Individual contributions made up the majority of retirement savings, so it's crucial that you are aware of all of your alternatives. An employer-sponsored 457(b) plan is a tax-deferred savings account that is authorized by the IRS and enables you to make pre-tax contributions for your retirement. Investing in a 457(b) retirement plan can help you accumulate money.
What is a 457(b) Plan ?
A 457(b) plan refers to a deferred compensation plan. Workers of some non-profit organizations and employees of state and local governments may participate in a type of tax-advantaged retirement plan known as a 457(b).
The 457(b) plan is most often offered to police personnel, civil servants, public services and other employees of government agencies, and nonprofit organizations such as churches, hospitals, and charitable organizations.
Over the years, the account increases in value without being taxed. Taxes on the amount withdrawn will be owed when the employee retires. Employees may contribute up to 100% of their wage as long as it stays under the annual monetary limit. Similar to a 401(k), a 457(b) plan enables you to invest pre-tax money from your salary and defer paying taxes on it until you withdraw it, typically for retirement.
Key Facts of 457(b) Plan
- An employer-sponsored 457(b) plan is a tax-favored retirement savings account that is primarily for employees of nonprofit organizations, local and state governments, and other public sector jobs.
- A 457(b) plan is also referred to as a deferred compensation plan, which you may have heard of.
- With 457(b) plans, you make pre-tax contributions that aren't taxed until you take the money out, unless it's a Roth 457(b), in which case you make after-tax contributions.
- 457(b) Plan is offered as a mutual fund or an annuity.
- Participants may contribute up to $22,500 in 2023, or 100% of their annual salaries, whichever is less.
- You don't have to wait until you're 59½ to start withdrawing contributions from 457(b) plans, which is a great feature.
- You can start withdrawing funds from 457(b) plan, whenever you stop working at your employer.
How Does a 457(b) Plan Work ?
Employer-sponsored 457(b) deferred compensation plans allow employees to set aside a portion of their current income for retirement on a tax-advantaged basis. These plans are typically provided by municipalities and other governmental bodies. Public sector workers and some nonprofit employees have access to a 457(b) plan.
Employees could have the choice to invest their contributions in annuities or mutual funds. Both are tax-deferred investments, which means that taxes are not levied until retirees withdraw their money. Employees can invest a portion of their wages in an employer-sponsored plan tax-advantageously through a 457(b) plan. Traditional pre-tax contributions and Roth contributions are also options available to employees.
Traditional pre-tax contributions :
Pre-tax contributions are made, which lowers the employee's taxable income. Taxes are accumulated when earnings are accumulated. Every distribution is subject to ordinary income tax.
Roth contributions :
After-tax dollars are used to make contributions. If distributions are issued five years after the original investment to the plan and the employee is over 59½, earnings grow on a tax-deferred basis and are tax-free.
A 457(b) retirement plan is similar to a 401(k) or 403(b) plan in that it is provided by your employer, and your contributions are deducted pre-tax from your paycheck, reducing your taxable income. Participants contribute a portion of their earnings to their retirement accounts. An array of alternatives, primarily mutual funds and annuities, are presented to the employees, who select how their money is invested.
NOTE :
You won't incur a 10% tax penalty if you need to withdraw retirement funds from a 457(b) before age 59½ due to early job termination or retirement, unlike a 401(k) or 403(b). This significant distinction could make this kind of plan much more appealing than its competitors.
Combining Plans
The compatibility of 457(b) plans with other plans is another advantage. For example, you can contribute the maximum to both plans, if you have a combination of two plans, such as a 457(b) and a 403(b) or a 457(b) and a 401(k).
Even if you're under 50, this increases your annual elective deferral limit for tax year 2023 to $45,000 (the maximum contributions allowed for tax year 2022 for 401(k) and 457(b), added together). The combined maximum for tax year 2022 is $41,000. Catch-up contributions and any appropriate employer matching are not included in this.
Types of 457(b) Plans
Governmental and non-governmental 457(b) plans are the two different types of 457(b) plans. Although both governmental and non-governmental plans are deferred contribution plans, they have very distinct requirements and obligations attached to them.
1) Governmental 457(b) Plans :
Governmental plans are backed by the government, whereas your employer supports non-governmental plans. Since they are not dependent on a specific firm or organization, governmental 457(b) plans are generally thought to be less hazardous. In a governmental plan :
- You can transfer money into other accounts, like an IRA or 401(k), to increase your investment options.
- The funds are kept in trust.
- Since this account is not based on the success or failure of a specific company, it is often thought to be less hazardous.
- We commonly refer to it as a "bonus 403b".
2) Non-governmental 457(b) Plans :
The contributions made to non-governmental 457(b) plans are not deducted from your compensation. Technically speaking, it's money that you haven't yet gotten. Your company is the account's owner and deducts the percentage (that you indicate) from your usual paycheck and puts it toward this fund instead. In a non-governmental plan :
- Only other non-governmental plans can have money transferred to them or withdrawn from them (i.e. if you leave your job, you could have to take a lump sum which could turn into a major tax headache).
- Funds cannot be transferred to IRAs or 401(k)s or other retirement savings accounts.
- Money is not held in a trust, it is available to your employer's creditors.
Who is Eligible for 457(b) Plan ?
457(b) plans are generally available for state and local government employees, as well as certain non-profit organizations. These nonprofit groups are tax-exempt under IRC Section 501.
Employees of state and local governments, including civil servants, municipal workers, law enforcement officers, police officers, public safety personnel, firefighters, and other civil servants, are eligible for a 457(b) plan. In addition, 457(b) plans are open to non-profit entities including hospital executives, charitable organizations, unions, and some independent contractors working for state and local government bodies.
Contribution Limits of a 457(b) Plan
In a 457(b) plan, participants can typically contribute up to 100% of their compensation or $22,500 for tax year 2023, whichever is less.
Catch-Up Contributions :
For the tax year 2023, your contribution limit increases by an additional $7,500, if you're 50 years old or older and your employer allows catch-up contributions.
Pre-Retirement Catch-Up :
If your plan allows you to use the Special 457(b) catch-up contribution, you may be able to make higher catch-up contribution, three years before retirement age, which is another significant benefit of 453(b) plans.
For tax year 2023, this catch-up strategy enables you to make contributions up to $45,000, which is double the annual maximum, or the current year's ceiling plus the amount you didn't use in prior years.
NOTE :
Age 50 or over catch-up contributions cannot be combined with the special 457(b) catch-up contributions. For 457(b) retirement plans, contribution limits often rise and fall over time. For the most recent information, visit the IRS website.
|
457(b) Plan Contribution Limit for 2023 | |
|
Annual Deferral Limit |
$22,500 |
|
Pre-Retirement Catch-Up Limit |
$22,500 |
|
Age 50+ Catch-Up Limit |
$7,500 |
457(b) Plan Withdrawals Rules
Before you turn age 59½, you might be allowed to take money out of your 457(b) account without incurring penalties. However, this only applies once you leave your employer, and you will still be responsible for paying any applicable income taxes on any withdrawals.
Your contributions are more locked up than they could be in other retirement accounts if you haven't quit your job. Withdrawals are generally not permitted unless you encounter an unexpected financial hardship, and even then, your employer's plan may not let them. Having said that, you might be able to borrow money from your 457(b) plan, albeit again, this depends on your employer's approval.
457(b) Plan RMDs Rule
You will eventually be required to take at least a small withdrawal from your retirement account, just like with the majority of other employer-sponsored retirement plans. Unless you are still employed by the company where you hold your 457(b), you must begin taking the required minimum distributions (RMDs) from your 457(b) once you turn 72. If so, you can postpone taking RMDs until April of the year following you retire.
457(b) Plan Early Withdrawals
If you retire early, 457(b) plans allow you to take early withdraws without paying a penalty, withdrawing for other reasons before you hit age 59½ is more challenging.
You can only withdraw money penalty-free from a 457(b) plan for an unexpected emergency, unlike 401(k) plans. The situation must be unusual and the outcome of unforeseeable circumstances. Some instances :
- You, your beneficiary, your spouse, or your children who are dependents suffer a serious illness or an accident that need medical care that is not covered by insurance.
- Your primary residence needs to be repaired if a natural disaster results in damage that is not covered by insurance.
- Funeral costs for your spouse or dependent must be covered by you.
If your plan permits it, you might be able to borrow money from your 457(b). The maximum loan amount is $50,000, or half of the vested account balance. However, if your plan permits it and your balance is less than $10,000, you can withdraw the entire amount. The loan must be repaid in five years with at least once-quarterly payments.
How to Invest in a 457(b) Plan ?
The only investment alternatives offered in 457(b) plans are typically annuities and mutual funds. Exchange-traded funds (ETFs) and individual stocks cannot be purchased in a 457(b) account, for instance.
In reality, this might not differ all that much from how people who have 401(k)s invest for retirement. Anyhow, the majority of 401(k) owners invest in mutual funds. You can create the kind of three-fund portfolio that most financial consultants advise as long as you have the ability to buy index funds that are based on stocks and bonds.
Consider moving some (or all) of your contributions to an individual retirement account (IRA) to augment your portfolio if your 457(b) plan does not provide the options you require, as you likely won't lose out on any employer matching funds. Compared to 457(b)s, IRAs offer a considerably wider range of investments but have much lower contribution caps. If you expect to save a lot for retirement, you might need to contribute at least some of your funds to your employer's plan.
Advantages of 457(b) Plan
- Tax-deferred contributions to a 457(b) plan.
- The retirement funds' earnings are tax-deferred.
- A decrease in your adjusted gross income, which, if you're on an income-driven repayment plan, can assist cut your tax liability and student loan payments.
- The capacity to tax-free investment growth.
- The only time money is taxed is when it is distributed or withdrawn during retirement.
- When an investor no longer works for their job, they can take money prior to retirement.
Disadvantages of 457(b) Plan
- Fewer possibilities for investment than 401(k)s (Not as common today).
- Only available to certain personnel of eligible nonprofit organisations or state or municipal governments.
- Employer contributions are included in the annual cap.
- Riskier 457(b) plans are non-governmental ones.
Frequently Asked Questions
How will my 457(b) be affected, if I leave my employer?
You can no longer make contributions to your 457(b) plan after leaving your work. To another plan, such as an IRA, 403(b), SEP-IRA, or another 457(b), you can roll it over. Even though you will owe tax on the payout, you can withdraw your money without incurring a penalty.
What is the differences between 457(b) plan and 403(b) plan ?
The main distinction usually relates to who has access to them. Government personnel in state and municipal governments typically have access to 457(b) plans. Employees of public schools and private nonprofits are the main beneficiaries of 403(b) plans. It's also important to keep in mind that the combined contribution ceiling for 403(b) plans for 2023 is $66,000, which includes the $22,500 in employee contributions, employer contributions, and catch-up contributions. If your employer makes a contribution to your 457(b) plan (which isn't common), it counts toward the $22,500 cap in 2023.
How can I make withdrawals from 457(b) plan?
A 457(b) has the benefit of allowing early withdrawals without incurring a tax penalty in the event of any "unforeseeable emergency". Although you should avoid doing this because you are wasting your retirement funds, unexpected circumstances do occur. Additionally, the amount you withdraw will be subject to income tax for that year.
An IRS worksheet determines the required minimum distribution (RMD) that you need to make. Once you reach a particular age, an RMD is a minimum amount that must be withheld annually from some retirement plans, such as a 457(b). Age is 73 if you were born between 1951 and 1959. The age is 75 if you were born in 1960 or after. Compared to the prior age of 72, this is a rise.
Is a 457 better than a 401(k) plan?
Withdrawals made before the age of 59½ are exempt from the 10% penalty tax that is applied to the majority of early 401(k) withdrawals since a 457 is not governed by ERISA requirements. Thus, if you decide to retire earlier than usual, it will be simple to access your funds. Employer matching contributions, in contrast to 401(k) plans, are incredibly uncommon with a 457 plans.
How much tax do I pay on a 457 withdrawal?
If a payout is made payable to you directly, federal income tax withholding of 20% is required.