What is a 457 Retirement Plan? | Bloom Financial
Planning for retirement is a smart move, especially when you have access to a variety of tax-advantaged savings options to help you achieve your long-term goals.
One option that stands out for public sector employees is the 457(b) retirement plan. But what is a 457 Retirement Plan, and why should you consider it as part of your retirement strategy?
Let’s explore the details of what a 457(b) retirement plan entails and how it can benefit you.
What is a 457 Retirement Plan
A 457(b) deferred compensation plan is a specialized tax-advantaged retirement savings account offered by certain state and local governments and tax-exempt organizations to their employees.
This plan is particularly beneficial for individuals in the public sector, including law enforcement officers, civil servants, and university employees.
When you enroll in a 457(b) plan, you typically contribute pre-tax dollars, which effectively lowers your taxable income.
The funds within the account can be invested, allowing them to potentially grow over time.
The annual contribution limit for 457(b) plans is set at $23,000 for 2024, an increase from $22,500 in 2023.
It's important to note that 457 plans are classified as nonqualified retirement plans, meaning they are not subject to the ERISA.
Who is eligible for a 457 plan?
A 457(b) plan is designed mainly for civil servants, municipal employees, law enforcement officers, and public safety staff.
Executives working at hospitals, charitable organizations, unions, and certain independent contractors hired by state and local government entities can also participate in 457(b) plans.
There are two different types of 457(b) plans, each with its own rules and regulations.
Government employees
Governmental 457(b) plans are retirement savings programs sponsored by government entities, including state and local governments as well as public schools.
Employees who meet the plan's eligibility criteria can typically participate, providing them with an excellent opportunity to save for retirement.
Similar to 401(k) plans, contributions made to governmental 457(b) plans are securely held in a trust, ensuring that they are protected from claims by your employer's creditors.
You can transfer money from a government 457(b) retirement plan into other retirement accounts like IRAs and 401(k)s. This gives you more flexibility to manage your retirement savings.
Both employees and employers can contribute, helping to maximize retirement savings while adhering to IRS annual contribution limits.
Non-governmental 457 plans
A non-governmental 457(b) plan, often referred to as a tax-exempt 457(b) plan, is sponsored by an organization such as a college or nonprofit entity.
In this type of plan, you specify the percentage of your income that you wish to contribute.
However, the account is owned by your employer, not by you, meaning your contributions could be at risk if your employer experiences financial difficulties or insolvency.
Also, since the employer technically owns the account, you can't transfer funds from a non-governmental 457(b) plan into other retirement accounts, and you may have limited control over the investment choices for your funds.
Unlike governmental plans, which allow you to take loans against your contributions, non-governmental 457(b) plans do not offer this option.
While you may be automatically enrolled in a governmental 457(b) plan, participation in a non-governmental plan requires you to actively elect to join.
How do contributions work in a 457 plan?
457(b) plans are pretty similar to many other retirement savings plans.
Employees can choose to contribute a portion of their income, up to the yearly limit, when they enroll.
Depending on how you contribute, you may get tax benefits when you make contributions or when you take money out of the plan.
Contribution limits and rules
For 2024, the basic contribution limit for 457(b) plans is set at $23,000.
For those aged 50 and older, the limit for catch-up contributions increases to $30,500.
In the three years leading up to retirement, you can contribute up to double the annual limit or 100% of your salary, whichever is lower.
However, you can't add more contributions than the previous years' unused eligible contributions. If you've already contributed the maximum each year, you may not be able to take advantage of this double contribution feature.
And if you choose to use this option, remember that it requires careful record-keeping to comply with IRS limits.
Additionally, if you are 50 or older, you cannot use the standard catch-up contribution option during the years when you are making double contributions.
Another important aspect is that if you have access to another employer-sponsored retirement plan, such as a 403(b), you can contribute the maximum employee amount to both plans.
For 2024, the catch-up contribution limit stays at $7,500.
Employer contributions
State and local government employers usually do not match contributions for 457(b) plans.
Many government employees already have pension benefits. A 457(b) plan is seen as an additional way to save money. This means that it's rare for employers to add money to the plan.
Key benefits of a 457 plan
Enrolling in a 457(b) plan has many important benefits, including:
- The chance to withdraw funds before age 60 without incurring penalties.
- Contributions to a 457(b) plan allow for tax deferral at both state and federal levels until you withdraw the funds, typically during retirement when you are likely in a lower tax bracket.
- Unlike 401(k) plans, 457(b) plans offer a double-limit catch-up provision, which means employees can contribute up to $45,000 in 2023 and $46,000 in 2024.
- 457 accounts also offer the option for hardship distributions in cases of unforeseen emergencies.
Tax advantages and withdrawals
A 457(b) plan offers tax-efficient growth for your retirement savings.
Contributions to your 457(b) are deducted directly from your paycheck and can be taxed in one of two ways:
- Traditional 457(b): When you contribute to your retirement account, the amount is not taxed immediately, reducing your current taxable income. However, you'll pay income taxes on the funds when you withdraw them during retirement.
- Roth 457(b): When you invest money into your account, you use already taxed funds. In return, you are able to make tax-free withdrawals during your retirement.
But withdrawals from a 457(b) plan can be somewhat complex.
Unlike many other tax-advantaged retirement accounts, 457(b) plans allow you to withdraw funds penalty-free before age 59½, but this benefit only applies if you have left your employer.
If you remain employed, however, your contributions are generally more restricted than in other retirement accounts.
You can normally only take money out if you have a serious money problem, and even then, your employer’s plan might not allow it.
Whether you can borrow from your 457(b) plan depends on your employer's rules.
Flexibility compared to other retirement plans
Unlike 403(b) and 401(k) plans, 457(b) plans allow you to withdraw funds penalty-free before age 59½ if the plan sponsor no longer employs you.
Additionally, governmental 457(b) plans are exempt from the 10% additional tax that typically applies to early withdrawals, except in cases where the distributions are related to a rollover from another type of plan or an IRA.
Conclusions
457(b) plans offer a retirement savings option for eligible public sector employees.
If you follow the rules, this retirement plan can help you save money for the future.
However, flexibility compared to other retirement plans can be perceived as limited in withdrawal and investment options.
Fortunately, you can have a 457(b) plan while investing in other opportunities.
At Bloom Financial, we’re here to help you navigate your retirement savings options and tailor a plan that meets your personal goals.
Let us guide you toward a more confident and financially secure retirement.
