Understanding the Benefits and Mechanics of a 457 Plan
A 457 plan is a valuable tax-advantaged retirement savings scheme specifically available to employees of many state and local governments, and some nonprofit organizations. It functions similarly to the more widespread 401(k) plan in the private sector. By depositing a portion of pre-tax earnings into a 457 account, employees defer income taxes on those earnings until the money is withdrawn during retirement, reducing current year’s tax burden.
A Roth version of the 457 plan might be available at an employer’s discretion, allowing contributions with after-tax money instead.
Types of 457 Plans
457 plans come in two main forms:
- The 457(b): This common version is available to state, local government employees, and nonprofit organizations. Participants enjoy retirement savings with significant tax advantages.
- The 457(f): Additionally offered to highly compensated executives in tax-exempt organizations, this plan supplements the 457(b) and effectively functions as a deferred salary agreement.
Key Takeaways
- IRS-recognized, tax-advantaged retirement plan offering.
- Specially designed for public service employees and staff at tax-exempt organizations.
- Contribute up to 100% of your salary, within the established annual dollar limit.
- Interest and earnings are tax-deferred until withdrawal, except for the Roth version that uses post-tax money.
Exploring the 457(b) Plan in Depth
The 457(b) plan is notably offered to civil servants, police personnel, and employees in various public sector agencies and nonprofits. Participants can allocate a portion of their salaries into a retirement account, with investment choices generally limited to mutual funds and annuities. These investments grow tax-deferred over time, with taxes applied upon withdrawal post-retirement.
2023 - 2024 Contribution Limits
Employees may contribute up to $22,500 in 2023, a figure increased to $23,000 in 2024. Special provisions like catch-up contributions allow individuals aged 50 and above to pay an additional $7,500 annually. This allows a maximum contribution up to $30,000 for 2023 and $30,500 for 2024.
Pushing this further, the double limit catch-up and contributions for employees within three years of retirement age potentially allow contributions up to $45,000 in 2023 and $46,000 in 2024.
Advantages and Disadvantages of 457(b) Plans
Advantages:
- Tax Benefits: Contributions to traditional 457(b) plans lower the current year’s taxable income. All generated interest and earnings remain untaxed until retirement withdrawal.
- No Early Withdrawal Penalties: If early withdrawal is necessitated by unforeseen circumstances or job separation, no 10% IRS penalty is applied.
Disadvantages:
- Employer Match is Rare: Although possible, most employers do not match 457(b) contributions. Even when they do, contributions, including employer’s, count towards the annual limit.
Early Withdrawals
One notable benefit is the penalty-free withdrawals for true emergencies, although this incurs corresponding income taxes for the withdrawal year.
Differences Between a 457(b) and a 457(f) Plan
While the 457(b) assists public and nonprofit workers with tax-deferred retirement savings similar to a 401(k), the 457(f) plan (often a Supplemental Executive Retirement Plan or SERP) targets highly-paid executives with employer-negotiated and deferred salary contributions as a retention strategy.
Comparison of 457(b) to 403(b)
Both plans cater to public sector and nonprofit employees, with similar tax-deferred benefits and contribution limits. The key distinction often lies in employee eligibility and slight variations in investment choices.
Tips for Utilizing a 457(b) Plan
Tapping into a 457(b) plan can provide as advantageous retirement savings as a 401(k) does, especially by maximizing pre-tax savings and manageable early withdrawal circumstances.
Related Terms: 401(k), 403(b), Roth 457, deferred compensation, tax-exempt organizations.
References
- Internal Revenue Service. “IRC 457(b) Deferred Compensation Plans”.
- Internal Revenue Service. “Comparison of Tax-Exempt 457(b) Plans and Governmental 457(b) Plans”.
- Internal Revenue Service. “401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000”.
- Investor.gov. “403(b) and 457(b) Plans”.
- Internal Revenue Service. “Comparison of Tax-Exempt 457(b) Plans and Governmental 457(b) Plans”.
- United States Code. “26 USC 457: Deferred Compensation Plans of State and Local Governments and Tax-Exempt Organizations”.
- Internal Revenue Service. “Coronavirus Relief for Retirement Plans and IRAs”.
- Internal Revenue Service. “Unforeseeable Emergency Distributions From 457(b) Plans”.
- Internal Revenue Service. “Retirement Topics - Exceptions to Tax on Early Distributions”.
- Internal Revenue Service. “401(k) Plan Overview”.
- Internal Revenue Service. “Retirement Topics - 457(b) Contribution Limits”.
- U.S. Securities and Exchange Commission. “A Guide for Teachers”.
- Internal Revenue Service. “Section 403(b) Tax-Sheltered Annuity Arrangement”. Page 1.
- Internal Revenue Service. “COLA Increases for Dollar Limitations on Benefits and Contributions”.
- BoliColi. “457(f) Supplemental Retirement Plans”.
- CFI. “Golden Handcuffs”.
- Internal Revenue Service. “Roth Account in Your Retirement Plan”.
- Internal Revenue Service. “Retirement Topics — Required Minimum Distributions (RMDs)”.
- Internal Revenue Service. “Retirement Topics — Required Minimum Distributions (RMDs)”.
- National Society of Tax Professionals. “SECURE Act 2.0 – When Does the RMD Start?”
