Retirement plans can be confusing, and saving for retirement can be difficult. Many people are familiar with a 401(k), but what if your employer does not offer one?
There are many other options available, including 457(b) plans. These plans are similar to a 401(k), but there are a few distinct differences. So, what is a 457b plan, and how does it work?
Keep reading to learn about them and whether or not you should add one to your retirement savings portfolio.
What Is A 457(b) Plan?
A 457(b) plan is a retirement savings plan sponsored by your employer and receives favorable tax treatment.
These plans are typically not considered qualified plans under Section 401 of the Internal Revenue Code. A 457(b) plan allows you to contribute pre-tax dollars to the plan and defer the income taxes on the contributions and investment growth until you begin making withdrawals at retirement age.
These plans are technically recognized as deferred compensation plans for the IRS. They are usually available to state and local government employees and highly paid executives at non-profit organizations.
457 plans come in two flavors. The first is the 457(b) plan, which is usually available to state and local government employees and is the most common type of 457 plan. These plans are typically not qualified retirement plans and are not subject to ERISA.
The other option is the 457(f). This plan is usually available to non-profit employees like hospitals or charity executives. Both types are considered defined contribution plans. Employees make contributions on a tax-deferred basis, and employers may also provide matching contributions.
An employee may contribute up to 100% of his or her salary in a given year if that amount does not exceed the overall contribution limit laid out by the IRS.
KEY TAKEAWAYS
- A 457(b) retirement plan functions similiar to a 401(k) plan; however, it is considered a deferred compensation plan and not a Qualified Retirement plan.
- Typically, investment options are somewhat limited with a 457 plan. The employer usually offers mutual funds and annuities as the primary investment options.
- One of the significant benefits of a 457(b) is the ability to make penalty free withdraws prior to age 59 1/2.
How A 457(b) Retirement Plan Works
A 457(b) plan works like one you are probably already familiar with. That is the 401(k) plan.
- An employee makes pre-tax contributions to the plan, and the investments in the plan are allowed to grow tax-free until the participant begins taking withdrawals.
- The employer may also make matching contributions to the plan.
- Contributions and earnings are taxed as income once withdrawals are made at age 59 1/2 or older.
However, a 457(b) retirement account does differ from a 401(k) in some aspects.
The investment options with a 457(b) are typically limited. These plans offer Annuities and mutual funds as the primary investment types.
- Both options offer tax deferrals, but you do not have nearly as many investment options as you would through an IRA or other retirement account.
- The other thing that sets a 457(b) apart is that you can sometimes take early withdrawals penalty-free.
If you leave your job or retire from your employer before age 59 1/2, you can still withdraw funds from your 457(b) without the 10% early withdrawal penalty that comes along with a 401(k).
This is one of the key differences between a 457(b) retirement plan and a 401(k). However, if the funds in the 457(b) are a rollover from a qualified plan like a 401(k), you might still be subject to the 10% tax penalty.
Similar to a 401(k), Roth versions of the 457 plan are also available. Roth accounts allow you to make after-tax contributions. Since these Roth contributions have already been taxed, you can withdraw them tax-free upon retirement.
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How To Enroll In A 457 Plan
Enrollment in a 457 plan is easy if your employer offers this type of plan. Your employer will lay out the specific eligibility rules, so you should check with your Human Resources department to determine whether you can enroll in a 457 plan.
Enrolling typically involves notifying your employer that you wish to participate in the plan. You will also tell your employer how much you want to contribute to the plan. Your contributions will be automatically deducted from your paycheck and placed into your 457 account.
Most employers allow you to change your contribution amount or even stop your participation in the plan anytime. To re-enroll, you typically need to notify your employer that you wish to begin making contributions again.
Some employers require completing a form or document, while others allow you to make your choices electronically. Either way, it is pretty easy to enroll in a 457 plan and make changes to your contribution amounts.
457(b) Contribution Limits For 2021
As with most retirement plans, a 457(b) also has an annual contribution limit. This is the maximum dollar amount that can be contributed to the account in any given year.
In 2024, that limit is $23,000. If you are 50 or older, the Internal Revenue Service will allow the plan participant to place an additional $7,500 in your account as a catch-up contribution and up to $46,000 for the special 457(b) catch-up.
Remember that your employer match also counts toward your contribution limit. For example, if your employer contributes $12,000 to your account, you can only contribute an additional $11,000.
TIP
There are two types of 457 plans. The 457(b) is usually available to state and local government employees, and the 457(f) is generally available to non-profit employees like hospitals or charity executives.
Advantages & Disadvantages Of 457(b) Plans
While a 457(b) plan offers many great advantages, it also has a few drawbacks or limitations. First, we will discuss the pros of this type of plan.
Advantages
Since your contributions are made on a pre-tax basis, your taxable income in the current year will be lowered. This means you get a salary reduction for tax purposes and a lower tax bill in the current year.
Another advantage to these plans is that they generally offer a great selection of mutual fund investment options. Mutual funds can provide great returns, and the income from these investments is not taxed until withdrawals are made.
Finally, one of the most significant benefits of the 457(b) is that you can make withdrawals penalty-free even if you retire before the designated retirement age.
Disadvantages
One major drawback of the 457(b) is that your employer matching contributions count toward your maximum contribution amount.
A maximum amount can be contributed to your account each year, including both the employee and employer contributions.
While you can access your money if you retire early, getting a hardship withdrawal from a 457(b) can be complicated. You must have no other resources available, and the withdrawal must be for an unforeseeable emergency.
The Bottom Line
If your employer offers a 457(b) plan, taking advantage of it is a great idea. These plans offer many great benefits and can help you stash away enough savings for retirement.
They also offer tax advantages, and you can withdraw money upon retirement penalty-free even if you retire early. If available, you should enroll in a 457 plan through your employer.
Frequently Asked Questions
Neither plan is better than the other. The two are very similar. Both plans allow you to make tax-deferred contributions into investments that are allowed to grow tax-free until retirement.
401(k) plans are employer-sponsored plans usually offered in the corporate world. 457(b) plans are generally provided to government employees and employees of non-profit organizations.
Your employer may offer access to both types of plans.
Yes, if you have access to both plans, you can max out your contribution to each type of plan.
In practicality, this would be a large sum of money, so only highly compensated individuals would likely be able to max out both accounts.
Remember that employer contributions to a 457(b) count toward the annual maximum, so it would be easier to max out both plans if your employer offers a significant matching contribution.
You should also know that the IRS has an individual limit on salary deferral each year, regardless of how many plans you are enrolled in.
There are few differences between a 403(b) and 457(b) plan. The main difference is what type of employer offers the plans.
A 403b plan is generally offered to employees of private non-profits and government employees, such as school employees.
A 457b, on the other hand, is usually offered to state and local government employees.
Both plans allow tax-deferred contributions and, under certain circumstances, penalty-free withdrawals before age 59 1/2.
There are only a few differences between a 401(a) and a 401(k). The main difference lies in the types of employers who sponsor the plan.
There are also differences regarding annual contribution limits and mandatory contributions. The tax treatment and early withdrawal rules are essentially the same.
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