457 plans are offered by state and local governments and some non-profits. These are pre-tax accounts; just like 401(k) and 403(b) plans, contributions come from your paycheck before income tax is withheld, but you will pay taxes when you withdraw the money in retirement. But in the meantime, the account is allowed to grow tax-free. There two types of 457 plans- 457(b) offered to state and local government employees, and 457(f) offered to highly compensated government and select non-government employees.
Key aspects of 457(b) plans:
- For 2021, yearly contribution limits for 457(b) accounts are $19500 for people younger than 50 and an extra $6500 catch-up amount for 50 and older. Contributions are made from January to December of that year.
- Unlike 401(k)s and 403(b)s, in a 457(b)-plan, employer and employee contributions count towards the $19500 for the under 50 and towards $26000 in the over 50. So, for example, if you are 35 and your employer adds $10,000, you can only add $9,500.
- 457(b) plans feature a “double limit catch-up” provision. This catch-up allows employees within three years of retirement age (as specified in their plan) to contribute $39,000, twice the annual contribution limit.
- If you leave an employer, you can take your money with you.
- 457(b) plans investment options are generally limited to annuities and mutual funds.
- You can make penalty-free withdrawals at any age. These funds often cover high-risk professions like firefighters who work these careers for set times like 20 or 25 years; because they might only work from 21 years old to 46 years, they need to access retirement fund before 59 ½.
- Required Minimum Distributions (RMDs) need to start at 72, but you can still contribute to this type of plan if you are still employed to offset this distribution income.
- You can take a low-interest loan on 457(b) accounts, up to $50,000 or 50% of your account balance. If your balance is $10,000 or less, you can take out the total amount. You will have to pay back the loan within five years (this period may be extended if the money is used to buy a primary home) or leave that job, or it becomes taxable income. The payments will most likely be held back from your paycheck.
Key aspects of 457(f) plans
- 457(f) plans are often used to lure executives from the private sector. Because they are a recruiting tool, they do not have any of the limits on contributions that 401(k)s, 403(b)s, or 457(b)s have in place. Though employees can defer any amount they choose to this account to grow tax-free until distribution, there are forfeiture rules. “Risk of forfeiture” means if you don’t fully honor your contract duration or employment standards, then you can risk losing the entire amount of your account.
- Your money will stay with this plan whether you move on to a new employer or not. And if you don’t meet the terms of your employment contract, you can forfeit the full account.
- 457(f) plan investment options are broader than 457(b) and range from fixed or variable annuities, mutual funds, and even life insurance.
- With the 457(f) plans, you can also fund a 401(k) or IRA.
- The employer owns the 457(f) account money until it is distributed, and often you, as the employee, are 0% vested until their distribution. However, some plans offer an incremental vesting schedule. In addition, because your employer owns it, these funds are available to the company’s general creditors in the event of litigation or bankruptcy.
- You can make penalty-free withdrawals at any age as long as your employment contract is met.
- Loans are not available.
- Required Minimum Distributions (RMDs) rules do not apply to 457(f) plans.
- It is vital to understand the details of your specific plan as not to risk forfeiture.
Key aspects of Both
- With all investment accounts, you expose some or all your invested money to loss for the chance to earn a higher profit. Investment gains hinge on an ongoing and long-term investment strategy that uses your risk tolerance and diversification to mitigate some risks. Even with these in place, you are exposing your money to loss.
- Matching is not standard for these types of plans. Employers often limit their role and do not provide employer contributions to the plan to remain exempt from ERISA rules. Employee Retirement Income Security Act (ERISA) of 1974 rules were implemented to safeguard employees who participate in employer-run retirement plans.
- Profit-sharing, where a company offers stock options to its employees, is not available with these types of plans since these organizations are non-profit or governmental.
- The distributions are reported on a W-2, not a 1099, unless a beneficiary requests the distribution; because of the distribution method, you will pay Social Security tax on all distributions.
Advisory services offered through Capital Asset Advisory Services, LLC, a Registered Investment Advisor. This material has been prepared for informational purposes.