It's time to fix 457 plans for public employees - or replace them with 401(k) plans.
The Orange County, Calif., disaster has highlighted the major flaw in the 457 plan concept. Even though the assets represent deferred compensation, they in effect belong to the plan sponsor until the employee actually retires or leaves the employer.
This flaw has thousands of public employees in 457 plans around the country worried about the safety of their accounts. Some have stopped contributing to their 457 plans.
In the case of Orange County, employee participants seem likely to lose 22% or even more of their account balances.
The assets of the $80 million Orange County Deferred Compensation Fund were managed by Robert L. Citron, who resigned as Orange County treasurer in December after the sensational losses were revealed. His overleveraging of a short-term investment program led the county into bankruptcy, which has entangled the assets of the fund.
Orange County officials seized 10% of the assets of the 457 plan in connection with the county's Chapter 9 bankruptcy proceeding. But the percentage loss could rise to at least 22% for all employees in the plan depending on the outcome of bankruptcy litigation, county labor leaders say (see story on page 33).
This is inexcusable. The Orange County employees have lost a good part of their savings in the deferred compensation plan through no fault of their own. Because of the tax law, the assets must be seen as county assets until each employee retires. But because they are legally county assets, they became part of the assets that will be used to repay the county's creditors in the bankruptcy.
Some way must be found for 457 plan assets to be legally segregated from plan sponsor assets so employees are not at risk. Either the law must be changed to provide for segregation of these assets in a trust, separate from sponsor and employees, or the 457 plan must be abolished, and all public employees allowed to participate in the 401(k) plan.
Now, only a few public employees can use 401(k)s. They were grandfathered when tax law changes in the mid-1980s prohibited further public employee 401(k)s.
There is no reason public employees should be relegated to second-class citizen status in a 457 plan while corporate employees can participate in the far safer and more flexible 401(k) plan. Apparently public employee 401(k)s were banned as a revenue raising measure in the tax law revisions, but there is no reason public employees should bear such a burden. It is an inequity.
Further, the Orange County fiscal disaster has harmed the willingness of public employees to save for their retirement through their 457 plans. In effect, it has weakened one of the legs of the proverbial three-legged retirement stool.
Congress should not waste its time trying to harness derivatives in a misguided attempt to prevent future Orange County fiscal disasters. Derivatives, afterall, played almost no role in causing the disaster.
Rather, if it wants to make something positive emerge from the Orange County situation, Congress can correct the 457 plan flaws.
It can do so either by allowing 457 assets to be segregated in trusts, or by restoring the right of public employees to participate in 401(k) plans.
The time to act is now - before long-lasting damage is done to public employees' faith in 457 plans or other employer-sponsored savings vehicles.