- 457(b) plans are available to government and non-profit employees.
- Contributions to 457(b) plans are tax-deferred, which means you only pay taxes when you collect your funds.
- You can withdraw funds without penalty if you leave your job.
A 457(b) plan is a tax-advantaged retirement plan available to employees of state and local government employees and employees of some non-profit organizations. These plans are similar to other retirement plans, such as the 401(k). However, 457(b) plans have some unique features that set them apart from other types of retirement plans.
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What is a 457(b) plan?
A 457(b) plan is what is known as a deferred compensation plan. With this type of plan, employers withhold a portion of an employee’s pay for retirement. A 457(b) plan allows you to invest your money, usually in annuities or mutual funds.
457(b) plans are available to state and local government employees, including firefighters, police officers and other civil servants. Executives at nonprofits such as charities, hospitals and unions may also be eligible. Independent contractors who work for state and government entities are often also allowed to use these kinds of plans.
457(b) plans are available to state and local government employees, including firefighters, police officers and other civil servants. This is the most common type of 457(b) plan, says Doug "Buddy" Amis, a CFP who owns Cardinal Retirement Planning, Inc.
“The less common type is called a ‘top hat’ 457(b) plan and is restricted to only highly paid executives or employees of a non-profit or tax-exempt company like a hospital,” Amis says.
There are substantial risks associated with top hat 457(b) plans because they are unfunded, which means employees don’t own the funds they save and invest in the plan, Amis says.
“Should the company go under and creditors sue to access the company's finances, the employee's 457(b) funds are at risk,” Amis says. “This is not the case for 403(b) and 401(k) plans.”
Typically, contributions to 457(b) accounts are tax-deferred. This means they reduce your taxable income and money in the plan grows tax-free. When you withdraw the money, it will be taxed as ordinary income.
In some cases, you may have a Roth 457(b) option, in which you pay taxes when you contribute, and none when you collect.
Contribution limits of a 457(b) plan
For 2022, the contribution limit to a 457(b) plan is 100% of compensation or $20,500, whichever is less. That includes both employee and employer contributions[2,3].
There are also catch-up contributions for 457(b) plans, similar to those available for 401(k) plans. Catch-up contributions are available to those aged 50 and allow additional contributions of $6,500 in 2022.
457(b) plans also offer a special three-year catch-up contribution, available in the final three years before retirement. It allows you to contribute either twice the normal limit ($41,000 in 2022) or the annual limit plus allowable amounts not contributed in prior years. If you have a governmental 457(b) that allows both the age-50 catch-up and the three-year catch-up, you can use the larger one, but not both.[5,6]
457(b) plans and employer matching
Employers may offer matching contribution plans, allowing them to save on FICA taxes on those contributions. However, as mentioned previously, 457(b) plans do not have separate limits for employee and employer contributions. Thus, matching contributions to a 457(b) plan count toward the $20,500 contribution limit.
FICA is a U.S. federal payroll tax. It stands for the Federal Insurance Contributions Act and is deducted from each paycheck. As you work and pay FICA taxes, you earn credits for Social Security benefits.
Despite this, an employer match can still be beneficial with a 457(b), especially if you aren’t capable of contributing the $20,500 maximum (or more if you are eligible for either of the two 457(b) catch-up contributions).
In some cases, withdrawing money from a 457(b) is similar to withdrawing from a 401(k) or any other retirement plan. For example, after age 59 ½, you won’t incur a penalty if you withdraw funds from a 457(b) if you are still working for the employer that sponsors the plan. You will, however, have to pay income tax on the withdrawal unless you have a Roth plan.
The key feature that sets 457(b) plans apart from other retirement plans is that you can withdraw money before age 59 ½ if you leave your job. However, you will have difficulty withdrawing funds early if still employed at the job that sponsors the plan. In that case, a hardship withdrawal may be your only option.
Also, there could be cases where a 457(b) could result in a 10% penalty, even if you have left your job. For example, suppose you previously rolled money from an old 401(k) into your 457(b) and then decide to withdraw that money from the 457(b). In this case, the money rolled over from the old 401(k) may be subject to a 10% early withdrawal penalty if you are younger than 59 ½, even if you have left your job.
Lastly, 457(b) plans are subject to required minimum distribution (RMD) rules, just like other types of employer-sponsored retirement plans (not including Roth plans). The rules mean you must begin taking distributions starting at age 72.
457(b) vs. 403(b)
Employees at government sector jobs and non-profit employees may have access to a 457(b), 403(b) or both. There are a few key differences that set these two types of retirement plans apart.
Contribution limits. 457(b) plans have a contribution limit of $20,500 for 2022, and that limit includes any employer contributions. 403(b) plans have a separate employer contribution of up to $40,500, for a total contribution limit of $61,000 in 2022. The total contribution limit for 403(b) plans is the lesser of that limit or 100% of employee compensation–potentially much higher than the $20,500 limit for 457(b) plans.
Catch-up contributions. Those aged 50 and over can contribute up to $6,500 to their 457(b) plans in 2022. In the last three years before retirement, they can contribute up to twice the normal contribution limit. For 403(b) plans, employees aged 50 and over can contribute an additional $6,500, plus up to a $3,000 extra contribution as part of a 15-year rule.
Early withdrawals. With a 457(b) plan, you can generally withdraw your money at any age without incurring a penalty as long as you have left your job. However, while you are still working, the restrictions on accessing your money can be stricter for 457(b) plans than for 457(b) plans.
Pros and cons of a 457(b) plan
Before you decide to invest in a 457(b) plan, they have both pros and cons to consider.
In most cases, there is no early withdrawal penalty before age 59 ½ once you leave your job.
These plans allow up to twice the normal contribution limit for those within three years of retirement.
You are permitted to roll a 457(b) into an IRA or a 401(k) once you leave your job.
Matching contributions are less common with 457(b) plans than with 401(k) and other retirement plans.
The contribution limit for 457(b) plans includes employer contributions, resulting in a total contribution limit of $20,500–far lower than the $61,000 contribution limit for 403(b) plans.
It can be difficult to withdraw your money from a 457(b) plan early unless you qualify for a hardship withdrawal.
What happens to my 457(b) when I quit?
You can generally withdraw money from a 457(b) after you quit your job. If you are younger than 59 ½, that money won’t be subject to a 10% withdrawal as long as it was not the result of a rollover from an old 401(k).
Is a Roth IRA better than a 457(b)?
Each plan has unique features that can be beneficial. For example, contributions to a Roth IRA are taxed, but earnings and withdrawals are tax-free. With a Roth IRA, you can withdraw contributions from the plan at any time, but you can’t withdraw earnings before 59 ½ without incurring a 10% penalty. Meanwhile, with a 457 plan, in most cases, you can withdraw both contributions and earnings from the plan at any time without a penalty as long as you have left your job.
Is a 457(b) plan a good idea?
There is generally no early withdrawal penalty on money in a 457(b) plan once you leave your job. Thus, these plans can be excellent if you intend to retire early or switch careers.