When it comes to tax-advantaged retirement accounts there are quite a few options but, depending on where you work, you may not have access to all of them.
Most working adults have heard of a 401(k), teachers will be familiar with a 403(b), and those without an employer-sponsored plan may just opt for an IRA. If you’re a government or non-profit employee you may be familiar with a 457(b) plan. But what is a 457(b) and how does it differ from a 401(k) and other plans? It’s important to know the similarities and differences before you start saving for retirement.
What is a 457(b) Plan?
A 457(b) is a type of employer-sponsored retirement plan offered by state or local governments and some tax-exempt organizations.
The 457(b) is one of two types of 457 plans. The 457(b) is the most common as it’s offered to state and local government employees, employees of certain non-profit organizations, charities and unions, and even independent contractors employed by state and local government.
A 457(f) plan is offered only to highly compensated government employees and non-profit executives as a deferred compensation benefit to promote tenure in the position.
How Does a 457(b) Work?
457(b) plans work similarly to 401(k) plans in that employers contribute to the plan on the employee’s behalf, up to a certain limit, through salary reductions. Employers can match contributions up to 100% but, unlike the 401(k), any contribution made by an employer to an employee’s 457(b) plan counts toward the annual limit. So if your employer’s match was 100% you’d only want to contribute up to half of the annual maximum to get the full employer match.
Most 457(b) plans defer taxes on contributions but some employers may have plans that allow you to make Roth contributions which would take taxes out now and allow for tax-free withdrawals in retirement.
Can a 457 be rolled into an IRA?
You can also roll any employer-sponsored plan from a previous job into a comparably taxed 457(b). But there are some withdrawal restrictions imposed by other plans that make it typically easier to roll those accounts into a separate IRA.
What to do with 457 after leaving job
As a rule of thumb, anytime you leave a job where your retirement plan is sponsored by the employer it’s a good idea to roll it over to an IRA as soon as possible. An IRA gives you total control over what your money is invested in and makes it easier to manage moving forward.
But the 457(b) plan may provide a caveat to this rule. The 457(b) is the only retirement plan where, as long as you are no longer employed where the plan is sponsored, you can take penalty free withdrawals, of both contributions and growth, from the account before 59 ½.
You will pay income tax on the withdrawals but if you need money because of a layoff or other emergency you may not want to roll it over immediately. As soon as a 457(b) is rolled into an IRA it will become subject to the same 10% early withdrawal penalties that applies to the rest of the IRA.
457(b) Contribution Limits
Employees are allowed to contribute up to 100% of their salary, provided it doesn’t exceed the contribution limit for the year. As of 2021, employees and employers can contribute up to $19,500 per year to a 457(b) account.
Like with other employer-sponsored programs, an employer can permit catch-up contributions. Workers aged 50 and older may contribute an additional $6,500, making their maximum annual contribution limit $26,000.
A unique feature of 457(b) plans is their "double limit catch-up" provision. In the three years before retirement, 457(b) plans allow you to contribute up to double the annual limit, which is currently $39,000, or 100% of your salary, whichever is less.
There are a few restrictions on the double limit catch-up. The additional contributions can’t exceed the value of unused eligible contributions from previous years. So if you contributed the maximum allowed every year you wouldn’t be eligible for the extra double contribution. And if you’re 50 or over you can’t use the regular catch-up contribution on top of double contributions.
An even more unique feature of the 457(b) is your ability to “stack it” with another employer-sponsored plan. Some government and non-profit workers may also have access to a 403(b). If that’s you you can contribute the employee maximum to both plans. This means in 2021 you could contribute $19,500 to your 457(b) and $19,500 to your 403(b).
Be aware that if you’re 50 or older, you still only have one catch-up contribution limit of $6,500 across all employer-sponsored plans.
Just like a tax-deferred 401(k) or 403(b), all contributions to 457 plans are made and grow tax-free. Withdrawals are then taxed like income either in retirement or once you leave the job where the plan is sponsored.
Remember that 457(b) plans are the only plan that allow you to take withdrawals on both contributions and earnings before 59 ½ without a 10% penalty. You just have to pay taxes whenever you take a withdrawal.
Finally, once you reach 72, you must take required minimum distributions (RMDs) from your 457(b). You can put those off until the April after the year you retire as long as you’re still working for the organization sponsoring your 457(b).
Can I withdraw from my 457 while still employed?
457(b) withdrawals may be easy if you’re no longer employed by your sponsoring organization but they’re much more difficult to access while you’re employed.
Withdrawals are typically not permitted for any reason unless you experience a qualifying unforeseeable financial hardship, and even then, your employer’s plan doesn’t have to allow it. You may also be able to take a loan from your 457(b) plan but again, this is contingent on eligibility.
How much tax do you pay on a 457 withdrawal?
All withdrawals made from a tax-deferred 457(b) are taxable as income, regardless of the participant’s age. It’s important to be aware that because distributions are taxed as regular income they can possibly push you into a higher income tax bracket if you’re not watching carefully.
To avoid a huge tax bill, avoid withdrawing your entire account balance all at once. If you want to withdraw your money do it incrementally to keep your tax burden in check. If you’re 59 ½ or don’t believe you’ll need the money until then, you can roll over the balance to an IRA without any tax liability. Remember that once it’s there it loses the penalty-free early withdrawal benefit.
Also, while rare, a Roth 457 allows you to make contributions on an after-tax basis and pay no taxes on qualifying withdrawals.
457(b) plans offer some great benefits that make them appealing if you have access to one.
Contributions are deducted directly from paychecks on a pre-tax basis, resulting in lower taxable income and more consistency with investing. And interest and earnings generated from the investments in the account don’t get taxed until the funds are withdrawn.
If you choose to resign or retire early and need to access your funds, there's no 10% penalty fee. Lastly, double catch-up contributions allow those needing to save extra before retirement contribute more than other common plans.
While there are some unique features, there are some disadvantages to them as well.
While most governmental and non-profit organizations don’t offer contribution matching, any employer-matched contributions you do get count toward the maximum contribution limit. And because 457(b) plans aren’t common the plans tend to be laden with fees and have very few investment options.
Difference Between 403(b) and 457(b)
A 403(b) plan is typically offered to employees of private nonprofits and government workers, most notably public school employees. Because of that, employees who have access to a 457(b) plan may find they have access to a 403(b) plan as well.
While extremely similar, there are some key differences that might make one more advantageous than the other for your personal situation.
Both plans permit employer contributions, but in 457(b) plans the employer contribution counts toward total max contribution. If you’re one of the few public-sector employees with the option of a match then take it in whichever plan you have access to it in. But if you have the choice, a 403(b) can give you an edge if you plan to max it out.
Both 457(b)s and 403(b)s have the same employee contribution amount which in 2021, for those under 50, is $19,500. If you have access to both plans, remember that you can max out both.
Both plans offer unique catchup contribution provisions. A 457(b) allows for double limit contributions within three years of normal retirement age. The 403(b) allows additional contributions, up to $15,000 total, to those who have worked for the same employer for 15 years.
Ultimately, if you want access to more investment options, a 403(b) is likely your best option. They’re far more common than 457(b)s so their plans are often more robust. If you’re nearing retirement and need to put away extra cash then you’ll probably want to go with the 457(b) and its hefty double catch-up option.
How to Invest in a 457(b)
If you want to invest in your organization’s 457(b) first examine the plan options. 403(b) plans are known for being some of the most expensive and limited employer-sponsored plans available and 457(b) plans have a similar reputation.
Even with fees and limited options, you’ll likely still be saving money on taxes by investing in your 457(b) over a traditional brokerage account. But if you’re not happy with the options you find, be sure to take advantage of an IRA first to have total control of at least part of your portfolio before you focus on your 457(b).
Then, if you weren’t automatically enrolled, contact your organization’s human resources department to enroll and set up your investing schedule. If there’s an employer match, start with investing at least enough to get the match then work up to investing at least 15% to 20% of your gross salary.
Are 457(b) Plans Worth it?
Public sector employees tend to be some of the most under-payed workers in the country. So it’s uncommon for those who have access to a 457(b) to be able to max it out, much less max out an IRA in addition.
It’s typically best practice to start with getting your employer match, if one is available to you, then max out an IRA before contributing more to your employer-sponsored plan. Many public sector employees will find a Roth IRA to have the best tax advantage but a financial advisor can tell you which is specifically best for you.
In the end, a 457(b) still offers tax savings that a traditional brokerage doesn’t. But as someone working on a limited income, make sure you’re taking advantage of your best investment options first.