Question

I recently changed jobs and my new job offers both a 403(b) plan and a 457(b) plan. I know the 403(b) is a lot like the 401(k) I used to have, but what is a 457(b) and should I use it?

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ACEP Now: Vol 42 – No 02 – February 2023

Answer

A 457(b) plan, like a 401(k), 403(b), or traditional IRA, is a tax-deferred retirement savings account. The primary difference between a 457(b) plan and those other accounts is the owner of the account. With an IRA, 401(k), or 403(b), the account contains your money. In a 457(b), the account contains the money of your employer. This is money your employer has promised to pay you at some point in the future, but it is not technically your money yet. Think of it as deferred compensation.

Despite 457(b) money not being yours, you are still allowed to control how it is invested in the plan. Like a 401(k), a 457(b) typically allows you to choose between various mutual fund investments in the plan and change that mix of investments periodically. For this reason, most people think of it and treat it as just another 401(k). That is fine most of the time, but as with many things in finance, the devil is in the details. You need to understand the details, especially when deciding whether to use the account or not. You always have the option of not using any retirement account and simply saving for retirement in a taxable, non-qualified brokerage account where you have maximum flexibility and unlimited contribution amounts.

457(b) contribution limits are exactly the same as the employee contribution amount to a 401(k), $22,500 in 2023. Thus, a 457(b) allows many investors to double their tax-protected retirement savings annual contribution. There are catch-up contributions too, but they do not work exactly like 401(k) catch-up contributions. Some plans do not allow them at all. The IRS permits a plan to offer the same $7,500 per year catch-up contribution that 401(k)s have for individuals over age 50. However, it also allows 457(b)s to offer two other types of catch-up contributions instead, whichever is less. The first of these allows you to double your contribution in the last three years before retirement age ($45,000 per year). The second allows you to make up for any contributions you were allowed to make but did not make in the past.

A big advantage of a 457(b) over a 401(k), 403(b), or IRA is that there is no penalty for withdrawing the money before a certain age. Once you have left the employer, you can pull the money out penalty-free whether you are 40 or 70. Thus, 457(b) money is often some of the first money an early retiree spends. If you still have money in a 457(b) at age 72, you are required to take Required Minimum Distributions (RMDs) from it, just like a traditional IRA.