There are many types of retirement plans available in the U.S., so it's important to learn how they differ and which ones you're eligible to invest in. There are 401(k), IRA, 403(b), SEP and 457 plans, plus many more.
If you're wondering what a 457 plan is and if it's an option for you, keep reading. This article will explain what it is, who it's for, as well as the advantages and the disadvantages of having one.
What Is a 457 Retirement Plan?
A 457 retirement plan is a type of IRS-approved, tax-advantaged deferred retirement plan. It was originally created in 1978 with the Revenue Act and is named after the section that defines it, "Internal Revenue Code Section 457."
Employees who are eligible for this retirement plan can set up automatic deductions from their paychecks and deposit their own pre-tax money into the plan, much like other employer-sponsored retirement accounts.
Employees use the money in the plan to invest in funds the plan offers. While they might not have access to a multitude of mutual funds or other types of investments, most plans offer a few choices.
Who Is a 457 Retirement Plan For?
Unlike a traditional 401(k), a 457 plan is specifically for state and local government employees, as well as certain nonprofit employees.
Here are some types of employers that might offer a 457 plan:
While not all of the employers that offer 457 plans fall into the above categories, many of them do. The two types of 457 plans are the 457(b) plan, which is the most popular, and the 457(f) plan.
What Is the Difference Between a 457(b) Plan and a 457(f) Plan?
The 457(b) is the most common 457 plan that government employees get as part of their compensation packages.
The 457(f) plan is for certain employees, both government and non-government, who get high compensation, such as executives.
The 457(b) Plan
A 457(b) plan is very similar to a 401(k) retirement plan, except it's specifically for government and some nonprofit employees. Recently, the IRS updated contribution limits for 457 plans. In 2022, employees will be able to contribute a total of $20,500 per year, which includes matching funds from an employer — an increase from the previous contribution limit of $19,500.
The 457(f) Plan
As mentioned, the 457(f) plan is typically for highly paid government or nonprofit employees. It has incredible benefits, but it often comes with specific requirements, like working for a set number of years in a job.
Under this plan, only the employer makes contributions, and there are no contribution limits. That means that depending on the plan, employers could even deposit up to 100% of an employee's income into the 457(f).
How Do I enroll in a 457 Retirement Plan?
If you're interested in enrolling in a 457(b) retirement plan, and you're a government or a nonprofit employee, speak to your employer about whether they offer this type of account. If you are eligible to enroll, you may still want to speak with an investment advisor before making any decisions regarding which funds to invest in for your retirement savings.
Do 457 Plans Have RMDs?
RMD stands for required minimum distribution. This means you must make withdrawals from your retirement plan account each year once you reach the age of 72. (The age has increased — if you turned 70 ½ before 2020, you may already be taking RMDs.) The amount of the distribution is based on your life expectancy and the value of your account at the time of the distribution. If you do not take the required minimum distribution, you could get charged a penalty.
Like other accounts, 457 plans do have RMDs. If you plan to keep working past 72, speak to your employer about whether RMDs will apply to you.
Do You Pay Taxes on 457 Withdrawals?
One of the biggest benefits of 457 plans is that you can withdraw your money at any time without penalty. However, you have to pay taxes on the money you take out.
Because you put money into a 457 plan pre-tax, you will have to pay taxes upon withdrawal. Not taking taxes into account with a 457 plan is one of the mistakes many employees make. So make sure you understand your tax requirements for the plan and use that information to help you decide when to withdraw your contributions.
Keep in mind, if you roll over your 457 into a different type of retirement account, like an individual retirement account, aka IRA, you likely will not be able to withdraw money without penalty because it won't be a 457 account anymore.
What Are the Advantages of a 457 Retirement Plan?
Here are some advantages of a 457 plan:
You can max out a 457 plan in addition to a 401(k) plan. In other words, you don't have to reduce the amount of money you put into a 457 plan if you're already contributing to another type of retirement account. This can help you grow your retirement savings.
According to the IRS, there are no penalties for early withdrawals from a 457(b) plan "except for distributions attributable to rollovers from another type of plan or IRA."
Employers may offer matching contributions into a 457 retirement plan, which can increase your savings potential.
Money contributed to the 457 is tax-deferred, meaning you don't pay taxes until you withdraw funds.
What Are the Disadvantages of a 457 Retirement Plan?
Here are some disadvantages of a 457 plan:
There are contribution limits on 457(b) retirement plans.
457(b) retirement plans typically offer limited investment choices.
457(f) plans are typically only available to highly paid executives.
Like a 401(k) plan, if you have a 457(f) plan and you quit your job or get fired before your money is vested — in other words, before you own 100% of the employer contributions to your account, based on a timeline set by the employer — you risk losing the money that is not yet vested in your 457(f) plan.
Is Investing in a 457 Retirement Plan a Good Idea?
Yes, it can be. If you are looking for tax-advantaged retirement savings options, then a 457 plan is definitely an option to consider. These plans allow employees of state and local governments as well as certain nonprofits the opportunity to save money for retirement.
The contributions you make to a 457 plan are not taxed until you withdraw them, which can provide significant tax savings. In addition, many employers offer matching contributions to their employees' 457 plans, which can help you build up savings for retirement.
If you are looking for a way to save money for retirement and want the potential for tax savings, a 457 plan might be a good option for you. Talk to your employer about whether this type of plan is offered and how you can start contributing.