The 457 plan is a tax-advantaged retirement savings account designed for employees of government entities and certain nonprofit organizations. Named after section 457 of the Internal Revenue Code, this plan provides participants with a means to save for retirement on a tax-deferred basis. Contributions are made with pre-tax dollars, reducing taxable income, and growth within the account is also tax-deferred until withdrawal.
Key Features and Benefits
Tax Deferred Contributions
Contributions to a 457 plan are made on a pre-tax basis, which significantly reduces the participant’s taxable income during their working years. For example, if an employee earns $50,000 annually and contributes $5,000 to a 457 plan, only $45,000 is considered taxable income for that year.
Contribution Limits
The 457 plan has specific contribution limits which are updated annually by the IRS. For 2023, the limit for employee contributions is $22,500. For those aged 50 and over, catch-up contributions are allowed, increasing their annual contribution limit.
Catch-Up Provisions
In addition to the standard catch-up provisions for those over 50, the 457 plan has a unique “final three-year” catch-up rule. Employees can contribute double the limit of regular contributions in the three years preceding their retirement age, provided they have not used those limits previously.
Withdrawals and Distributions
Withdrawals from a 457 plan are taxed as ordinary income upon distribution. However, unlike 401(k) and 403(b) plans, there is no early withdrawal penalty for participants who take distributions before the age of 59½, making it a more flexible option for some employees.
Applicability and Participation
Eligible Participants
The 457 plan is usually offered to employees of state and local government entities and certain non-governmental organizations, including hospitals, charitable organizations, and more. Entities offering 457 plans are required to follow specific guidelines and maintain the plan to stay compliant with IRS regulations.
Plan Administration
457 plans are typically administered by third-party financial institutions or mutual fund companies. They provide the necessary tools for account management, including regular statements, investment options, and customer service.
Investment Choices
Participants in a 457 plan can choose from a variety of investment options similar to other retirement plans; these frequently include mutual funds, target-date funds, and sometimes annuities.
Comparisons with Other Retirement Plans
457 Plan vs. 401(k)
Both 457 and 401(k) plans allow for pre-tax contributions and have similar basic structures, but the lack of an early withdrawal penalty is unique to the 457 plan. Additionally, the 457 plan’s final three-year catch-up rule is distinct.
457 Plan vs. 403(b)
The primary difference lies in the eligibility: while 457 plans are for government and select non-profits, 403(b) plans are specifically geared towards employees of public schools and certain tax-exempt organizations. Investment options are also typically broader in 403(b) plans.
Special Considerations
Estate Planning
457 plans offer beneficiaries flexibility in terms of withdrawal options after the death of the plan participant, which can be an important aspect of estate planning.
Financial Hardship Withdrawals
Some 457 plans offer provisions for financial hardship withdrawals, allowing participants under financial duress to access funds in times of need, though such withdrawals would be subject to regular income tax.
FAQ
Can I contribute to both a 401(k) and a 457 plan?
Yes, employees can contribute to both plans if offered by their employer, taking advantage of separate contribution limits for each.
What happens to my 457 plan if I change jobs?
Most 457 plans allow for rollovers into other qualified retirement plans like 401(k)s, IRAs, or other 457s, preserving the tax-deferred status of your savings.
Are there Roth options available with a 457 plan?
Some 457 plans offer a Roth option, which allows for contributions with after-tax dollars and tax-free growth and withdrawals under qualifying conditions.
Summary
The 457 plan stands out as an attractive retirement savings option for government and nonprofit employees due to its tax advantages and unique features like the absence of early withdrawal penalties and special catch-up contributions. Understanding how a 457 plan works and its benefits can be crucial for retirement planning and financial security.
References
- IRS: Retirement Topics - 457(b) Plan Contribution Limits
- Financial Industry Regulatory Authority (FINRA): 457 Plan FAQs
- Office of Personnel Management (OPM): Understanding Your Retirement Plan
By leveraging the 457 plan, eligible employees can effectively plan for retirement with significant tax savings and flexible withdrawal options.
