A 457 plan is the government employee's answer to the 401(k) plan.
It's a retirement plan geared toward state and local government employees, and also can be used by select non-profit career professionals to stash money away for retirement.
Since public and non-profit sector employees operate under different rules than private sector employees, 457 plans do have some unique wrinkles, risks and attributes that plan participants should know about if they're to maximize their retirement plan's full potential.
What Is a 457 Plan?
In financial and legal terms, a 457 plan is a retirement plan for government and non-profit employees that offers tax-advantaged benefits.
By and large, 457 plan participants can make salary deferral contributions to the plan, using pre-tax money, and can benefit as their contributions to the plan compound for decades, without being taxed until the cash is withdrawn once the employee reaches retirement.
There are two primary models for 457 plans, as follows:
- 457(b) plans. The 457(b) retirement plan is the most widely used 457 plan model, commonly provided to state and local government career professionals.
- 457(f) plans. The 457(f) plan isn't nearly as common as the 457(b) retirement plan. It's offered to more highly-compensated state and local government employees and to select non-profit employees (usually at the executive and management level.)
Who Qualifies for a 457 Plan?
While the usage of 457 plans has grown in recent years, as the federal government has loosened the rules on offering such plans for employers, the actual list of professions that qualify for 457 plans is limited.
Primarily, the following employees can 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, like sanitation, highway maintenance and landscaping workers, for example
- State and local politicians and their staff workers
- State or local workers
- State or local administrators
- Non-profit employees and other highly-compensated employees, primarily at hospitals, trade associations, and charitable organizations.
It's worth mentioning that independent contractors may be able to qualify for a 457 plan in certain circumstances, primarily when they contract with an employer who offers 457 plans.
What Are the Benefits of a 457 Plan?
There are multiple benefits that come 457 plans, mainly on the plan's contribution and tax levels:
The most commonly cited benefit of a 457 plan is that money can be contributed to a plan on a pre-tax basis. That enables plan participants to pay taxes on the contributions once they reach retirement, when they're invariably in a lower tax bracket. It also helps lower a plan participant's tax liability in his or her working years.
Here's an example.
Let's say a state government worker earns $5,000 per month, and contributes $700 per month to her 457 plan. Based on that contribution level, that employee's taxable income for that particular month is only $4,300 ($5,000 - $700 = $4,300.)
No Penalty for Early Withdrawals
Unlike a 401(k) plan, where a plan participant is penalized 10% of any early plan withdrawal amount, 457 plan participants are not subject to any early withdrawal penalties for taking money out of their account before retirement age. That's due to the fact that 457 plans, unlike 401(k) plans, are not deemed by Uncle Sam as qualified retirement plans, meaning they are exempt from any tax mandates stemming from the Employee Retirement Income Act of 1974.
That said, a 457 plan participant who takes cash out of his or her plan early will have to pay the standard tax amount due based upon the amount of the withdrawal.
Double Catch-Up 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, like the 401(k) and individual retirement accounts (IRA), do offer expanded catch-up plan contributions, the 457 catch-up provision is especially generous, enabling a 457 plan user to make a contribution that is double their annual maximum contribution ($19,000 is the maximum contribution amount in 2019.)
A Variety of Investment Options
457 plan participants certainly don't lack investment choices. A wide variety of mutual funds and exchange-traded funds are available to 457 users, allowing them to balance their retirement portfolio in a risk-efficient way, depending on their long-term financial goals.
Good Flexibility Participants who are covered by government employers may be able to roll their 457 plan funds into a new employer's 457 plan, or even into 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
Both 457 and 401(k) plans share basic similarities - they both offer tax-advantaged retirement savings, employee matching, and automatic payroll contributions, for example.
But they also differ in certain areas, too:
Early Withdrawal Penalties There is a 10% penalty 401(k)for withdrawing funds from a 401(k) before retirement (at age 59½) while 457 plans have no penalty.
Different Employees 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.
Higher Contribution Limits 457 plan participants are allowed to contribute up to 100% of their annual salaries to their retirement plans, as long as that contribution remains within annual 457 contribution limits.
Employer Matches Are Rare With 457 plans While employers are allowed to add matching contributions to 457 plans, most don't. That's mostly because state and local governments and non-profits don't have the revenues of for-profit companies.
It's also due to the way plan rules are written. For example, a 401(k) plan limit ($19,000 in 2019) only pertains to an employee's own contributions. That's not the case with 457 plans. If an employer matches, say, $5,000 in plan contributions, that $5,000 will count to the employee's annual contribution limits.
"Catch-Up" Rules Can Differ In general, 401(k) plan participants enjoy greater plan contribution limits than 457 plan users. Adding in the 401(k)'s catch-up provision of $6,000 on an annual basis, the maximum contribution for a 401(k) plan users from both employer and employee is $62,000 ($56,000 plus the $6,000 catch-up contribution.)
While government employer plans also can offer a $6,000 catch-up (and a double catch-up in specific circumstances), non-profit 457 providers usually don't offer the same catch-up limits.
What a 457 plan can offer employees that is unique to government and non-profit plans is a major catch-up contribution opportunity in the last three years of their employment. In that scenario, 457 plan contributors 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 don't have that option.
Hardship Withdrawal Limit for 457s Unlike 401(k) plans, which offer ample opportunities to take early "hardship withdrawals" before age 59½, 457 plans offer fairly limited hardship withdrawal options.
For example, a 401(k) plan participant can withdraw plan funds early for the purchase of a new home or for college tuition purposes. A 457 plan user can't withdraw funds via hardship status for either a new home or for college costs.
The Takeaway on 457 Plans
457 retirement plans are a good deal for government and non-profit employees if they pay close attention to plan rules and opportunities, especially as they draw closer to retirement (that's especially the case with 457 catch-up rules in the last three years of employment.)
Check with your plan benefits adviser to ensure you're maximizing your 457 plan.
When retirement eventually does roll around, you'll be glad you did.
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