457(b) Retirement Plan

What Is 457(b) Retirement Plan?

A 457(b) Retirement Plan is a type of nonqualified tax-deferred compensation retirement plan offered to certain employees of governmental and non-profit organizations. These employees can defer income taxation on retirement savings into future years. It allows participants to increase earnings through investments and defer their taxes until retirement, when they are likely to have a lower tax rate. The plan is named after section 457(b) of the Internal Revenue Code.

What Is the History of 457(b) Retirement Plan?

The 457(b) Retirement Plan was established by the U.S. Congress in 1978 as a provision in the Internal Revenue Code. The aim was to provide a retirement savings vehicle to state and local government employees, as well as certain eligible employees of tax-exempt organizations that are non-governmental in nature.

Over the years, the rules and regulations governing 457(b) plans have been revised and refined. Notably, the Economic Growth and Tax Relief Reconciliation Act of 2001 allowed for an increase in contribution limits and permitted plan loans for the first time.

Additionally, the Pension Protection Act of 2006 further enhanced the 457(b) plan by allowing for automatic enrollment, free transfers between various types of retirement plans, and certain other provisions to make retirement savings more accessible and flexible.

What Is the Method for Calculating Contributions to a 457(b) Retirement Plan?

The contributions to a 457(b) Retirement Plan usually involve a percentage of an individual's salary that goes directly into the plan through automatic paycheck deductions.

For 2022, the maximum contribution limit to a 457(b) plan is $20,500. This is the combined total for all employee and employer contributions. Additionally, if you are aged 50 or older, you can make "catch-up" contributions, allowing you to contribute an additional $6,500 for a total of $27,000 per year.

A special feature of the 457(b) plan is the "double-limit catch-up", which applies to participants who are within 3 years of normal retirement age. This provision allows for a catch-up contribution up to twice the standard annual limit, so in 2022, this could be as much as $41,000.

However, these contribution limits and catch-up options are subject to change as they are periodically adjusted for inflation. It's always recommended to check the latest guidelines from the IRS.

What's the Difference Between 457(b) Retirement Plan and 401(k) Retirement Plan?

Both the 457(b) and 401(k) retirement plans are types of tax-advantaged retirement savings plans offered to employees. They have similar maximum contribution limits and have tax-deferred growth on investments. However, there are a few key differences:

1. Employers: 401(k) plans are offered by private-sector employers, while 457(b) plans are mainly offered by governmental and non-profit organizations.

2. Early Withdrawal Penalty: In a 401(k) plan, generally, if you withdraw funds before the age of 59.5, you will incur a 10% early withdrawal penalty in addition to regular income tax. However, in a 457(b) plan, there is no early withdrawal penalty. You will only pay regular income tax on withdrawals, regardless of age.

3. Catch-Up Contributions: Both plans offer catch-up contributions for those aged 50 or older, but only the 457(b) plans offer the "double-limit catch-up" provision for individuals within 3 years of normal retirement age.

4. Loans: Most 401(k) plans allow participants to take loans against their account balance, while this feature is less common in 457(b) plans and depends on the plan's specific provisions.

5. Rollovers: It's generally easier to roll over funds from a 401(k) to another kind of retirement account, such as an IRA. Rolling over funds from a 457(b) plan, especially one offered by a non-governmental institution, can be more complicated.

Remember, the plan's specific rules can vary by employer, so it's important to review your plan's documents to understand the exact rules that apply to you.

What's the Difference Between 457(b) Retirement Plan and 403(b) Retirement Plan?

The 457(b) and 403(b) retirement plans are types of employer-sponsored, tax-advantaged retirement savings plans. But they cater to different types of employees and have some unique characteristics.

1. Eligible Employers: 403(b) plans are offered to employees of tax-exempt organizations operating under Section 501(c)(3) of the tax code - typically, these are non-profit organizations, schools, hospitals, and churches. On the other hand, 457(b) plans are provided to employees of state and local governments and certain non-governmental entities.

2. Early Withdrawal Penalty: One key difference is the treatment of early withdrawals. Under a 403(b) plan, withdrawals before age 59.5 are typically subject to a 10% penalty. On the contrary, the 457(b) plans do not have a 10% early withdrawal penalty, which grants more flexibility to retirees who wish to access their funds early.

3. Maximum Contributions: The contribution limits are the same for both plans - $20,500 for 2022. Both plans also allow for additional catch-up contributions for employees aged 50 or older. However, only 457(b) plans offer the "double-limit catch-up" provision for those within 3 years of their normal retirement age.

4. Loans: Both 457(b) and 403(b) plans potentially allow loans, depending on the plan's rules set by the employer.

5. Rollovers: Both plans allow for rollovers to other types of eligible retirement plans (including traditional IRAs), but the rules can be complex and specific to each plan.

As always, the specific terms and conditions of an individual's plan can vary, so it's essential to review your plan's documents or consult with a financial advisor to fully understand your options.

What Factors Predict Participation and Contributions to a 457(b) Retirement Plan?

Several important factors can predict participation and contributions to a 457(b) Retirement Plan:

1. Income Level: Typically, individuals with higher income levels are more likely to participate and contribute more to their retirement plans. This is because they can more easily afford to set aside money for retirement and are often looking for tax-advantageous ways to save.

2. Employer Match: If an employer offers a matching contribution, employees are more likely to participate. The matching contribution effectively increases their return on investment, making the plan more attractive.

3. Financial Literacy: Higher levels of financial literacy and awareness can lead to increased participation and higher contributions. People who understand the benefits of tax-deferred savings, compound interest, and employer matches are more likely to take full advantage of these plans.

4. Age: Older workers are often more motivated to save for retirement, leading to higher participation rates and larger contributions. Additionally, individuals over 50 are allowed "catch-up" contributions, potentially increasing their investment.

5. Job Tenure: Employees who've been with an organization for a longer period are typically more likely to participate and contribute more due to increased job security and potential for higher earnings.

6. Plan Features: The specifics of the 457(b) plan (such as investment options, fees, ease of enrollment) can impact participation and contribution rates. For instance, plans that simplify the enrollment process or offer a diverse range of investment options may promote greater participation and contributions.

7. Attitude Toward Risk: Individuals who are more risk-averse might contribute more to their retirement funds as a form of financial security for their future.

As always, individual circumstances can greatly vary, and these factors do not guarantee or prevent participation or contribution levels.

What Are the Benefits of 457(b) Retirement Plan?

There are several benefits to participating in a 457(b) retirement plan:

1. Pre-Tax Contributions: Your paycheck contributions are made pre-tax, so your taxable income is reduced in the contribution year.

2. Tax-Deferred Growth: The earnings from your investments grow tax-deferred until withdrawal.

3. No Early Withdrawal Penalty: Unlike other retirement plans (like 401(k) and 403(b)), the 457(b) plan does not include a 10% early withdrawal penalty if you withdraw funds before age 59.5.

4. Double Limit Catch-up: If you’re nearing retirement (within 3 years of normal retirement age), the "double-limit catch-up" contribution feature enables you to contribute twice the annual limit to help boost your retirement savings.

5. Flexible Withdrawals: As a 457(b) participant, you have the flexibility to start withdrawals as soon as you stop working, regardless of your age.

6. Roll-Over Options: 457(b) funds can be rolled over into other retirement accounts, such as an IRA or a new employer's 401(k) plan.

7. Potential for Employer Match: Some employers may offer a matching contribution feature, effectively boosting your retirement savings rate.

These benefits combined can lead to substantial retirement savings and ensure that your money is working for you in a tax-efficient manner. However, the specifics of your plan (like investment options and potential employer match) can depend on your employer's particular setup of the 457(b) plan.

What Are the Potential Drawbacks or Disadvantages of a 457(b) Retirement Plan?

While 457(b) retirement plans offer several benefits, they also have a few potential drawbacks to consider:

1. Limited Investment Options: Compared to Individual Retirement Accounts (IRAs), 457(b) plans may offer more limited investment options. The specific options available are usually chosen by the plan provider which may or may not align with an individual's investment preferences.

2. Taxation at Withdrawal: While contributions are made on a pre-tax basis and grow tax-deferred, distributions in retirement are taxed as ordinary income. If you anticipate being in a high tax bracket in retirement, your tax on withdrawals could be significant.

3. Lack of Employer Matching: Not all employers offer matching contributions. If yours does not, you may miss out on free money that you might receive under other employer-provided plans such as 401(k)s.

4. Penalty for Excess Contributions: If you contribute more than the annual limit to your 457(b), the excess could be subject to a penalty tax. It's important to keep track of your contributions to avoid surpassing the limit.

5. Non-Governmental Plan Risks: Non-governmental 457(b) plans are not protected from the employer’s creditors. This means in the case of bankruptcy, for example, assets in these plans might be at risk.

As always, it's essential for each individual to evaluate their own financial situation, retirement goals, and tax implications before deciding to contribute to a 457(b) plan. It may be beneficial to consult with a financial advisor or tax professional to discuss your particular circumstances and ensure you're making the best decision for your financial future.

Which Employers Typically Offer a 457(b) Retirement Plan to Their Employees?

457(b) Retirement Plans are typically offered by the following categories of employers:

1. State and Local Governments (Public sector): This includes entities such as city and county governments, public schools, colleges and universities, police departments, fire departments, public hospitals, and other tax-exempt governmental entities.

2. Tax-Exempt Non-Governmental Institutions (Private sector): Some non-profit organizations, such as charitable organizations and certain hospitals, which are tax-exempt under section 501(c) of the Internal Revenue Code, can offer 457(b) plans to a select group of management or highly compensated employees.

It's important to note that while private for-profit companies cannot offer 457(b) plans, they can offer similar retirement plans like 401(k) or 403(b) plans.