What Is a 403(B) Plan?
A 403(b) plan is a retirement savings plan offered to many public schools and non-profit organizations. Employees can have a portion of their salary deducted from their paycheck and contributed to the 403(b) plan.
The money in the 403(b) plan grows tax-deferred until it is withdrawn at retirement.
Employers may also contribute to a 403(b) plan. Just like a 401(k), penalties will be due for early withdrawals or withdrawals made before 59.5 years old.
What Is a 457(b) Plan?
A 457(b) plan is a retirement savings plan offered by state and local government agencies and some non-profit organizations. Employees can have a portion of their salary deducted from their paycheck and contributed to the 457(b) plan.
The money in the 457(b) plan grows tax-deferred until it is withdrawn at retirement.
Opposite to a 403(b) plan, 457(b) plans do not charge penalties for early withdrawals.
403(b) vs 457(b)
Eligibility
The Internal Revenue Service (IRS) sets the eligibility requirements for 403(b) and 457(b) plans.
To be eligible to participate in a 403(b) plan, an employee must work for a public school, a tax-exempt organization, or certain ministers.
Participants include teachers, school administrators, other employees of public schools, doctors, nurses, and workers from charitable organizations.
To be eligible to participate in a 457(b) plan, an employee must work for a state or local government agency or a tax-exempt non-profit organization under IRC 501(c).
Participants include police officers, firefighters, and other state and local government agency employees.
Contribution Process
Both 403(b) and 457(b) plans allow employees to have a portion of their salary deducted from their paycheck and contributed to the plan. The contribution is made before taxes are withheld from the paycheck.
The contribution reduces the employee's annual taxable income and boosts their retirement savings.
Employers may also contribute to 403(b) and 457(b) plans called matching contributions.
Contribution Limits
For 2022, the contribution limit for 403(b) and 457(b) plans is $20,500. In 2023, the contribution limit for both is $22,500.
Catch-Up Contribution
Employees who are 50 years old and older may make catch-up contributions of up to $6,500 for both 403(b) and 457(b) plans in 2022. This brings up the total contribution limit to $27,000.
In 2023, employees may make catch-up contributions of up to $7,500 for both 403(b) and 457(b) plans, bringing up the total contribution limit to $30,000.
Both plans allow employees to contribute even more to their plans through "special catch-up contributions."
403(b) plans have an expanded contribution limit for employees who have rendered more than 15 years of service with a "qualified organization."
This organization could include educational organizations, hospitals, home health service agencies, health and welfare agencies, and churches.
Qualified employees can contribute an extra $3,000 each year, given they have contributed an average of $5,000 or less for those 15 years prior.
On the other hand, 457(b) plans allow workers within three years of normal retirement age as the plan specifies making special catch-up contributions. Qualified employees can contribute up to $41,000 in 2022 and $45,000 in 2023.
Investment Options
The investment options for both 403(b) and 457(b) plans are similar. They offer various investment options, including mutual funds, annuities, and bonds.
Tax Implications
Contributions to 403(b) and 457(b) plans are made on a pretax basis, meaning the contributions are made before taxes are withheld from the paycheck.
The contribution reduces the employee's annual taxable income and boosts their retirement savings. Withdrawals are then taxed as ordinary income at retirement.
The 10% early withdrawal penalty only applies to 403(b) plans and not 457(b).
The 457(b) plan rules allow waiver of the 10% penalty if an employee resigns or retires before age 59.5 and needs to withdraw funds from the 457(b) account.
Although the 403(b) plan requires a 10% tax penalty for early withdrawals, employees over the age of 55 who have lost their jobs may be able to avoid the penalty in line with the provisions of the CARES Act.
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The Bottom Line
The 403(b) and 457(b) plans are both retirement savings plans that offer employees tax-deferred growth on their investments.
They differ in eligibility, catch-up contribution provisions, and penalty-free withdrawal age. Employees should consult with their employer to see if they can participate in either of these plans.
FAQs
1. What is the main difference between a 403(b) and a 457(b) plan?
The early withdrawal penalty is the main difference between a 403(b) and a 457(b) plan. The 10% early withdrawal penalty applies to funds withdrawn from a 403(b) plan before the age of 59.5. This penalty does not apply to 457(b) plans.
2. What are special catch-up contributions?
Special catch-up contributions are additional contributions that employees can make to their 403(b) or 457(b) plan if they meet certain criteria. These contributions are on top of the regular catch-up contribution. It allows employees to boost their retirement savings even more.
3. What are 501(c) organizations?
501(c) organizations are tax-exempt and include educational organizations, hospitals, home health service agencies, health and welfare agencies, and churches.
4. What is the early withdrawal penalty?
The 10% early withdrawal penalty applies to funds withdrawn from a 403(b) plan before the age of 59.5. This penalty does not apply to 457(b) plans.
5. What is the CARES Act?
The CARES Act is a law that was enacted in response to the COVID-19 pandemic. It stands for Coronavirus Aid, Relief, and Economic Security. One of the CARES Act provisions allows employees over the age of 55 who have lost their jobs to withdraw funds from their 403(b) plan without incurring the 10% early withdrawal penalty.
