What is a 457(b) plan?
Find out about the 457(b) plan, including how it works, its benefits and drawbacks, contribution limits, and how it differs from other retirement savings options.
Summary
The 457(b) plan is a retirement plan available to state or local government employees.
It is a tax-advantaged retirement option sanctioned by the IRS.
The money only becomes taxable when the individual withdraws the retirement funds.
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What is a 457(b) plan?
The 457(b) plan is a tax-advantaged retirement option primarily offered to state or local government employees.
Some tax-exempt non-governmental institutions also participate in this plan.
The structure of these plans allows employees to defer income tax on their retirement funds until the withdrawal date.
How does a 457(b) work?
Employers will deduct the 457(b) plan contribution from an employee’s salary before applying tax, resulting in a lower taxable income. When the individual withdraws their retirement funds, the money will be taxable.
The IRS sets annual contribution limits, which may change from year to year. Workers may contribute up to 100% of their salaries. Currently (2024), the annual contribution limit is $23,000.
Employees or their financial advisors typically invest their retirement savings in annuities and mutual funds. The dividends and interest on these investments are only taxable when they withdraw their savings.
What are the pros and cons of a 457(b) plan?
If you make or plan on making 457b plan contributions, knowing the pros and cons that come with it is helpful.
Pros
Employees pay no tax on their contributions, dividends, and interest until they withdraw from the fund.
If they leave their jobs, they can roll over the account into a 401(k) or an IRA plan.
If contributors are within three years of retirement age, they can double their annual contributions for the year ($46,000 in 2024).
Employees can make early withdrawals without incurring a 10% penalty.
Cons
State and local government employers rarely make matching contributions.
If the employer matches the worker’s contribution, the two together still have an annual limit of $23,000.
The maximum annual contributions, including catch-up payments, are far less than that of the 401(k).
Employees forfeit all their savings if they leave their position before completing two years of service.
What are the contribution limits of a 457(b) plan?
Currently, the 457b plan max contribution 2023-2024 limit set by the IRS is $23,000.
Individuals older than 50 can make catch-up contributions of $7,500, taking the total contribution limit up to $30,500.
Additionally, in the final three years before retirement, a 457(b) plan allows employees to contribute up to twice the yearly limit or 100% of their salary, whichever is lower.
What are the distribution rules of a 457(b) plan?
When can you withdraw from your 457b plan?
With a 457(b) plan, employees can withdraw some or all of their funds at retirement, even if they are not yet 59 ½ years of age. Unlike other plans, early withdrawals don’t incur a 10% penalty, although these withdrawals will be taxable.
The 457(b) plan falls under the IRS required minimum distribution (RMD) regulation, which states that a contributor must start withdrawing a specific portion of their retirement savings at a certain age. Failing to abide by this rule will incur a heavy penalty.
What are the rollover rules of a 457(b) plan?
Employees may roll over their 457(b) assets into most other retirement accounts, including a 401(a), 401(k), traditional IRA, Roth IRA, or another 457(b).
They may roll over some or all of their funds. Generally, workers can't roll over their funds while still employed. However, some plans permit "in-service” withdrawals after a specific age. After retirement, individuals can roll over their funds into any IRS-listed account.
If a rollover destination account is also a tax-deferred plan, the assets will retain the tax-deferred status. If the funds are rolled over into a Roth account, the IRS will demand income tax from it. However, funds transferred from one account to another don’t count towards the annual contribution limit.
What are the differences between 457(b) plans and other retirement plans?
Some non-profit organization employees and public sector workers can have 403(b) and 457(b) retirement accounts. They are similar in some ways but also have significant differences:
Both plans allow employer contributions, but when comparing a 457b plan vs. a 401k, this rarely happens.
403(b) plans allow for double the 457(b) maximum contributions due to employer contributions.
Catch-up contributions vary. 403(b) plans allow extra contributions if the person has worked for the same employer for 15 years (a maximum of $15,000).
457(b) plans allow early withdrawals at any age after leaving your employer. 403(b) plans allow penalty-free withdrawals from age 59 ½
Whereas 457(b) plans are offered to state and local government employees, private sector workers are eligible for 401(k) retirement options.
Early withdrawals from a 401(k) incur a 10% penalty unless the individual withdraws due to financial hardship. There are no penalties on a 457(b) plan.
401(k) plans do not have the double catch-up limit available.
Get expert financial advice
457b plan contributions can help state and local government employees save for their golden years. Its contribution allowances help employees to grow their savings substantially in the three years prior to retirement. Although there are pros and cons to this plan, saving for retirement is essential for your future.
Let Unbiased help you prepare for your retirement by matching you with a financial advisor for expert financial advice.
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