.00 deducted from your paycheck (net take-home)
+ $ 9.00 is the amount that would have gone to federal and state taxes.

The $9.00 represents tax dollars that will be working for you in your chosen investments with your $41.00. The total of $50.00 credited to your account for 26 pay periods will reduce your W-2 taxable income for the year by $1300.00. After 20 years in such a plan you would have $65,629 (assuming 8.5% not guaranteed).

There is no cost to each governmental jurisdiction other than the incidental costs associated with payroll deduction. Deferred compensation is an optional benefit governmental jurisdictions can offer to employees. Many employers feel it is the most valuable benefit they offer. •

Page 12 / Illinois Municipal Review / August 1990