Definition: A 457(b) plan is an employee-sponsored savings plan considered one of the tax-advantaged retirement savings options offered to public service employees and some employees of non-profit organizations. Similar in many aspects to a 401(k) plan, a 457(b) plan allows you to contribute pre-tax amounts from your salary and invest them, with taxes deferred until you withdraw the money, typically for retirement.
How Does a 457(b) Plan Work?
A 457(b) plan is similar to a 401(k) or 403(b) plan for government or non-taxable public organization employees, although there are some key differences regarding early withdrawals and contribution options that may make a 457(b) plan better for some individuals. This deferred compensation plan is available to local and state government employees such as police officers, firefighters, and civil service employees, as well as some high-earning managers in certain non-profit organizations like hospitals, charitable organizations, and unions. It is offered by the employer and contributions are deducted from your salary on a pre-tax basis, thus reducing your taxable income. You will pay taxes at ordinary income rates when you withdraw the funds.
Contribution Limits for 457(b) Plans
Participants in a 457(b) plan can contribute up to 100% of their salary or $22,500 for the year 2023 ($20,500 for 2022), whichever is less.
457(b) Plan Matching by Employers
While employers may match the amount you contribute to a 457(b) plan, it is relatively rare for them to do so. Most government organizations also offer pensions, which means the 457(b) plan serves as an additional savings plan for employees. If your employer provides a match on your contributions, it counts towards your contribution limits, unlike a 401(k) plan. For example, if your employer contributes a total of $6,000 in 2023 to your 457(b) plan, you can contribute the maximum of $16,500 if you are under 50 years old. In total, you cannot exceed the limit of $22,500.
Early Withdrawals from 457(b) Plans
While 457(b) plans allow you to withdraw early without penalty if you retire early, withdrawing funds for other reasons before reaching age 59½ is more difficult. Unlike 401(k) plans that waive penalties if you withdraw money to purchase a first home or pay college tuition for a dependent, you can only take money from a 457(b) plan without penalties in the case of an unforeseen emergency.
Advantages and Disadvantages of 457(b) Plans
Advantages
– Allows penalty-free withdrawals if you retire early.
– May allow contributions up to double the regular limit in the three years before retirement.
– Does not interfere with contribution limits for other types of plans like 403(b) or 401(k).
Disadvantages
– Most government employers do not match contributions.
– Fewer investment options compared to private retirement plans.
– Early withdrawals not related to early retirement have restrictions or are subject to a 10% penalty.
457(b) vs 403(b)
– How do 457(b) plans and 403(b) plans compare, and what are the differences between them?
– Both plans are often offered by public and non-profit institutions, which typically do not offer 401(k) plans. When you have both a 403(b) and a 457(b) plan, you can contribute the maximum allowed to both plans.
– The primary differences in the plans revolve around who has access to them. 457(b) plans are typically available to local and state government employees and those in non-profit organizations, while 403(b) plans are primarily offered to public institutions and public schools.
You should also note that there is a total contribution limit for 403(b) plans of $66,000 for the year 2023, which is the amount you can contribute as an employee, in addition to contributions from the employer, plus catch-up contributions. If you have a 457(b) plan and your employer contributes (which is rare), their contributions count toward the limit of $22,500 for the year 2023.
Frequently Asked Questions (FAQs)
What happens to a 457(b) plan if you leave your employer?
– Once you leave your job, you can no longer contribute to a 457(b) plan. You can roll it over to another plan like an IRA, 403(b), SEP-IRA, or another 457(b) plan. You can also withdraw your funds without penalties, although you will owe taxes on the withdrawn amount.
Which is better: 403(b) or 457(b)?
– In terms of preference, the plan you wish to save more with will depend on how close you are to retirement. With a 403(b) plan, you can save up to $61,000 per year ($66,000 in 2023) through employee contributions, employer contributions, and optional contributions.
– With a 457(b) plan, your limitation will be the annual limit of $22,500 for 2023 and $20,500 for 2022, plus age-related catch-up contributions (unless you qualify for a Special Catch-Up Contribution that allows you to contribute up to $41,000 in 2022, $45,000 in 2023). But this is still lower than what is allowed in a 403(b) plan.
– On the other hand, you will face penalties for early withdrawal from a 403(b) plan, but not from a 457(b) plan.
Source: https://www.thebalancemoney.com/what-is-a-457-b-plan-2894165
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