What is a 457 plan?

A 457 plan is the government employee’s answer to the 401(k) plan.

It is a retirement plan for state and local government employees, and can also be used by select non-profit professionals to save money for retirement.

Since nonprofit and public sector employees operate under different rules than private sector employees, 457 plans have some unique details, risks, and attributes that plan participants should be aware of if they want to maximize the full potential of their benefits. your retirement plan.

What is a 457 plan?

In financial and legal terms, a 457 plan is a retirement plan for government employees and nonprofits that offers tax advantages.

In general, 457 plan participants can make deferred salary contributions to the plan, using pre-tax money, and can benefit as their plan contributions accumulate over decades, tax-free until the cash is withdrawn once the employee retires.

There are two main models for 457 plans:

• 457(b) Plans: The 457(b) retirement plan is the most widely used model 457 plan, commonly provided to state and local government career professionals.
• 457(f) Plans: The 457(f) plan is not as common as the 457(b) retirement plan. Offered to higher-paid state and local government employees and select employees of non-profit organizations (generally at the executive and management levels).

Who qualifies for a 457 plan?

While the use of 457 plans has grown in recent years as the federal government has relaxed the rules for offering such plans to employers, the actual list of professions that qualify for 457 plans is limited.

Primarily, the following employees may qualify for a 457 plan:

• Police and law enforcement officers
• Firefighters and Emergency Medical Technicians/Paramedics
• Public school teachers and administrators
• State or local municipal employees, such as sanitation, road maintenance, and landscaping workers.
• State and local politicians and their staff
• State or local workers
• State or local administrators
• Non-profit employees and other highly paid employees, primarily in hospitals, trade associations, and charitable organizations

It’s worth noting that independent contractors may qualify for a 457 plan in certain circumstances, primarily when they hire an employer that offers 457 plans.

What are the benefits of a 457 plan?

Multiple benefits come from 457 plans, mainly at the contribution and tax levels of the plan:

Has benefits before taxes

The most commonly cited benefit of a 457 plan is that money can be contributed to a plan on a pre-tax basis. That allows plan participants to pay taxes on contributions once they retire when they are invariably in a lower tax bracket. It also helps reduce a plan participant’s tax liability in their working years.

Here is an example.

Let’s say a state government worker makes $5,000 per month and contributes $700 per month to their 457 plan. Based on that level of contribution, that employee’s taxable income for that particular month is only $4,300 ($5,000 – $700 = $4,300 ).

There is no penalty for early withdrawals

Unlike a 401(k) plan, where a plan participant is penalized 10% of any early withdrawal amount from the plan, 457 plan participants are not subject to any early withdrawal penalties for withdrawing money from their account before retirement age. This is because 457 plans, unlike 401(k) plans, are not considered by Uncle Sam to be qualified retirement plans, which means they are exempt from any tax mandates under the Retirement Income Act. of employees from 1974.

That being said, a 457 plan participant who withdraws cash from their plan early will have to pay the amount of standard tax due based on the amount of the withdrawal.

Remember there is a double recovery provision

Participants who have fallen behind on their retirement savings can make so-called “double catch-up” contributions to their 457 plan. While other formal retirement plans, such as 401(k)s and individual retirement accounts ( IRA), offer expanded contributions to the catch-up plan, the 457 catch-up provision is especially generous, as it allows a 457 plan user to make a contribution that is double their maximum annual contribution ($22,500 is the maximum contribution amount in 2023 ).

457s offer a variety of investment options

457 plan participants are certainly not without investment options. A wide variety of mutual funds and exchange-traded funds are available to 457 users, allowing them to balance their retirement portfolio efficiently based on risk, based on their long-term financial goals.

They have a ton of flexibility

Participants who are covered by government employers can transfer funds from their 457 plan to a new employer’s 457 plan, or even to an IRA or Roth IRA, if they leave their current employer. (It’s a good idea to check with your future employer before making this move.)

401(k) vs. 457 Plans

The 457 and 401(k) plans share basic similarities: Both offer tax-advantaged retirement savings, employee matching, and automatic payroll contributions, for example.

But they also differ in certain areas:

457s have early withdrawal penalties

There is a 10% 401(k) penalty for withdrawing funds from a 401(k) before retirement (at age 59½), while 457 plans have no penalty.

They have a different employee base

401(k) plans are offered to for-profit (private sector) employees, while 457 plans are offered to state and local government employees and non-profit workers.

There are higher contribution limits

457 plan participants may contribute up to 100% of their annual salaries to their retirement plans, as long as that contribution stays within the annual 457 contribution limits.

Employer matches are rare

While employers can add matching contributions to 457 plans, most don’t. That’s mainly because state and local governments and nonprofit organizations don’t have the revenue from for-profit businesses.

It is also due to the way the plan rules are written. For example, the limit of a 401(k) plan ($22,500 in 2023) only applies to contributions from one employee. That’s not the case with 457 plans. If an employer matches, say, $5,000 in contributions to the plan, that $5,000 will count toward the employee’s annual contribution limits.

“Catch-up” rules may differ

In general, 401(k) plan participants enjoy higher plan contribution limits than 457 plan users. Adding the 401(k) catch-up provision of $6,000 annually, the maximum contribution for 401(k) plan users k) from both the employer and the employee is $62,000 ($56,000 plus the update contribution of $6,000).

While government employer plans may also offer a $6,000 payback (and a double payback in specific circumstances), nonprofit 457 providers generally don’t offer the same payback limits.

What a 457 plan can offer to employees who are exclusive to government and non-profit plans is a significant contribution opportunity to catch up on the last three years of your employment. In that scenario, 457 plan filers can contribute up to twice their maximum allowable limit ($18,500 x 2 = $37,000) under current contribution levels for the last three years of employment. 401(k) plan participants do not have that option.

Also, there is a hardship withdrawal limit.

Unlike 401(k) plans, which offer ample opportunity for “hardship withdrawals” before age 59½, 457 plans offer fairly limited hardship withdrawal options.

For example, a 401(k) plan participant may withdraw funds from the plan early to purchase a new home or pay for college tuition. A 457 plan user cannot withdraw funds through the hardship status for a new home or for college costs.

Takeout in 457 plans

457 retirement plans are a good deal for non-profit and government employees if they pay close attention to the plan’s rules and opportunities, especially as they get closer to retirement (that’s especially the case with payback rules). 457 in the last three years of employment).

Check with your plan’s benefits advisor to make sure you’re maximizing your 457 plan.

When retirement finally rolls around, you’ll be glad you did.