It’s never too early or too late to start planning for retirement. No matter when you begin, the varied types of plans can seem overwhelming. A 457 plan is a very specific type of retirement plan which isn’t talked about as much as the more common 401(k). But if your employer offers one, it’s good to know what it is and why you might want it.
What Is a 457 Plan?
457 plans are tax-advantaged, deferred compensation retirement plans. They are non-qualified, which means they do not follow the Employee Retirement Income Security Act (ERISA) guidelines. This exempts them from the non-discrimination testing that other plans have, making them ideal for highly-compensated employees. Non-qualified plans aren’t tax-deductible for either the employee or the employer. But they allow employees to defer taxes until retirement when they might be in a lower tax bracket.
Employees can contribute up to 100% of their salary as long as it doesn’t exceed the dollar limit for the year. As of 2021, the limit is $19,500 per year. If the employer offers contribution matching, then this amount counts towards the dollar limit.
Differences Between 457 and 401(k) Plans
A 457 plan is similar to a 401(k). But they are typically offered by state or local governments, or for high-paid executives at non-profit organizations. Also, as 457s do not follow ERISA guidelines, they handle certain elements like early withdrawals or hardship distributions differently than with a 401(k).
As of 2021, both plans give employees over the age of 50 a catch-up provision which allows an additional $6,500 in contributions. 457s have a double limit provision, which lets employees contribute up to $39,000. This helps them make up for years where they were eligible to contribute to their plans but didn’t do so at the time.
If you make withdrawals from a 401(k) before the age of 59 ½, then you will pay a 10% tax penalty unless you withdraw due to financial hardships, as defined in each particular 401(k) plan. 457s do not have the same tax penalty, but their withdrawal is still subject to normal income tax.
Since 457s are non-qualified plans, it is possible for employees to have both a 401(k) and a 457 simultaneously and contribute to both if their employers offer both options.
Is a 457 Right for You?
Your age, not simply your income, is the key consideration if you’re debating between a 457 or a 401(k).
Younger people may prefer the 457, since it allows them to tap into their funds without a tax penalty. They can then using the 457 as both a savings fund for emergencies and a retirement fund.
Older adults who find themselves closer to retirement may prefer the 401(k) if their employer offers matching contributions. But if they have a high income and no matching contributions, the double limit provision of a 457 looks more appealing.
Get Help With Your Retirement Decisions
Your personal circumstances are crucial in navigating the complexities of choosing a retirement plan. And the right answer might change with new tax laws and rules. Contact us to find an experienced financial advisor who can help you out with a big decision.