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What Is A 457 Plan?

457 retirement plans are made available to state or local government employees, as well as some non-profit organizations that fall under the IRC Section 501. 457 are defined contribution plans meaning a percentage of your income is set aside and put into the plan. These retirement plans offer an opportunity for pre-tax income to grow tax-deferred, as well as lowering your current year’s taxable income. 

Types Of 457 Plans

There are two types of 457 plans. 457(b) is much more common than their 457(f) counterpart, but they are drastically different. We’ve highlighted the two plans below: 

457(b)

457(b) plans are nonqualified, defined contribution plans made available to state and local government employees, and particular non-profit organizations. Eligible non-government organizations will fall underneath in the Internal Revenue Code (IRC) Section 501. 457(b) plans have the same $19,500 contribution limit as 401(k)’s, as well as offer tax-deferred growth on savings. 

457(f)

457(f) plans are put together for highly paid, non-profit executives where compensation and taxes are deferred until retirement, death or disability. Unlike other retirement plans, compensation is contingent upon the executives successful completion of service, and furthermore, hitting performance goals. Because of the pre-defined service and performance goals, the executive’s deferred compensation is subject to high risk of forfeiture. 

What Is The 457 Plan Contribution Limit?

The 457(b)’s 2019 and 2020 contribution limits are $19,000 and $19,500, respectively. Contributions can be made up of the lesser of 100% of an individual’s compensation, or $19,500. This is the same 2020 contribution limit as 401(k) plans. If you are ages 50+, you can qualify for catch-up contributions up to $6,500, or $26,000 in total.

The IRS also includes special “double catch-up contributions” to eligible plans. 3 years prior to a predetermined retirement date, an individual can contribute the lesser of twice the limit (or $39,000 for 2020), or the annual limit plus the remaining previous year’s contribution’s limit, assuming you did not make the maximum contribution.

For example, if an individual contributes $15,000 to the plan in 2019, could contribute $23,500 ($19,500 + $4,000). Where did we get the extra $4,000 from? The difference of last year’s contribution limit, and what was contributed.

457 Pros And Cons

Each plan has its own unique benefits and drawbacks. Here are some of the pros and cons of a 457 plan.

457 Pros

A major benefit of 457 plans is the double-catch up option. This feature lets savers stash a total of $39,000 in 2020 — these savings only add up towards the tail end of your career. Also, because 457 plans are non-qualified plans, they lack withdrawal penalties compared to other retirement plans. Early distributions from your 457 plan are not penalized with any additional taxes if you are to retire or resign early. 

457 Cons

457 plans are only available to eligible employees of government and/or non-profit organizations. Also, governments don’t match contributions often, and if they do, their match adds towards the annual contribution limit of $19,500. 

457 vs 401(k)

The main difference between 457 and 401(k) plans are the customers they’re made available to. 457 are for government or nonprofit organizations, while 401(k)s are offered by for-profit businesses or corporations. Furthermore, 401(k) plans are qualified plans, while 457 plans are not.

Another substantial difference between the two is the 457 plan’s double catch-up contribution. Both 457 and 401(k)s have a 2020 contribution limit of $19,500, and if you’re ages 50+, can qualify to contribute an additional $6,500, for a total of $26,000. If the organization’s 457 plan allows, individuals may double contributions for the last three years leading up to retirement ($39,000 in total for 2020).

Early withdrawals from 401(k)s must fall within the IRS’s list of prequalified events to avoid the 10% penalty tax. On the other hand, early withdrawal from 457 plans are not hit with a penalty tax, but are taxed at your standard income tax. Early withdrawals from a 457 plan must be considered absolute financial emergencies or “hardship withdrawals.” 

It is good practice to consider these savings untouchable until you hit retirement, hit 59 ½, or are in a need to access emergency funds.

What’s Next: Hiring A Financial Advisor Or DIY Financial Planning

If you are a government or nonprofit employee that is being lured into a 457(b) plan, it’s important to understand what you’re signing up for. This is especially true when a percentage of today’s income is what’s being contributed to the plan. 457(b) plans can be seen as the government-edition to its corporate 401(k) relative aside from the few minor differences mentioned.

Not sure where to start? Don’t worry, retirement plans are not common sense whatsoever, nor should you take uninformed risks with your potential retirement income. Meeting with a financial advisor can help clear any questions you may have about your 457 plan, or potential other areas of your personal finance. Investment Firms has partnered with financial advisors in your area to help get you qualified advice on your financial goals. Check out the Financial Advisor matching tool today!