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 either a 403(b) or a 457 plan – and sometimes both! These plans offer many benefits, and they 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 when it comes to 403b vs 457b plans. This includes similarities as well as key differences, so keep reading to learn the details.
How A 403(b) Plan Works
The 403(b) plan is much like a 401(k) for government employees and employees of non-profit organizations. This type of qualified retirement plan was specifically created by law and recognized by the IRS in 1958. At the time, the law stated that investments in these plans were limited to annuity contracts. For that reason, they were often referred to as a tax sheltered annuity or tax-deferred annuity. While the investment options have expanded slightly since then, the options in this type of plan are much more limited than some other traditional retirement plans.
At the basic level, a 403(b) plan allows the participant to contribute funds on a tax-deferred basis for retirement. The investments in the plan are allowed to 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. In a single year, you may contribute up to $19,500 into your 403(b) plan. If you are over age 50, then you can make an additional catch up contribution of $6,500. Your employer might also decide to make matching contributions into your plan. However, the total deposits into your plan between both employee and employer contributions cannot exceed $58,000 for 2021.
When it comes to 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 that 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. Upon reaching age 72, required minimum distributions begin. The only way to avoid these RMD’s is by rolling your plan over into a Roth IRA or other Roth retirement account.
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 this kind of plan are different from other plans. These plans, like 401a plans, are typically offered to state and local government employees, and they are still considered defined contribution plans. The savings in these plans can grow tax-free, although the amount that you can contribute and the distribution rules are a little different.
The contribution limit for 2021 into a 457(b) plan is $19,500. Again, if you are over age 50, you can make an additional catch up contribution of $6,500. However, if you are within three years of retirement age, you may be able to contribute up to $39,000 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 age 59 1/2 yet. If you are still working at your employer, then you can begin taking distributions at age 70 1/2 or as needed for an unforeseeable emergency. With a 457(b), you also have the option to rollover 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 they are often referred to as deferred compensation plans. The benefits are directly related to years of service and certain performance metrics. If the goals are not met, then 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.
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 be comparing it to a 457(b) if you are a government employee. We will compare the two plans below, highlighting the key differences between the two 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.
Both plan types offer Roth options, but you should always check with your employer to make sure that your specific plan allows for Roth contributions. With Roth plans, you make contributions into 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 age 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
Similar to a 401(k), you will probably be paying an early withdrawal penalty if you remove funds from your account before reaching normal retirement age. With a 403(b), you’ll pay an extra 10% tax penalty for making withdrawals 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.
Your employer may make contributions to your account under either plan. However, the annual limit on the amount that they can contribute varies greatly between these types of plans. You are much more likely to get an employer match into a 401(k) plan than a 403(b) or 457(b), but matches into these plans do exist. Under a 403(b) plan, you may contribute up to $19,500 into your account with your employer making additional contributions to a total maximum of $58,000. With a 457(b), the maximum contribution per year is $19,500 considering both employer and employee contributions.
Catch Up Contributions
Under both plans, employees age 50 and older may make catch up contributions to help grow their savings more quickly. Both plans allow for annual catch up contributions of $6,500. The 403(b) contribution limits also allow for an additional $3,000 on top of this if you have been with your employer for at least 15 years. A 457(b) has special provisions for those who are within three years of retirement. For those individuals, you may be able to contribute an additional $39,000 into your account. This is much more than is allowed with a 401(k)!
Both a 403(b) and 457(b) allow for a maximum annual contribution of $19,500. Again, if over age 50, you may contribute an additional $6,500 into your account. As previously mentioned, your employer may also make contributions to your plan. With a 457(b), the $19,500 annual limit is the maximum allowable amount for both employee and employer contributions combined. However, that limit only applies to employee contributions for a 403(b). Your employer may contribute additional amounts up to a total contribution of $58,000.
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 specifically what choices are available. You may choose to invest in both fixed and variable annuities, but you cannot invest in many other options that might be available through a 401(k) or IRA.
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 you can max out your contributions to both plans in each calendar year. This means that you could contribute $19,500 to each plan for a total tax-deferred savings of $39,000!
The Bottom Line
Both 403(b) plans 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 now know the key differences between the two and how to choose the right one for you. As always, if you have any questions, you should consult a financial planner to help you make the right decision.
Frequently Asked Questions
Is a 403b or 457 better?
It depends on your specific situation. You may only have one option, and might not have to pick between the two plans. If you have access to one of these plans, then you should contribute to the plan 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 when it comes to contribution limits, withdrawal rules, and investment options.
Can I have both 403b and 457b?
Yes, you can be enrolled in both plans! The contributions that you make into these plans are completely separate, so you can max out your contribution to each plan. This means that you can contribute up to $19,500 per plan per year. This is a great way to quickly grow your retirement nest egg!
What are the benefits of 457b?
One of the big benefits of this plan is that you are allowed to double your contributions if you are within three years of retirement. This means that you could contribute up to $39,000 to your plan in 2021 if you are within three years of retirement age. Another benefit to these plans relates to withdrawals. Most plans assess a penalty for withdrawals before age 59 1/2. However, a 457b allows you to make withdrawals penalty-free regardless of your 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.
What are some advantages to a 403b?
The 403b plan allows your savings to grow tax-free or tax-deferred until reaching retirement age. Employers may make matching contributions into your plan to help your savings grow more quickly. As with many other retirement plans, however, you will incur early withdrawal penalties in a 403b for taking your money out before reaching age 59 1/2.