When it comes to different types of retirement plans there are far more options out there than you might be aware of: 401k’s, 403b’s, Keogh Plans, DB(k)’s. Is your head spinning yet?
One lesser know retirement plan is the 457 Plan, which is often referred to as a Deferred Compensation plan or Deferred Comp. It’s a lesser known retirement plan because it is only offered to certain types of employees.
What is a 457 Plan?
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A 457 plan is a type of tax-advantaged retirement savings plan offered by governmental employers in the United States. It is named after Section 457 of the U.S. Internal Revenue Code and allows employees to set aside a portion of their salary into an account that is exempt from federal income taxes until it is withdrawn at retirement.
The accounts are regulated by the IRS, and employers can choose to offer them as part of their benefits package.
State and local public employees and sometimes nonprofit organization employees are often offered the 457 retirement plan. Only employers who are exempt from paying federal income taxes and non-church organizations can offer 457 plans, including:
- State and local governments
- Hospitals
- Educational Organizations
- Charitable Organizations or Foundations
- Trade Associations
The 457 is similar to the more widely known 401(k) plan, where you can choose to contribute to the 457 plan through automatic deductions from your paycheck before the taxes are taken out. Also, like the 401(k), money grows tax-deferred in a 457 retirement account until the time you withdraw the money.
Contribution limits and early withdrawals are treated differently for 457 plan holders, however. which we’ll take a look at here.
457 Contribution Limits
If your employer offers only a 457 plan as your retirement account option, you can contribute a maximum of $22,500 in 2023 if you’re under the age of 50, and up to $30,000 if you’re over the age of 50.
If your employer also offers either a 401(k) or a 403(b), you have the option of contributing to both the 457 plan and one of the other available retirement accounts. I have several clients who are employed by the local university and they have the option of contributing to both the 457 plan and a 403(b). You can invest up to the maximum limit for each account!
This means you could contribute $22,500 in the year 2023 to your 457 plan, and another $22,500 into the 401(k) or 403(b) plan if you’re under the age of 50. This probably goes without saying it, but you do have to have enough income to be able to contribute this amount.
This is a great option for people who are starting their retirement savings later than planned, or who just want to take advantage of tax breaks or employee matching as much as possible.
For 2023 and future years, the maximum contribution for these plans will increase by $500 increments, and indexed for inflation.
Catch Up Contribution Limits for 457 Plans
If you’re over the age of 50 before the end of the calendar year, you’re eligible for a “catch-up contribution” in 2023. You can contribute an additional $7,500 if you have a governmental 457 plan.
| Year | 403(b) Maximum | Catch-Up Contribution | Maximum Allocation |
|---|---|---|---|
| 2023 | $22,500 | $7,500 | $66,000 |
| 2022 | $20,500 | $6,500 | $61,000 |
| 2021 | $19,500 | $6,500 | $58,000 |
Early Withdrawals from a 457 Plan
Money saved in a 457 plan is designed for retirement, but unlike 401(k) and 403(b) plans, you can take a withdrawal from the 457 without penalty before you are 59 and a half years old. This is a very important rule that often times goes overlooked with the 457 plan.
I had one encounter with an individual that had retired early and had rolled their 457 plan into an IRA based on a recommendation from their former advisor. (Notice I said “former”). By rolling into the IRA, you lose the ability to cash out early to avoid the penalty in case you need access to your funds.
There is no penalty for an early withdrawal, but be prepared to pay income tax on any money you withdraw from a 457 plan (at any age).
Just like other retirement plans, you do need to start taking distributions from your 457 plan by the age of 70 and a half years old.
How to Invest in a 457(b) Plan
If you’re looking for investment options, you can’t go wrong with a 457 plan. A 457 plan offers an array of different investments, including stocks, bonds, mutual funds and even annuities. By diversifying your portfolio within the 457 plan, you can make the most of your money by balancing both short-term and long-term gains.
And if that sounds too tricky, some plans even offer the option to use a professional financial advisor to manage your portfolio – so let them navigate the turbulent investing waters while you kick back and relax.
Can You Roll a 457 Plan Into an IRA?
As I mentioned above, you do have that option if you are a government employee. The process is very similar to rolling over a 401k into an IRA. As a reminder, you just need to be cautious if you retire early for the reasons noted above.
If you don’t need the money immediately it’s in your best interest to leave the money in the account to compound until you are ready for retirement, but it’s nice to know that you won’t pay a 10% penalty on early withdrawals should there be no other option.
If you do decide to roll your 457 plan into an IRA, I recommend a platform like M1 Finance.
Can You Roll Your 457 Plan Into a 403b or 401k?
Yes, you can roll your 457 plan into a 403b or 401k. However, it is important to note that the rules for doing so vary depending on the plan and provider.
If you are considering rolling over your 457 plan into a 403b or 401k, you should contact your plan administrator for more information about whether this option is available to you and how it works.
The Bottom Line – 457 Retirement Account Rules
The bottom line of the 457 Retirement Account Rules is that it offers a variety of tax benefits for those who take advantage of them. Contributions to a 457 plan are not subject to Social Security or Medicare taxes, making them a great way to save for retirement.
Withdrawals from the account are federally income tax-free after age 59 1/2 as long as certain criteria have been met. Employers may offer matching contributions, adding even more to your retirement savings.
Participants should be aware that if they withdraw money before age 59 1/2, they will likely incur an early withdrawal penalty and any earnings on that amount will be subject to federal income tax as well as state penalties.
| 457 Plan | Description |
|---|---|
| Type of plan | A type of retirement plan available to employees of state and local governments, as well as certain tax-exempt organizations. |
| Contributions | Employees can contribute up to the IRS annual limit ($22,500 in 2023) through pre-tax or after-tax (Roth) contributions. |
| Catch-up contributions | Employees age 50 or older can make additional catch-up contributions up to $7,500 in 2023. |
| Withdrawals | Withdrawals can begin at age 59 1/2 without penalty, and must begin by age 72 (or retirement, if later). Withdrawals are subject to income tax. |
| Loans | Some 457 plans allow for loans, with repayment typically required within five years. |
| Rollovers | Funds can be rolled over from another 457 plan or a qualified retirement plan, such as a 401(k) or 403(b). |
| Employer contributions | Some employers may offer matching contributions or non-elective contributions to employee accounts. |
| Advantages | Offers tax-deferred growth potential, flexibility in contributions and withdrawals, and may offer lower fees and expenses compared to other retirement plans. |
| Disadvantages | Limited to employees of state and local governments and certain tax-exempt organizations, may have limited investment options, and may be subject to certain withdrawal restrictions. |
FAQs on 457 Retirement Account Rules
Eligibility for a 457 plan depends on the employer’s plan and the type of employer. Government employers, tax-exempt organizations, and some non-profit organizations may offer 457 plans.
457 plans are similar to 401(k) plans in terms of tax benefits and investment options, but there are some differences such as eligibility, contribution limits, and early withdrawal rules.
Distributions from a 457 plan before age 59 1/2 may incur a 10% early withdrawal penalty in addition to regular income tax.
Investment options in a 457 plan vary, but they usually include mutual funds, exchange-traded funds (ETFs), and individual stocks. The options available depend on the specific plan.
Yes, you can roll a 457 plan into a Roth IRA. This means that you will withdraw money from the 457 account and then contribute it to a Roth IRA. However, keep in mind that there may be tax implications when rolling over a 457 plan into a Roth IRA. The tax implications are very similar to rolling a 401k into a Roth IRA.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
