You’ve probably heard about 401(k) plans, but do you know about the lesser-known 457(b) retirement plan? Whether you are an experienced investor or just starting to consider your financial future, understanding the intricacies of this plan is critical for making sound selections.
This blog looks at everything from the 457 (b) plan contribution limit, rules, rollover and transfer choices, advantages, and downsides, as well as frequently asked questions.
So take a cup of coffee, sit comfortably, and let’s explore the intricacies of 457(b) plans together!
What is a 457 (b) Plan?
A 457(b) plan is similar to special retirement savings accounts provided to employees of the state, government, local governments, and tax-exempt organizations, such as law enforcement personnel, public officials, and university staff.
When you contribute to a 457(b), you put a part of your earnings away before taxes, which can assist in reducing your taxable income. The money you save in the account can be invested and has the potential to grow over time. When you ultimately take money out, you must pay taxes on the amount removed.
Depending on your employer’s plan, there may be a Roth option available. This option allows you to contribute after-tax funds. Through this option, you can avoid paying taxes when you withdraw the money later.
What are the Different Types of 457 (b) Plans?
There are two main types of 457(b) retirement plans: governmental and non-governmental. Let’s break it down for you.
- Governmental 457(b) Retirement plan
A government 457(b) plan is a retirement savings plan sponsored by a government agency. Contributions, as 401(k), are held in trust and safeguarded from your employer’s creditors.
Money that is saved in a governmental 457(b) can also be transferred to other retirement accounts like IRAs and 401(k). It’s an excellent method to invest for retirement while maintaining freedom and safety. - Non-governmental 457(b) Retirement plan
A non-governmental 457(b) is also referred to as a tax-exempt 457(b) plan. It is provided by institutions such as colleges and nonprofits. In this sort of plan, you decide how much of your salary to contribute, but your employer owns the account. So, if your employer experiences financial difficulties, your savings may be jeopardized.
Unlike a governmental 457(b), a non-governmental 457(b) plan does not allow you to transfer funds to another retirement account. You may not be able to influence how your funds are invested. Furthermore, you cannot get a loan against the cash in your non-governmental account.
In a governmental 457(b), you may be automatically enrolled. The non-government 457(b) plan requires you to select to engage in a non-governmental plan.
What is the 457 (b) Plan Contribution Limit?
In the year 2023, you were able to put up to $22,500 per year into your 457 plan. And this limit goes up to $23,000 for 2024. But wait, there’s more! If your employer allows catch-up contributions and you are over 50, you can add an extra $7,500 a year. That makes the max contribution $30,500 ($23,000 + $7,500) for the tax year 2024.
Moreover, the 457(b) has a “double limit catch-up” provision. This is for folks nearing retirement who want to make up for years when they didn’t contribute to the plan but could have. So, if you are within three years of retirement age, you can put up to $46,000 in 2024.
How Do 457 (b) Plans Work?
As mentioned earlier, 457(b) plans are a retirement option for state and local government employees and specific tax-exempt nonprofits. They work much like other employer-offered retirement accounts. When you contribute to a 457(b) retirement plan, the money is taken out of your paycheque. It lowers your taxable income for the year.
However, remember you are required to pay taxes on the money you withdraw when you retire. One advantage of 457(b) is that contributions can be taken out before reaching the age of 59 ½. When you cease working for your employer, you can begin utilizing the money.
However, non-governmental 457(b) plans have specific withdrawal restrictions. Some plans may compel you to withdraw all of your money in a short period. This might result in some tax complications. Still, 457(b) provides greater flexibility with your money, unlike 401(k) accounts, which require early withdrawal penalties and taxes before age 59 ½.
What are the Withdrawal Rules for 457(b) Plans?
For non-governmental plans, 457(b) withdrawals are taxed as income or wage. This means you must disclose them as taxable income on your tax return for the year. As with 401(k) and 403(b) plans, after you reach a specific age, you must begin drawing required minimum distributions (RMDs) from your 457(b).
Typically, this starts on April 1, following the calendar year in which you turn 73. However, there is one exception: if you continue to work for the plan sponsor, you are not required to take RMDs. However, you can normally make penalty-free withdrawals at any time if the plan sponsor no longer employs you or discontinues the plan.
This exception was primarily designed to help state and local government employees, such as firemen and police officers, who retired prematurely due to a disability or accident.
In some situations, you may be eligible for an early hardship distribution, which allows you to take cash without penalty while still employed by the plan sponsor. If you experience a difficulty, such as an illness, accident, eviction, funeral bills, or other unanticipated events, you may be eligible for a hardship withdrawal.
In addition, if you exhaust all your financial means, you can take advantage of early distribution. However, these distributions can be complex. It’s best to speak with a financial or tax professional beforehand.
Remember, even though you can withdraw your 457(b) money without penalty, you should consider it hard before tapping into your retirement resources. Taking money out before you retire might influence your retirement planning.
What Options Do You Have When it Comes to 457(b) Rollover and Transfer?
You have various alternatives to roll over your 457(b) funds. If you have a government 457(b) plan, you can transfer the funds to a Roth IRA, 401(k), 403(b), or another 457 governmental plan.
However, if you have a 457(b) retirement plan via a private tax-exempt organization, the regulations are stricter. You can only move your funds to another non-governmental 457 (b) plan.
What are the Pros & Cons of 457(b)?
457(b) plans have some great perks! But, Of course, there are some things to consider too. So, it’s always good to weigh the pros and cons before making any decisions. The following table can be helpful:-
| Advantages of 457(b) | Disadvantages of 457(b) |
|---|---|
| If you are on an income-driven repayment plan, lowering your adjusted gross income can cut your tax bill and, potentially, your student loan payments. | There are fewer investment options like 401(k), which may restrict your selections. |
| You can increase your investments tax-free. | These plans are only offered to specified workers of state and local governments, as well as eligible organizations. |
| It provides you greater freedom to manage your finances as you are only taxed when you withdraw the money in retirement. | Employer contributions are included against the yearly limit. Therefore, there is a maximum amount you can contribute. |
| If you leave your work, you can still access the assets before retirement begins. | Non-governmental 457(b) plans might be riskier, so take that into account. |
| You may be able to contribute up to double the standard maximum in the three years leading up to retirement. | |
| Do not interfere with contribution restrictions for other types of plans, such as 403(b) or 401(k). |
457(b) Plan vs. 403(b)
There are several notable parallels and distinctions between 457(b) plans and 403(b) plans. Let’s check them out:-
- Both types of plans allow you to contribute up to $22,500 for the tax year 2023 and $23,000 for the tax year 2024. Additionally, if you are over 50, you can make an extra payment of $7,500.
- 457(b) plan and 403(b) plans are frequently offered by public-sector and nonprofit organizations, particularly those that do not provide 401(k) plans.
- The only contrast between the two is who can access them. 457(b) plans are typically provided to state and local government employees, whereas 403(b) plans are primarily offered to employees of private nonprofits and public schools.
So, while both programs have commonalities in terms of contribution limitations and target organizations, their accessibility and contribution restrictions are different.
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457b Plan vs 401k
Both 457(b) and 401(k) plans are provided by your company and supported via pre-tax payments. They also have the same yearly contribution limit. However, there are some significant distinctions between them, such as:-
- One significant advantage of the 457(b) plan is that it stands on its own, allowing you to max out your 401(k) while also maxing out your 457(b).
- A 457(b) plan also provides certain unique benefits. For example, the annual contribution maximum is doubled for three years previous to the plan’s stated retirement age. This feature allows you to contribute $46,000 per year rather than the customary $23,000 in the three years before retirement.
- Another advantage is that you do not need to wait until retirement to begin taking assets from a 457(b) plan. You can start withdrawing cash as soon as you leave your job, giving you more control over your retirement savings.
- Unlike 401(k) plans, not everyone has access to 457(b) plans.
- 457(b) plans may have fewer investment alternatives than 401(k) plans. Also, they do not often include matching employer contributions.
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FAQs
When can you withdraw from a 457 plan with no penalty?
Suppose you leave your job in or after the year you turn 55. In that case, you may be eligible to accept distributions from your 457(b) without paying the early withdrawal penalty. Some exclusions may apply in the event of unanticipated events, such as medical emergencies.
If I quit my employment, what happens to my 457(b)?
When you leave your employment, you usually have numerous alternatives regarding your 457(b) plan. You may keep the money in the plan, transfer it to another qualifying retirement account, or withdraw it (though this may have tax ramifications).
It’s critical to remember that you won’t be able to make contributions to your existing account after you leave.
Which is preferable: 403(b) or 457(b)?
Your own financial status, goals, and demands determine the answer to this question. Both 403(b) and 457(b) plans provide distinct features and advantages, as mentioned in this post. If you feel confused, it’s best to consult with a financial counselor to discover which plan is most suited to your needs.
How are 457 withdrawals taxed?
A 457 withdrawal is taxed as regular income and does not incur IRS early withdrawal penalties.
Can 457 withdrawals deemed a form of income for Social Security purposes?
457 payouts are not earned income and do not have an impact on social security payments.
How can you avoid paying taxes on 457 withdrawals?
Withdrawals from 457 retirement plans are taxed as regular income. However, payouts from a Roth 457 plan do not need tax withholding. Additionally, 457 plan members can transfer their money to other eligible plans. Rollovers, with the exception of Roth IRAs, are not taxable occurrences.
What transpires if you contribute too much to your 457(b)?
If you exceed the contribution limit, you may face tax penalties. Suppose you do not eliminate excess contributions before April 15 of the following year (typically Tax Day). In that case, those funds may be taxed twice: once for the year you or your employer contributed and again when you get the dividend.
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