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, just what is a 457b plan and how do they work? Keep reading to learn all 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 that is sponsored by your employer and receives favorable tax treatment. These plans are typically not considered qualified plans under Section 401(a) of the Internal Revenue Code. 457(b) plans allow 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 employees of state and local government as well as highly-paid executives at non-profit organizations.
457 plans come in two flavors. First is the 457(b) plan which is usually available to state and local government employees. This is the most common type of 457 plan. These plans are typically not qualified retirement plans, and they are not subject to ERISA. The other option is the 457(f). This plan is one that is usually available to non-profit employees like the executive of a hospital or charity. 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, as long as that amount does not exceed the overall contribution limit laid out by the IRS.
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How A 457(b) Retirement Plan Works
A 457(b) plan works much like a plan that 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 into the plan. The contributions and earnings are taxed as income once withdrawals are made at age 59 1/2 or older. The 457(b) retirement account does vary from a 401(k) in some aspects though.
The investment options with a 457(b) are typically limited. Annuities and mutual funds are the two main investment types offered through these plans. Both of these options offer tax deferrals, but you do not have nearly as many investment options as you would through an IRA or other type of retirement account. The other thing that sets a 457(b) apart is the fact 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 457b retirement plan and a 401k. If the funds in the 457(b) are a rollover from a qualified plan like a 401(k), however, you might still be subject to the 10% tax penalty.
Similar to a 401(k), there are also Roth versions of the 457 plan available. Roth accounts allow you to make after-tax contributions. Since these Roth contributions have already been taxed, then you get to withdraw them tax-free upon retirement.
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How To Enroll In A 457 Plan
Enrollment in a 457 plan is easy, as long as 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. The process for enrolling typically involves notifying your employer that you wish to participate in the plan. You will also tell your employer how much you wish 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 at any time. To re-enroll, you typically just need to notify your employer that you wish to begin making contributions again. Some employers require the completion of 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.
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Advantages & Disadvantages Of 457(b) Plans
While a 457b plan offers many great advantages, there are also a few drawbacks or limitations to this type of plan. First, we will discuss the pros of this kind of plan. Since your contributions are made on a pre-tax basis, your taxable income in the current year will be lowered. This means that you essentially get a salary reduction for tax purposes and a lower tax bill in the current year. Another advantage to these plans is the fact that they generally offer a great selection of mutual fund investment options. Mutual funds can offer great returns, and the income from these investments is not taxed until withdrawals are made. Finally, one of the biggest benefits of the 457(b) is the fact that you can make withdrawals penalty-free even if you retire before normal retirement age.
One major drawback of the 457(b) is the fact that your employer matching contributions count toward your maximum contribution amount. There is a maximum amount that can be contributed to your account each year, and that includes 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 difficult. You must have no other resources available, and the withdrawal must be for an unforeseeable emergency.
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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 placed into your account during any given year. In 2021, that limit is $19,500. If you are age 50 or older, the Internal Revenue Service will allow the plan participant to place an additional $6,500 in your account as a catch-up contribution. Remember that your employer match also counts to your contribution limit. For example, if your employer contributes $12,000 to your account, then you can only place an additional $7,500 into the account.
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The Bottom Line
If your employer offers a 457(b) plan, then it is a great idea to take advantage of it. These plans offer many great benefits, and they can help you stash away enough savings for retirement. They offer tax advantages as well, and you can withdraw money upon retirement penalty-free even if you retire early. If available, you should go ahead and enroll in a 457 plan through your employer today.
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Frequently Asked Questions
Is a 457b better than a 401k?
Neither plan is really better than the other. In fact, 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 that are usually offered in the corporate world. 457(b) plans are usually offered to government employees and employees of non-profit organizations. It is possible that your employer offers access to both types of plans.
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Can you max out both a 401k and a 457b?
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 individuals who are highly compensated would likely be able to max out both accounts. Remember that employer contributions to a 457b count toward the annual maximum, so you might be able to max out both plans if your employer offers a large 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.
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What’s the difference between a 403b and a 457b?
There are few differences between a 403b and 457b. The main difference is what type of employer offers the plans. 403b plans are generally offered to employees of private non-profits and government employees like school employees. A 457b, on the other hand, is usually offered to state and local government employees. Both plans allow tax-deferred contributions, and both plans allow for withdrawals penalty-free before age 59 1/2 under certain circumstances.
