What is the 457 Plan?

A Guide to Tax-Advantaged Retirement Savings
The 457 Plan

The 457 Plan

A Guide to Tax-Advantaged Retirement Savings

A 457 plan offers valuable retirement savings options tailored for employees of state and local governments, as well as select nonprofit organisations. Similar to the 401(k) plan in the private sector, it offers tax advantages by allowing pre-tax contributions, thereby reducing taxable income and deferring taxes until retirement. 

This article delves into the intricacies of 457 plans, including their types, contribution limits, and withdrawal regulations, to help individuals make informed decisions about their retirement finances.

Overview of 457 Plan

A 457 plan is a retirement savings option designed for employees of state and local governments, as well as certain nonprofit organisations. It provides them with tax advantages similar to those of a 401(k) plan in the private sector. Through this plan, employees can contribute a portion of their pre-tax earnings into an account, reducing their taxable income for the year and deferring taxes until withdrawal during retirement. Depending on the employer's discretion, a Roth version of the 457 plan may allow after-tax contributions. 

There are two main types of 457 plans: the 457(b), which is commonly offered to state and local government employees and nonprofit workers as a tax-advantaged retirement savings plan, and the 457(f), exclusively available to highly compensated executives in tax-exempt organisations, which functions as a supplement to the 457(b) by deferring compensation. 

Participants in a 457 plan can contribute up to 100% of their salaries, subject to a yearly dollar limit, and taxes on interest and earnings within the account are postponed until withdrawal, except in the case of the Roth option, where only post-tax funds are deposited.

<div class="paragraphs"><p><strong>The 457 Plan</strong></p></div>
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Different Types of 457 Plans

The 457 plan offers two main types: the 457(b) and the 457(f)

The 457(b) Plan

This plan is commonly available to civil servants, police officers, and employees of government agencies, public services, and nonprofit organisations like hospitals and churches. Much like a 401(k), participants allocate a portion of their salary into a retirement account, with the flexibility to choose investment options such as mutual funds and annuities. The account grows tax-deferred until withdrawal during retirement, with contribution limits allowing employees to set aside up to 100% of their salary, within specified yearly dollar limits. Notably, contributions to a 457(b) plan may have specific catch-up provisions for those nearing retirement age.

The 457(f) Plan

In contrast, the 457(f) plan, also termed a Supplemental Executive Retirement Plan (SERP), caters exclusively to high-paid executives in tax-exempt organisations like hospitals and universities. This plan supplements the 457(b) by allowing employers to make additional contributions to the employee's retirement account beyond regular limits, often negotiated through contract as deferred salary adjustments. However, if the executive resigns before a predetermined vesting period, the contributions may be forfeited. The 457(f) plan serves as a strategic tool for executive retention, commonly referred to as "golden handcuffs."

Comparing 457(b) and 403(b) Plans

For public service employees, understanding the differences between the 457(b) and the 403(b) plans is crucial. Both are commonly available benefits, especially for professions like public school teaching. Originating in the 1950s, the 403(b) initially focused solely on providing annuities, but today, participants have the flexibility to invest in mutual funds as well.

Over time, the 403(b) has evolved to resemble the private sector's 401(k) plan, but with relatively fewer investment choices. Interestingly, both plans share identical annual contribution limits, mirroring those of the 457(b) and 401(k) plans. So, if you're a public employee, chances are your employer might offer either a 457(b) or a 403(b), providing you with options to save for your retirement.

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457(b) Withdrawals

Making withdrawals from your 457(b) account comes with rules to follow. If you face an unexpected emergency, you can take out money early without getting hit by a tax penalty. However, it's not the best idea because you're dipping into your retirement funds, and you'll still have to pay income tax for that year on the withdrawn amount.

Another thing to keep in mind is the required minimum distribution (RMD), which is the least amount you must withdraw from your 457(b) each year after a certain age.

The IRS provides a worksheet to calculate this figure. If you were born between 1951 and 1959, you are required to start withdrawing at age 73. For those born in 1960 or later, the age is 75, which was adjusted from the previous requirement of 72.

Conclusion

In conclusion, understanding the intricacies of 457 plans empowers employees to make sound financial choices for their retirement. Whether opting for the 457(b) or the 457(f), participants benefit from tax advantages and flexible contribution options tailored to their employment sector. 

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