A 457 Plan is a type of tax-advantaged, employer-sponsored retirement savings plan available to certain employees of state and local governments, as well as some nonprofit organizations. It allows participants to contribute a portion of their salary to the plan on a pre-tax or, in some cases, after-tax (Roth) basis, which can then grow tax-deferred until withdrawal.
Key Features of a 457 Plan:
- Eligibility:
- Public Sector Employees: The most common type of 457 plan is the 457(b) plan, which is offered to employees of state and local governments, including public schools, police departments, and other government agencies.
- Nonprofit Organizations: Certain nonprofit organizations, like hospitals, charities, and unions, can also offer 457(b) plans to their employees.
- 457(f) Plans: A different type of 457 plan, the 457(f), is designed for highly compensated employees of tax-exempt organizations. It has different rules regarding contributions and distributions.
- Contribution Limits:
- Annual Contribution: As of 2024, employees can contribute up to $22,500 per year to a 457(b) plan. This limit may be adjusted annually for inflation.
- Catch-Up Contributions: Employees aged 50 and older can make additional catch-up contributions of $7,500, allowing a total contribution of $30,000 for those eligible.
- Special Catch-Up: In the last three years before reaching the plan’s normal retirement age, participants may be eligible to contribute up to twice the annual limit (totaling $45,000 in 2024), depending on prior underutilized contributions.
- Tax Benefits:
- Pre-Tax Contributions: Contributions are typically made on a pre-tax basis, reducing the participant’s taxable income for the year. The contributions and earnings grow tax-deferred until they are withdrawn.
- Roth Option: Some 457(b) plans offer a Roth option, allowing employees to make after-tax contributions. Withdrawals from Roth 457(b) plans are tax-free in retirement, provided certain conditions are met.
- Withdrawal Rules:
- No Early Withdrawal Penalty: One of the unique aspects of 457(b) plans is that there is no 10% early withdrawal penalty for distributions taken before age 59½, which is common with other retirement plans like 401(k)s and 403(b)s. This can make 457 plans more attractive for those who may need access to funds before traditional retirement age.
- Taxes on Withdrawals: Withdrawals are taxed as ordinary income in the year they are taken unless they come from a Roth 457(b) plan, in which case qualified withdrawals are tax-free.
- Required Minimum Distributions (RMDs): Like other retirement plans, participants must begin taking RMDs at age 73 (as of 2024) unless they are still working and the plan allows deferral.
- Investment Options:
- Variety of Choices: Participants can typically choose from a range of investment options, including mutual funds, target-date funds, and other investment vehicles offered by the plan. The choices vary depending on the plan provider.
- Portability:
- Rollovers: Funds from a 457(b) plan can be rolled over into another eligible retirement plan, such as an IRA, 401(k), or 403(b), upon separation from service. However, rolling over a 457(b) plan to another type of plan might subject the funds to early withdrawal penalties if withdrawn before age 59½.
Advantages of a 457 Plan:
- No Early Withdrawal Penalty: The absence of a 10% early withdrawal penalty makes 457(b) plans particularly attractive for those who may need to access their retirement savings before age 59½.
- Tax-Deferred Growth: Contributions grow tax-deferred, meaning you don’t pay taxes on the earnings until you withdraw them in retirement.
- Catch-Up Contributions: The special catch-up provision allows participants to increase their contributions significantly as they approach retirement.
Disadvantages of a 457 Plan:
- Limited Availability: 457 plans are only available to certain employees, mainly those working for state and local governments or nonprofit organizations.
- Investment Options: The range of investment options might be more limited compared to other retirement plans, depending on the plan sponsor.
- Lower Contribution Limits: While the contribution limits are similar to other retirement plans like 401(k)s, they might still be lower for individuals with higher income looking to maximize their retirement savings.
In summary, a 457 Plan is a retirement savings plan available to employees of state and local governments and certain nonprofit organizations. It offers tax advantages, flexible withdrawal options, and higher contribution limits, making it a valuable tool for retirement planning, particularly for public sector employees.
