Many people only associate retirement accounts with a 401(k) or an IRA. However, not all employers offer these retirement savings options. A 401(k) is generally only available to those employed in the private sector, so what about government employees and others who work in the public sector?
Many employers in this space offer a 403(b) or a 457 plan – and sometimes both! These plans offer many benefits and can be a great way to put away a good nest egg. So, how do they work, and which one should you choose?
We’ll explain everything you need to know about 403(b) vs. 457(b) plans, including similarities and critical differences. Keep reading to learn the details.
How A 403(b) Plan Works
The 403(b) plan is similar to a 401(k) for government employees and employees of non-profit organizations. These plans are not considered qualified retirement plans. They were created by law and recognized by the IRS in 1958.
The law at the time stated that investments in these plans were limited to annuity contracts. For that reason, they were often referred to as tax-sheltered annuities or tax-deferred annuities. While the investment options have expanded slightly since then, the options in this type of plan are much more limited than those in some other traditional retirement plans.
- At the basic level, a 403(b) plan allows the participant to contribute funds tax-deferred for retirement. The investments in the plan grow tax-free until the participant begins taking withdrawals at retirement.
- In the current year, the participant’s taxable income is reduced by the amount that goes into the plan. You may contribute up to $23,000 to your 403(b) plan in a single year. If you are over 50, you can make an additional catch-up contribution of $7,500.
- Your employer might also decide to make matching contributions to your plan. However, your plan’s total deposits between employee and employer contributions cannot exceed $69,000 for 2024.
Regarding distributions, a 403(b) is very similar to a 401(k). You may begin taking distributions at age 59 1/2 without a penalty. At that time, you will pay regular income taxes on any distributions you receive.
If you take a distribution before reaching age 59 1/2, then you will be subject to an additional 10% penalty on that money. Roth options are available, and withdrawals from a Roth plan are generally tax-free.
Minimum distributions are required upon reaching age 73. The only way to avoid these RMDs is to roll your plan into a Roth IRA or other Roth retirement account.
KEY TAKEAWAYS
- Deciding between participation in a 403(b) or 457(b) plan will depend on your situation. Each offers good options for saving for retirement.
- With a 403(b) plan, you can contribute $23,000, and your employer could contribute $46,000 ($69,000 combined). With a 457(b) plan the standard combined contribution limit is $23,000.
- A unique feature of a 457(b) plan is the ability to double your contributions if you are within three years of retirement.
How A 457(b) Plan Works
A 457(b) plan is quite unique. While it is still a tax-deferred retirement savings plan, many of the rules associated with it differ from those of others.
These plans, like 401(a) plans, are typically offered to state and local government employees and are still considered defined contribution plans. The savings in these plans can grow tax-free, although the amount you can contribute and the distribution rules are slightly different.
- The contribution limit for 2024 into a 457(b) plan is $23,000. Again, if you are over 50, you can make an additional catch-up contribution of $7,500.
- However, if you are within three years of retirement age, you may be able to contribute up to $46,000 into your account. This is vastly different from most other retirement accounts.
- When it comes to distributions, you can begin taking distributions from your plan once you are no longer employed with your company, even if you are not yet 59 1/2. If you are still working at your employer, you can begin taking distributions at age 70 1/2 or as needed for an unforeseeable emergency.
- With a 457(b), you can also roll over your funds into a 401(k) or IRA upon leaving your employer.
Another type of 457 plan is the 457(f). These plans are typically only available to top-level executives at non-profit organizations.
These plans are quite different from the 457(b) and are often referred to as deferred compensation plans. The benefits are directly related to years of service and specific performance metrics.
If the goals are unmet, this compensation never comes to fruition. Note that these plans are not very common, and you are not likely to encounter one unless you become an executive at a tax-exempt organization.
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403(b) vs 457(b) Retirement Plans: Comparison And Key Differences
While some people might compare a 403(b) with a 401(k), you are more likely to compare it to a 457(b) if you are a government employee. We will compare the two plans below, highlighting the key differences between them in several important categories.
The IRS lays out strict eligibility requirements for each plan type, and as long as you meet the requirements, you may participate in the plan of your choosing.
Roth Options
Both plan types offer Roth options, but you should always check with your employer to ensure your specific plan allows for Roth contributions. With Roth plans, you contribute to your plan on an after-tax basis.
This means that you can take withdrawals tax-free.
- With a 403(b) plan, you can begin taking your Roth withdrawals tax-free after reaching 59 1/2.
- However, with the 457(b) plan, you must reach age 59 1/2, and your first Roth contribution must have been at least five years ago.
Early Withdrawal Rules
Like a 401(k), you will probably be paying an early withdrawal penalty if you remove funds from your account before reaching the designated retirement age.
- With a 403(b), you’ll pay an extra 10% tax penalty for withdrawing before age 59 1/2.
- The rules are a little different with a 457(b). If you leave your employer, you can begin taking withdrawals penalty-free even if you have not reached age 59 1/2.
Employer Contributions
Your employer may make contributions to your account under either plan. However, the annual limit on the amount they can contribute varies significantly between these plans. You are much more likely to get an employer match into a 401(k) plan than a 403(b) or 457(b) plan, but matches into these plans do exist.
- Under a 403(b) plan, you may contribute up to $23,000 into your account, with your employer making additional contributions to a maximum of $69,000.
- With a 457(b), the maximum annual contribution, considering employer and employee contributions, is $23,000.
Catch Up Contributions
Under both plans, employees aged 50 and older may make catch-up contributions to help grow their savings more quickly. Both plans allow for annual catch-up contributions of $7,500.
- The 403(b) contribution limits also allow for an additional $3,000 if you have been with your employer for at least 15 years.
- A 457(b) has special provisions for those within three years of retirement. For those individuals, you may be able to contribute an additional $23,000 to your account. This is much more than is allowed with a 401(k)!
Contribution Limits
A 403(b) and a 457(b) allow for a maximum annual contribution of $23,000. Again, if you are over age 50, you may contribute an additional $7,500 to your account.
As previously mentioned, your employer may also make contributions to your plan.
- With a 457(b), the $23,00 annual limit is the maximum allowable amount for employee and employer contributions combined.
- However, with 403(b) plans, that limit only applies to the employee contribution. Your employer may contribute additional amounts up to a total contribution of $69,000.
Range Of Investment Options
The range of investment choices in these plans is somewhat limited. Both plans generally only allow for investments in mutual funds and annuities.
Your plan documents will describe precisely what choices are available. You may choose to invest in fixed and variable annuities but cannot invest in many other options available through a 401(k) or IRA.
TIP
If your employer offers a 403(b) and a 457(b) plan, you can choose to participate in either one or both. If you decide to participate in both plans, you can double your annual contribution amount.
Dual Enrollment: 403(b) & 457(b)
So, what if both plans are available to you through your employer? In that case, you can absolutely participate in both if you choose to do so.
The Internal Revenue Service has no rule that prevents you from participating in both plans. This can be a great way to maximize your savings. The deferral limits on each plan are separate so that you can max out your contributions to both plans in each calendar year.
This means you could contribute $23,000 to each plan for a total tax-deferred savings of $46,000!
The Bottom Line
403(b) and 457(b) plans allow you to make pre-tax contributions to help grow your retirement savings. These elective deferrals can grow tax-free in your plan until you reach retirement age.
These plans are generally available to public school employees and other government employees. Each plan has some unique attributes, and you should know the key differences between the two and how to choose the right one.
As always, if you have any questions, you should consult a financial planner to help you make the right decision.
Frequently Asked Questions
It depends on your specific situation. You may only have one option and might not have to choose between the two plans. If you have access to one of these plans, you should contribute to it to help you prepare for retirement.
Should you have access to both types of plans, you can contribute to both plans or consult a financial professional to help you decide between the two. There are pros and cons to each regarding contribution limits, withdrawal rules, and investment options.
Yes, you can be enrolled in both plans! Your contributions to these plans are completely separate, so you can max out your contributions to each plan.
You can contribute up to $23,000 per plan per year. This is a great way to grow your retirement nest egg quickly!
One significant benefit of this plan is that you can double your contributions within three years of retirement.
This means you could contribute up to $46,000 to your plan in 2024 if you are within three years of retirement age.
Another benefit of these plans is withdrawals. Most plans assess a penalty for withdrawals before age 59 1/2.
However, a 457(b) allows you to make penalty-free withdrawals regardless of age after you leave your employer. So, if you retire at age 50 and leave the employer sponsoring your plan, you can begin taking withdrawals without a penalty.
The 403(b) plan allows your savings to grow tax-free or tax-deferred until retirement age. Employers may make matching contributions to your plan to help your savings grow more quickly.
However, as with many other retirement plans, you will incur early withdrawal penalties in a 403(b) if you withdraw your money before reaching age 59 1/2.
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