457(b) Plan: What is it and who qualifies for one?

There’s a good chance you’ve heard a lot of talk about retirement savings plans. In particular, most people are familiar with 401(k) plans.

But if you work in the public sector, you likely won’t be able to get your hands on a 401(k). Instead, your employer probably offers a 403(b) option. Those retirement plans are important, but there is another retirement plan some people can also utilize.

A 457(b) plan is a deferred compensation retirement plan, available for specific state and local governments and some tax-exempt non-governmental organizations.

Contributions to a 457 plan are made through salary deferrals of your pre-tax dollars. Or after-tax in a Roth 457 plan if available.

In 2021, the contribution limit of a 457(b) plan is $19,500. You may also be able to include additional “catch-up contributions” of up to $6,500 if you’re 50 or older.

457(b) plans are rare, and as a result, they are often misunderstood.

Once you determine if you are eligible to participate, exploring the pros and cons of this retirement plan option will help you see if it's something you'll want to add to your retirement portfolio (Hint: it probably is!).

The Basics of a 457 Plan – How it Works & Who Qualifies

What Is a 457(b) Plan?

A 457(b) plan is a deferred compensation retirement plan. The reason you may not have heard much about them is that only a select group of individuals qualify for this retirement plan.

To use a 457(b) plan, you must be a state or local government employee. Think firefighter, teacher, police officer, and the like. Even then, not every employer offers these options.

Typically, most non-federal government workers will qualify for a 457(b) plan.

Note: A small group of individuals who are either highly compensated or part of the management group would be eligible to use a 457(f) plan instead.

Contributions to a 457 plan are made through salary deferrals of pre- or post-tax dollars. Limits are currently $19,500 per year (2021). Those 50 and older may contribute an additional $6,500 in 2021.

Benefits of a 457(b) Plan

There's a myriad of benefits to 457(b) plans. While some of these benefits are similar to the benefits you may receive from other retirement plans, there are several benefits specific only to 457(b) plans making them valuable tools in retirement portfolios.

Three significant benefits include:

1. Reduced Taxable Income

Because you contribute to your 457(b) plan using pre-tax dollars, your taxable income for the year is reduced. This reduction can be a big boost at tax time.

Your money also grows tax-deferred. So you won't pay taxes until you withdraw from your 457(b) plan down the road.

2. Catch-up Contributions

Many retirement vehicles feature catch-up options based on your age, and this holds true for 457(b) plans.

In 2021, you can contribute an additional $6,500 each year once you're past the age of 50.

As an added incentive, some employers will actually allow you to contribute up to twice the limit for the last three years before retirement age. That’s $39,000 off your taxable income for the year!

3. Penalty-free Withdrawals

Most retirement plans come with a stiff penalty for withdrawals made before retirement age. Think 10% of your money gone in a click.

That isn’t the case when it comes to 457(b) plans.

If you leave your job, you're able to roll over your plan into another retirement plan.

You can also begin to access the money before retirement age, free from penalty.

Catches of a 457(b) Plan

If your employer matches contributions to 457(b) plans, you may not be able to contribute as much as you think.

That's because the employer-matched portion counts toward your total allowable contribution for the year.

Essentially if your employer contributes $5,000, you can only add $14,500 or less given the $19,500 current contribution limit.

The silver lining here is that most government employers do not offer matches, so you're likely to be on your own when it comes to the $19,500 limit anyway.

Another drawback to 457(b) plans has to do with the way they're offered to employees.

Typically, the options are few—some people are limited only to annuities—and many come with high fees and other hidden costs.

Depending on your financial goals and how long you intend to work for your employer, it's essential you explore the costs attached to your 457(b) options.

You want to ensure your money is working for you as you build your financial house and that you're keeping as much of your money as possible.

Are 457(b) Plans Worth It?

401. 403. 457. There are a lot of numbers to keep straight when it comes to retirement planning. And that’s just in terms of determining which plans you qualify for.

As a state or local government worker, there's a good possibility you may be able to use a 457(b) plan.

Benefits like a reduced taxable income, high contribution limits, and penalty-free withdrawals have some people calling a 457(b) plan one of the best retirement options around.

However, as with any part of your financial plan, it's essential to do your homework.

In addition to having specific contribution limits, often, high fees and hidden costs can take a bigger bite out of your money than you would expect.

Roll up your sleeves, crunch the numbers, ask the questions, and determine if a 457 plan is right for you.

Article written by Penny

Last Updated 03-2021