What is a 457(b) Plan?

Nov 07, 2023 By Triston Martin

The 457(b), a tax-advantaged retirement program, is primarily for civil servants, police officers, and law enforcement officers. A 457(b) plan is also available to executives of hospitals, unions, law enforcement officers, and independent contractors working for state or local governments. The 457(b), like other employer-sponsored retirement plans, provides tax-efficient growth to retirement savings. You don't have to pay capital gains taxes on investments you purchase and sell in your account. This gives your retirement nest egg more room for growth.

Your paycheck is deducted from your 457(b) contributions. You may also be taxed on withdrawals. You pay income tax on withdrawals made when you withdraw money from your retirement account. Roth 457(b) allows you to fund your account using money already taxed in exchange for tax-free retirement withdrawals. This includes earnings that your money earns while in your Roth 457(b). Roth contributions to a 457 (b) account are not allowed by all organizations.

How the 457(b) Plan Works

The 457(b), which allows workers to save money in a special retirement account with tax benefits, is similar to the 401(k). This will allow you to grow your savings tax-deferred. Like a 401(k), you can only defer a dollar amount per year. The cost-of-living indexes determine how much you can defer. For workers younger than 50 years old, the employee contribution limit for 2022 is $20,500. Like the 401 (k), a catch-up provision allows workers 50 years and older to contribute an additional $6,000.

Like the 401(k), which offers both a pre-tax Roth and an after-tax Roth version of its program, 457(b) plans might also offer these two types of retirement plans. What is the main difference? The pre-tax plan allows you to contribute money today and get a tax deduction at retirement. However, you will have to pay taxes when you withdraw money from the account. The Roth version of the 457 (b) lets you put money in after-tax. You'll pay taxes today on your contributions but no tax on any withdrawals in retirement.

How to Invest in 457(b)

The investment options in 457(b) plans are limited to mutual funds and annuities. For example, you can't purchase individual stocks or exchange-traded funds in a 457 (b) account. This may not be a significant difference from how 401(k) or other retirement accounts invest. Most 401(k) holders invest in mutual fund funds. You can build the three-fund portfolio that financial advisors recommend as long as you can buy stock-based and bond index funds.

No matter what portfolio structure you choose, you will want to keep a higher percentage of stock-based funds as you get older and gradually switch to more conservative, bonds-based investments. You can avoid the hassle and stress of selecting funds by looking at your 457(b). These mutual funds will invest you in a mixture of mutual funds, automatically adjusting as you approach your retirement date.

457(b) Employer Matching

Some employers will match your contribution to a 457b plan up to a limit. If you are lucky enough to be employed by such an employer, make sure to contribute at least the same amount to the plan as the match. Your employer will pay $500 per month if you contribute $1,000 per month and the match is 50%. It might be worth contacting your employer to request a 457(b). You'd be lucky to have a chance to save in a retirement plan with a 457(b).

Non-Governmental 457(b) Plans

As the plan's viability hinges on the employer, non-governmental plans are more at risk. Non-governmental 457B plans don't take money directly from your paycheck. It's the actual money you haven't received yet. Your employer owns the account. Your employer takes the percentage you indicated and contributes it to the fund.

Early Distributions

Distributions to workers who can retire earlier are less taxing. Distributions to workers under age 59 1/2 from 457(b) plans are exempted from the 10 percent penalty for 401(k). This is a valid reason. Police and fire departments were typically the participants in 457 plans covering counties or municipalities. They would often retire before they were disabled. If the 457 plan did not have an exemption for early distributions, these workers would have been punished and wouldn't be able to access the money they needed. However, penalty-free early distributions can be flexible, but they can also be a double-edged sword as workers are allowed to spend money that should be saved. It is almost always a good idea to keep the money in a tax-sheltered account for as long as possible.

Related Articles