What Is A 457 B Plan

Are you a public sector or non-profit employee looking to secure your financial future? Many are! In fact, a significant portion of the workforce relies on employer-sponsored retirement plans to build a nest egg for their golden years. Understanding these plans, especially those unique to your sector, is crucial for making informed decisions about your savings and ensuring a comfortable retirement.

One such plan, often available to state and local government employees, as well as employees of certain tax-exempt organizations, is the 457(b) plan. This deferred compensation plan offers valuable benefits like tax-deferred growth and the potential for employer contributions. However, it also comes with its own set of rules and regulations that can be confusing. Knowing the ins and outs of a 457(b) plan can empower you to maximize its potential and avoid costly mistakes, setting you on the path to a secure retirement.

What are the key things I need to know about a 457(b) plan?

What types of employers offer a 457(b) plan?

457(b) plans are primarily offered by state and local governments, as well as certain tax-exempt organizations. This makes them a common retirement savings option for public sector employees like teachers, police officers, firefighters, and other government workers. It's less common to find these plans offered in the private sector.

The eligibility to offer 457(b) plans is tied to the employer's tax status. Governmental entities at the state and local level are explicitly permitted to sponsor these plans under Section 457 of the Internal Revenue Code. Some non-governmental tax-exempt organizations, typically those described under Internal Revenue Code Section 501(c), may also offer 457(b) plans, though this is often subject to stricter regulations and limitations. It's important to note that not all tax-exempt organizations are eligible; typically, these are organizations providing public services or quasi-governmental functions. It's essential to confirm with your employer or benefits administrator whether a 457(b) plan is indeed available to you. If you are employed by a governmental entity or a tax-exempt organization, inquire about the specific eligibility requirements and contribution rules associated with their plan. Many employers also offer other retirement savings options in addition to or instead of a 457(b) plan, such as a 403(b) or a traditional pension plan, so understanding your full range of options is crucial.

How are distributions taxed in a 457(b) plan?

Distributions from a 457(b) plan are taxed as ordinary income in the year they are received. Unlike Roth accounts, contributions to a 457(b) plan are typically made on a pre-tax basis, meaning you don't pay income taxes on the money until you withdraw it in retirement. Therefore, when you take distributions, the full amount is subject to federal and state income taxes, just like your regular salary would be.

Distributions are taxed at your current income tax rate in retirement, which could be higher or lower than your tax rate was when you made the contributions. Careful planning is key to managing your tax liability. Many retirees choose to spread out their distributions over several years to avoid bumping themselves into a higher tax bracket. Required Minimum Distributions (RMDs) also apply to governmental 457(b) plans, starting at age 73 (or 75, depending on your birth year). Failing to take the RMD can result in a significant penalty. It's important to distinguish between governmental and non-governmental 457(b) plans, though the taxation is the same. However, the assets in a governmental plan are held in trust for the benefit of the employee, offering greater security. In contrast, assets in a non-governmental plan are generally subject to the claims of the employer's creditors, adding a layer of risk. Regardless of the type, understanding the tax implications is crucial for effective retirement planning.

What's the contribution limit for a 457(b) plan?

For 2024, the contribution limit for a 457(b) plan is $23,000. This limit applies regardless of age. There's also a special catch-up provision available in the three years prior to your normal retirement age, allowing you to contribute up to twice the regular limit, or $46,000 for 2024, provided certain conditions are met based on underutilized contributions from prior years.

The contribution limit represents the maximum amount you can defer from your pre-tax salary into the 457(b) plan each year. This limit is subject to change annually based on IRS guidelines and cost-of-living adjustments. It's crucial to stay informed about the current year's limit to optimize your retirement savings strategy. The "special catch-up" provision in the three years before your normal retirement age can significantly boost your savings if you haven't maximized contributions in previous years. This catch-up allows you to contribute the lesser of twice the applicable limit ($46,000 in 2024) or the sum of the applicable limit plus the amount of underutilized deferrals from prior years. It is important to note that you cannot use both the age 50+ catch-up and the special 457(b) catch-up in the same year.

How does a governmental 457(b) differ from a non-governmental one?

The primary difference lies in the security of the assets. Governmental 457(b) plans hold assets in trust or custodial accounts for the exclusive benefit of participants, offering greater protection against employer insolvency. Non-governmental 457(b) plans, offered by tax-exempt organizations, generally do not require assets to be held in trust; instead, the assets remain the property of the employer, subject to the claims of its general creditors until distribution.

While both governmental and non-governmental 457(b) plans allow employees to defer pre-tax income and potentially grow their investments tax-deferred, the crucial distinction regarding asset ownership creates a significant difference in risk. In a governmental 457(b) plan, participants have a higher degree of assurance that their retirement savings will be available, even if the government entity faces financial difficulties. This security stems from the legally mandated trust or custodial account structure. Conversely, in a non-governmental 457(b) plan, the employee essentially becomes an unsecured creditor of the employer. This means that if the tax-exempt organization experiences financial hardship or bankruptcy, the deferred compensation held in the 457(b) plan is at risk of being claimed by the organization's creditors. This difference is a major consideration for employees when evaluating the risk profile of each type of plan. In addition, governmental 457(b) plans may offer the ability to transfer the assets in the plan to another retirement account. Non-governmental 457(b) assets are usually only able to be distributed as a lump sum or annuity.

Can I roll over money from a 457(b) to another retirement account?

Yes, generally you can roll over money from a 457(b) plan to another eligible retirement account, but the specific rules and eligible destination accounts depend on whether your 457(b) is a governmental or nongovernmental plan. Governmental 457(b) plans offer more rollover flexibility than nongovernmental plans.

Governmental 457(b) plans, sponsored by state or local governments, typically allow rollovers to other governmental 457(b) plans, 401(k)s, 403(b)s, traditional IRAs, and Roth IRAs (subject to applicable tax rules for Roth conversions). This provides significant flexibility in managing your retirement savings and consolidating accounts. Rollovers avoid immediate taxation, allowing your investments to continue growing tax-deferred (or tax-free in the case of Roth accounts). Nongovernmental 457(b) plans, typically offered by tax-exempt organizations, have more restrictive rollover options. You usually can only roll over to another 457(b) plan. However, upon separation from service, some nongovernmental 457(b) plans may allow distributions or rollovers into an IRA. It's crucial to review your plan document and consult with your plan administrator to understand your specific rollover options and any associated restrictions or penalties.

Are there penalties for early withdrawal from a 457(b)?

The penalties for early withdrawal from a 457(b) plan depend on the type of 457(b) plan you have. Governmental 457(b) plans generally do not have the 10% early withdrawal penalty that applies to other retirement accounts like 401(k)s and IRAs, though withdrawals are still taxed as ordinary income. However, non-governmental 457(b) plans (also called "ineligible" plans) typically *do* have stricter withdrawal rules and may be subject to penalties and restrictions depending on the plan's specific terms.

Withdrawals from a governmental 457(b) are usually permitted upon separation from service (leaving your employer), reaching age 73 (required minimum distributions), or in cases of unforeseeable emergency, as defined by the IRS. Because governmental 457(b) plans aren’t subject to the 10% early withdrawal penalty, this offers more flexibility compared to other retirement plans. You will, however, owe ordinary income tax on any amounts you withdraw. Non-governmental 457(b) plans, often used for highly compensated employees of tax-exempt organizations, are treated differently. These plans are often subject to substantial risk of forfeiture, meaning that the assets are still technically owned by the employer until distributed, and may be subject to employer discretion. Because of this risk, they're governed by stricter rules that generally prevent distributions before separation from service. While they also avoid the 10% early withdrawal penalty of qualified plans, these ineligible deferred compensation plans are only available to a select group of employees and come with risks that qualified plans do not.

What investment options are typically available in a 457(b)?

Investment options within a 457(b) plan often mirror those found in 401(k) or 403(b) plans, primarily focusing on mutual funds, fixed or variable annuities, and sometimes individual stocks or bonds through a brokerage window. The specific choices depend on the plan sponsor (employer) and their agreement with the investment providers.

Investment choices are usually categorized to offer diversification and cater to different risk tolerances and investment timelines. Common categories include:

Ultimately, the investment options available in your specific 457(b) plan will be outlined in the plan documents provided by your employer. It is crucial to review these documents and consider your own financial goals, risk tolerance, and time horizon when making investment decisions. Seeking advice from a qualified financial advisor is also recommended, especially if you are unsure about the best investment strategy for your situation.

Hopefully, this has shed some light on what a 457(b) plan is and how it can help you secure your financial future! Thanks for reading, and we hope you'll come back soon for more helpful tips and information.