If you work for a nonprofit or for the government, you don’t have the option to contribute to a 401(k) retirement account like you would working for a for-profit company. But nonprofit and government employees do have access to some similar retirement savings accounts. The 403(b) plan is designed for those who work for nonprofits, while the 457(b) plan is for government employees. Let’s take a look at each in detail to see how they differ.
What is a 403(b) Plan?
A 403(b) plan is a type of retirement plan for nonprofit employees, including church and public school employees. Like a 401(k), a 403(b) is a tax-advantaged plan designed to make it as easy as possible to save for retirement while also scoring a tax break.
There are two types of 403(b) accounts: traditional and Roth. The difference is how each type treats your taxes. While a traditional 403(b) account takes pre-tax contributions, a Roth 403(b) taxes your contributions but then gives you tax-free withdrawals upon retirement.
Similarly to a 401(k) plan, your employer may offer a matched contribution to your 403(b), though it’s much less common.
What is a 457(b) Plan?
A 457(b) plan is a retirement savings account offered to state and local government employees. As with the 403(b) plan, you may be able to choose between a traditional and a Roth 457(b) account, making it easier to determine how your retirement savings are taxed.
While it is possible for employers to contribute to a 457(b) plan, the reality is that most do not, so you’re on your own when it comes to making sure you’re saving adequately.
Differences between 403(b) and 457(b) plans
Although 403(b) and 457(b) plans have a lot of similarities, they are also different in quite a few ways. Here’s a breakdown of their differences.
Employees of nonprofits are eligible for a 403(b) plan if offered by their employer. Not all nonprofit employers will offer them, so you’ll need to check with yours to see if you are eligible for such a plan.
457(b) plans are offered by some state and local governments and certain non-governmental entities. It’s important to ask your employer for more information if you think you might be eligible for a 457(b) plan.
Both employers and employees may contribute to 403(b) and 457(b) plans, but that doesn’t mean you’re guaranteed to get an employee match. In fact, employer contributions are much less common with these types of plans than they are with a 401(k).
The best thing to do is ask your employer whether they offer an employer contribution when you first join the organization. If a lack of employer contribution is a deal-breaker to you, it may lead you to take a job elsewhere rather than limiting your retirement investment savings in the long run.
The contribution limits are quite different between the two plans. For 2022, the limit for contributions for a 457(b) plan is $20,500 — and that includes employer contributions if you get any. So, if your employer contributes $5,000, you would only be able to contribute an extra $15,500 before hitting your limit.
With a 457(b) plan, you’re also able to contribute an extra $6,500 per year in catch-up contributions in 2021 and 2022 if you are 50 years or older.
The 2022 contribution limit for a 403(b) plan is $61,000 total, which includes $20,500 from an employee. That means you could contribute the maximum allowed for an employee and still receive contributions from your employer without worrying about your limit. It also makes it easier to save more for retirement with a 403(b) plan than with a 457(b) plan.
Like with the 457(b) plan, you can contribute an extra $6,500 per year in 2021 and 2022 once you hit 50 years of age with a 403(b) plan. That makes it easier to squirrel away more money the closer you get to retirement age.
Both the 403(b) and the 457(b) plan are more limited than a typical 401(k) when it comes to investment choices. You typically have two choices for your investments: annuities and mutual funds. If you’re looking for a more diverse portfolio, you may need to open a personal IRA in order to expand your investments, since the 403(b) and 547(b) plans are much more limited.
As with a 401(k) plan, you won’t be able to take withdrawals from your 403(b) or 457(b) account before the age of 59 1/2 without paying a 10% penalty. That’s because both the 403(b) and 457(b) plans are designed to help you save for retirement. It’s a good idea to also have an emergency savings account to help you out in times of need, reducing the risk that you’ll need to dip into your retirement plan and pay that hefty penalty.
However, the 457(b) plan does allow you to make penalty-free withdrawals earlier than that if you leave the employer that sponsors the plan, even if you are younger than 59 1/2.
Both 403(b) and 457(b) plans have two options when it comes to how they treat taxes.
If your plan is a traditional one, your contributions are pre-tax. That decreases your taxable income and could provide you a nice tax break in the short term, but it does mean you’ll need to pay taxes on the money when you withdraw it at retirement.
If you have a Roth 403(b) or a Roth 457(b), your contributions are taxed, but when you come to withdraw the money at retirement you won’t be required to pay taxes on it.
If you have the option of choosing one or the other, weigh up the pros and cons of both. Is it more important to lower your taxable income to get a tax break now, or would you prefer to pay taxes on your contributions so you don’t owe any at retirement? Think about your current tax bracket compared to your expected tax bracket at retirement. If you expect to retire in a higher tax bracket, it’s a good idea to have at least some of your retirement savings in a Roth account.
Can you contribute to both a 403(b) and a 457(b)?
Some nonprofit employers may choose to offer both a 403(b) and a 457(b) plan to their employees. If eligible, it’s a good idea to have one of each type of account so you can maximize your contributions and save even more for retirement.
If you aren’t eligible for both, it’s a good idea to sign up for whichever plan your employer offers, and then also open an IRA outside of your workplace so you have a couple of different tax-deferred retirement plans.
Should You Pick a 457(b) or a 403(b)?
If you have a choice between the two plans, the smartest option is to pick both. But if you only want one retirement account, your choice should be based on what features are most important to you.
If you are nearing retirement age and need to save as much as you can in order to retire on time, a 457(b) plan is your best option. That’s because once you get within three years of the federal retirement age, it allows you to double your annual contribution, bringing the total annual contribution to $41,000 (2022 limit). That can help you sock away some extra money before you retire so you’re in a better place, financially, when you decide you’re done with work.
On the other hand, if you’re looking to invest your savings in a wider variety of places, a 403(b) is going to be a better choice, because it’ll typically give you a larger choice of providers than a 457(b) plan will. It’s a good idea to check with your employer to see exactly what options you have for your particular plan.
Both the 403(b) and the 457(b) plans are good retirement investment options if you work for a government or nonprofit. While many employers only offer one or the other, some may offer both. If you’re eligible, signing up for both plans can be a good way of maximizing your savings and setting yourself up for success once you reach retirement.