What Is a 457(b) Plan?
A 457(b) plan is a type of tax-advantaged, employer-sponsored retirement savings vehicle that is eligible to receive deferred compensation.
Contributions made to a 457(b) plan are made with pre-tax dollars which means no taxes are collected until you make withdrawals from your account.
This type of plan is usually offered to state and local government employees like firefighters, police officers, school teachers, and other public sector employees.
What Is a 401(k) Plan?
A 401(k) plan is a type of defined contribution plan in which employees make pre-tax contributions with the intention of saving for retirement.
Contributions to a 401(k) are usually made by an employer, but employers may also contribute on behalf of their employees.
Employers often match employee contributions in some capacity, at least partially but sometimes up to 100%.
401(k) plans are very popular with private sector companies and provide tax benefits for both the employer and employee. Sustainable 401(k)s even offer climate-friendly investment options.
Comparing Features of 457(b) and 401(k) Plans
Before deciding which retirement savings vehicle is right for you, it is important to understand the differences between the two plans.
Contribution Limits
The contribution limits set for 457(b) and 401(k) plans are identical. For 2022, the limits for both types of account are as follows:
- $20,500 for holders below 50 years of age
- $27,000 for holders age 50 and above; limit is inclusive of catch-up contribution allowance of $6,500
Employer Matching Contributions
Employer matching contributions are much less common with 457(b) plans compared to 401(k) plans.
If an employer chooses to match the employee's contributions in a 457(b) plan, contributions should not exceed the limits stated above.
This means that if an employer makes matching contributions amounting to $10,000, then the employer will only be allowed to make contributions up to $10,500.
Catch-up contributions will still apply given the employee's age qualifies.
Special Catch-Up Contributions
A 457(b) plan allows for special catch-up contributions for holders.
Workers who are three years away from retirement age are allowed to contribute the lesser of:
- Twice the annual contribution limit or $41,000 for 2022
- The regular annual limit plus the amount of the annual contribution limit not used in prior years given the employee is below 50 years of age.
A 401(k) plan also offers a catch-up contribution. Anyone age 50 or over may contribute:
- Up to $6,500 for 2022
Early Withdrawal Penalty
A 10% early withdrawal penalty applies for 401(k) plans while 457(b) plans do not impose such.
This should be a decisive factor for high income earners as 401(k) plans penalize early withdrawals, which could affect other financial decisions.
Investment Options
In terms of investment options, 401(k) plans offer a wider range of options compared to 457(b) plans.
Having a limited range of options for investments could be a problem to a holder's diversification strategy. If you need to compare 401(k) portfolios, use the 401(k) Comparison Tool to understand your company's best option.
Fees
Generally, 457(b) plans have higher administrative and management fees than other retirement plans.
This can be a huge issue for employees with large contributions in the plan, especially when returns are low.
Pros and Cons of Having a 457(b) Plan
Pros
A key advantage of having a 457(b) plan over 401(k) plans is the leeway it offers to early withdrawals.
A 457(b) plan is technically not a retirement plan which makes it not subject to withdrawal rules and penalties like that of a 401(k) plan.
This leeway in withdrawals makes it a more flexible plan especially when the holder needs to use the money for personal reasons before reaching retirement age.
Cons
Some disadvantages of a 457(b) compared to 401(k) plans are the investment options available for the plan and the management fees that come with it.
457(b) plans typically have a limited range of investment options and even have higher management and administrative fees compared to 401(k) plans.
_Plan.png?width=1920&name=Pros_and_Cons_of_Having_a_457(b)_Plan.png)
Pros and Cons of Having a 401(k) Plan
Pros
An advantage of a 401(k) plan over a 457(b) plan is the leeway it offers when it comes to employer matching contributions.
401(k) plans have a higher contribution limit when employers choose to match their employee's contributions to the account.
Although 457(b) plans also allow employer matching contributions, the limit is only up to the same limit set for employee only contributions.
Investment options and fees are also more favorable for 401(k) plans than 457(b) plans because of the wide range of options it offers and lower fees it imposes.
Cons
A notable disadvantage of a 401(k) plan, though, is that it comes with a 10% penalty for early withdrawal by the account holder.
_Plan.png?width=1920&name=Pros_and_Cons_of_Having_a_401(k)_Plan.png)
457(b) vs 401(k): Which Is a Better Choice?
Now that the significant differences between a 457(b) plan and 401(k) plan are clear, it might be helpful to give an insight of which may be the better choice for workers.
Make sure to carefully consider each of the plan's pros and cons based on your own personal situation.
However, the most significant advantage of having a 457(b) plan over 401(k) plans is that 457(b) plans allow for early withdrawals without penalty, unlike 401(k) plans which impose withdrawal penalties.
If you need to use your money before reaching retirement age, then it is best to go with a 457(b).
For borrowers who would like to make investments in mutual funds within their retirement accounts, focus more on the investment options available under each plan for them to maximize their diversification strategy.
Lastly, consider how comfortable you are making investments with these accounts.
A 401(k) plan offers higher contribution rates than a 457(b), but a 457(b) allows for more flexibility in withdrawing funds which might be an issue to some investors.
Based on the differences between a 457(b) plan and 401(k), it is likely that if you are comfortable with making investments, you will have better chances of maximizing your diversification strategy as well as being able to withdraw from your account by going with a 401(k).
However, those who prioritize having access to their money before retirement should go with a 457(b) over 401(k).
Ultimately, the decision on whether to choose a 457(b) vs 401(k) plan should be based on what is most appropriate to each holder's investment needs.
FAQs
1. Can I have both a 401(k) and 457(b) plan at once?
Yes, it is possible to have a 401(k) and a 457(b) plan at the same time.
2. What is the advantage and disadvantage of having to contribute pre-tax dollars to a retirement account?
The advantage of having to contribute pre-tax dollars to a retirement account is that it will lower your taxes. The disadvantage of having to contribute pre-tax dollars to what you are saving for retirement is that the money saved this way will be taxed when taken out during retirement.
3. Should I go for retirement plans that offer pre-tax or post-tax contributions?
The best option will be to look at your current financial situation and consider other forms of tax credits you might be qualified for. Check whether your retirement savings strategy is appropriate for having pre-tax or post-tax contributions. When you know how much you need to save, check the specific requirements set by the agencies that offer these accounts and then choose which one suits your needs better.
4. What is the purpose of special catch-up contributions in 457(b) plans?
The special catch-up contribution in 457(b) plans is for those workers who are nearing retirement age. This type of contribution gives them the chance to contribute more money on top of their regular contributions that increases their retirement savings.
5. Are 457(b) plans covered by the Employee Retirement Income Security Act (ERISA) of 1974?
457(b) plans are not entirely covered by ERISA since they are considered to be deferred compensation programs.
