30 Apr The Interesting Features of 457(b) Plans
In the changing and complex retirement landscape, the more common retirement vehicles are well known – IRA’s, 401(k), and 403(b) plans. However, there are lesser-known retirement vehicles that have some interesting features. If you work for a tax-exempt organization or are employed by a state or local government, you may have access to a 457(b) plan. Like its more familiar cousin, the 401(k) plan, the 457 plan is a tax-advantaged plan that allows participants to contribute pre-tax money and allows investments to grow tax-deferred. However, there are some critical differences in these two retirement vehicles that make the 475 plan unique and interesting.
So, what are the differences?
1. Only certain employers can have a 457 plan. They are most commonly used by state and local government employees and certain tax-exempt organizations. Teachers, law enforcement, firefighters, city and local officials, and hospital employees are among some of the professions that may have access to a 457 plan.
2. 457 plans are “nonqualified” and not governed by the Employee Retirement Income Security Act (ERISA)- the law governing the most common employer-sponsored retirement plans. Therefore, there is no early withdrawal penalty of 10% if funds are taken out of a 457 before age 59 ½. This gives participants more flexibility if they need to use the funds for an emergency or tap it for college expenses.
3. Not all employees can join a nongovernmental 457(b) plan; only highly compensated executives, managers, and other key employees are eligible. These parameters are defined in the plan document. There is no discrimination testing or annual Form 5500 filing for 457 plans which can simplify plan administration.
4. Public government and nonprofit 457 plans allow independent contractors who perform services for the employer to participate, unlike a 401k.
5. Most 457 plans do not provide for an employer matching contribution. They are viewed as supplemental savings plans for employees.
6. Because 457 plans are nonqualified, it is possible to simultaneously contribute to both a 401k and a 457, allowing the participant to effectively double the amount set aside for retirement. Annual limits for each of these plans are $19,500 in 2021 with a $6500 catch-up provision (for those 50+ in a governmental plan) for a total of $26,000. If a 50-year-old participant maximized each plan they could contribute a total of $52,000 annually ($26,000 each) to these 2 retirement plans.
7. There is a special catch-up provision for workers who are 3 years away from normal retirement age (as defined by the plan) in a 457. These employees can contribute the lesser of twice the annual contribution limit ($39,000 in 2021) or the regular annual limit plus the amount of the annual contribution limit not used in prior years.
8. Governmental 457 plans can be rolled over to an IRA when you terminate employment but nongovernmental 457 plans cannot. When an employee of a tax-exempt employer changes jobs or retires, they generally have 3 options: leave the assets in the plan, transfer the assets to another nongovernmental plan or begin taking distributions (or a lump sum).
9. Loans are allowed in 457 governmental plans but prohibited in 457 nongovernmental plans.
10. Unlike a 401k, the assets of 457 nongovernmental plans are not held in trust for the employees. They remain the property of the employer and available to creditors in the event of a lawsuit or bankruptcy. This risk can complicate decisions around contributions and distributions.