What Are 457(b) Plans?
457(b) plans are employer-sponsored deferred compensation plans that offer tax advantages to employees. They are mainly for workers at state and local governments and nonprofits. They are similar in design to 401(k) plans but have double limit contributions that enable employees to contribute more catch up contributions to the plan.
Basics of 457(b) Plans
457(b) plans are deferred compensation plans, meaning employees defer part of their compensation for later income. The deferral results in tax advantages because money kept inside a 457 plan does not incur tax. Withdrawals from a 457 plan are taxed at regular rates after the age of 59.5 years.
457(b) plans are offered to employees at state and local governments. Workers in the federal government are offered Thrift Savings Plans (TSP). In a nonprofit, provisioning of 457(b) plans is limited to top earners due to Employee Retirement Income Security Act (ERISA) of 1974.
How Do 457(b) Plans Work?
457(b) plans are similar in design to 401(k) plans. They are defined contribution plans in which employees make a regular pre-tax income contribution to a retirement account managed by the employer. The employee is offered a menu of investment options to grow their compensation inside the account.
Employees can take an annuity or lump-sum payment from the account, after the age of 72. Withdrawals after the age of 59.5 years are taxed at regular income tax rates. Unlike 401(k) plans, there is no 10% penalty charge on money withdrawn from the account before that age.
457(b) plans can also be rolled over to other retirement accounts. In general, however, 457(b) plans offered by government organizations are more portable than those offered by nonprofits. For example, funds from a nonprofit 457(b) plan can only be rolled over to another nonprofit 457(b) plan.
How Do 457(b) Plans Differ from 401(k) Plans?
The main difference between 457 plans and 401(k) plans is their contribution limits. 457 plans have contribution limits identical to 401(k) plans for certain categories of people. The contribution limits for both are $19,500 in 2021. Participants over the age of 50 in a 401(k) plan can pay $6,500 more for a total $26,000 contribution limit.
In contrast, eligible participants in 457 plans can make double limit contribution limits. What this means is that they can make a total of $39,000 ($19,500 + $19,500) in a given year. The eligibility for these deferral limits is restricted to those who have missed making catch up contributions in the past. They should be above the age of 50 and three years away from retirement.
Employers can also offer 457(b) plans and 403(b) plans simultaneously. There are combined contribution limits for 401(k) plans and 403(b) plans. But there are no such limits on 457(b) plans and 403(b) plans. The absence of limits can be especially beneficial for employees who are under the age of 50 and have access to both plans. They will be able to contribute the maximum allowable limit to both plans.
Pros and Cons of 457 Plans
The advantages of 457 plans are:
- They provide tax-deferral benefits to employees and ensure that money compounded inside an account is not taxed.
- Contributions to 457(b) plans are made with pretax income, enabling a reduction in current tax liabilities.
- 457(b) plans have higher contribution limits as compared to 401(k) plans and can be combined with 403(b) for more yearly savings for those under the age of 50.
- Unlike 401(k) plans, which charge a 10% penalty for withdrawal under the age of 50, withdrawals from 457(b) plans do not incur a penalty at any age.
The disadvantages of 457(b) plans are:
- They offer a limited choice of investment options as compared to other retirement plans.
- Fees for investment options, such as annuities, available in 457 plans can be expensive and build up over time, eating into potential savings.
- 457(b) plans are not as portable as other retirement accounts, such as 401(k)s.
457(b) Plan FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.