Understanding the 457 Plan

Understanding the 457 Plan

Let me explain what a 457 plan is—it's a tax-advantaged retirement savings plan designed for employees of state and local governments, as well as some nonprofit organizations. The most common version is the 457(b), which works much like a 401(k) in the private sector by letting you save pre-tax earnings, cutting your current income taxes and delaying taxes until you withdraw the money in retirement.

There's also a Roth version where you make after-tax contributions, and the 457(f) is a supplemental plan reserved for highly compensated executives in tax-exempt organizations.

Key Takeaways

You should know that the 457(b) is an IRS-approved plan offering tax advantages for retirement. It's available only to public service workers and those at tax-exempt organizations. Remember, the interest and earnings in your account stay untaxed until you pull the funds out.

Contribution Limits

When you're contributing to a 457 plan, you can typically pick mutual funds or annuities, and you can put in up to 100% of your salary, capped by the IRS annual limit, which gets adjusted for inflation each year. If you're 50 or older and your plan allows it, you can add catch-up contributions, with that limit also rising annually.

Under the SECURE 2.0 Act, government plans now let people in their early 60s—specifically ages 60 to 63—make a 'super catch-up' that's higher than the standard one, based on a set dollar amount or a percentage. There's also a 'double limit' feature where you can contribute up to twice the annual limit for three years before your normal retirement age.

One important update: the SECURE 2.0 Act pushed the required minimum distribution age to 73, so if you turned 72 in 2023, your first RMD is due by April 1, 2025.

Advantages and Disadvantages

On the plus side, a traditional 457 lets you deduct contributions pre-tax, which lowers your taxes now, and all growth is tax-deferred until withdrawal. A big advantage is no penalty for early withdrawals— if you retire early or leave your job, you can access funds without the IRS's 10% hit. You can even withdraw for unforeseeable emergencies without changing jobs, unlike a 401(k).

But watch out: if you roll over from a 457 to another plan like a 401(k), early withdrawals from the rollover could trigger that 10% penalty. Employers rarely match contributions in 457 plans, and if they do, it counts against your limit—unlike 401(k)s. Also, employer contributions might vest over time, and investment choices are often more limited than in private sector plans.

Comparing 457(b) to 403(b)

The 403(b) plan is similar to the 457(b) and targets public service employees like teachers in public schools. It started in the 1950s focused on annuities, but now you can choose annuities or mutual funds. It mirrors the 401(k) closely, with the same contribution limits as 457(b) and 401(k) plans.

Differences Between 457(b) and 457(f)

Here's the distinction: the 457(b) is like a 401(k) for public and nonprofit workers, helping you save for retirement with deferred taxes. The 457(f), or Supplemental Executive Retirement Plan (SERP), is for top executives in tax-exempt places like hospitals or universities, and it supplements a 457(b).

Is a 457(b) Better Than a 401(k)?

A 457(b) stacks up against a 401(k) by letting you reduce taxable income and invest for retirement, but it often lacks employer matching, which is common in 401(k)s.

Withdrawing From a 457(b)

You can withdraw from a 457(b) without penalties for unforeseeable emergencies. Once you retire, you'll need to take required minimum distributions (RMDs) as set by the IRS, which is the minimum you must pull out each year after reaching the specified age.

The Bottom Line

In summary, a 457(b) is akin to a 401(k) but for government, public service, and nonprofit employees like those in hospitals or charities. The traditional version uses pre-tax contributions for tax advantages, while the Roth uses post-tax ones.