What is a 457 Plan?

457 plans are like super retirement accounts. You get all of the tax benefits, but with none of the penalties for early withdrawal.

With some many retirement plans out there, it can be difficult to know which account is which. While most people know about 401(k)s and IRAs, one little-known retirement account is the 457 plan.

The 457 plan is seldom heard of because it can only be offered to employees of state and local governments and non-profit organizations. Many organizations also place eligibility restrictions on their 457 plans, allowing only individuals whose salary exceeds a certain amount to contribute.

If your employer offers a 457 plan and you qualify to make contributions to it, you should learn how to make the most of the valuable opportunity.

Benefits of a 457 Plan

457 plans come with all of the benefits of more common retirement plans like 401(k)s. You can contribute a portion of each paycheck to a 457 plan, up to a limit of $18,000 each year. In exchange for contributing to the 457 plan, you get to deduct the money you contribute from your income taxes, letting you save money up front.

One thing that makes 457 plans special is that they can be offered in addition to 401(k) plans, and the contribution limit for each plan is separate. Unlike IRAs and Roth IRAs, which share a $5,500 annual contribution limit, you can contribute the maximum of $18,000 to both your 401(k) and your 457. That gives you $36,000 in tax advantaged space.

The thing that really sets 457 plans apart from other retirement accounts is how they treat early withdrawals.

457 Plan Early Withdrawals

401(k)s and IRAs charge you a 10% penalty if you want to withdraw your money before retirement age. With a 457 account, you can take the money out anytime, completely penalty free. All you have to do is pay the taxes on the income.

This is because 457 plans aren’t actually retirement plans at all. They’re what are called “deferred compensation” plans. You’re not putting the money aside for retirement, you’re just deferring your pay to sometime in the future. When that future time happens to be is up to you.

Although 457 plans are not retirement plans, they do share one other rule of retirement accounts. When you turn 70 ½ you’ll need to take required minimum distributions from the account each year, or else you’ll face tax penalties on the account’s balance.

How to Use a 457 Plan

With their tax advantages and ability to withdraw money anytime, 457 plans are nearly the perfect vehicle for saving your money. You can take advantage of your 457 plan in a variety of ways.

The most obvious way to use your 457 plan is as an additional retirement account. If you run out of contribution space in your 401(k), you can start filling up your 457. Though I’d argue that once you contribute to your 401(k) up to your employer’s matching requirements, it would be a better choice to fill your 457 before your 401(k) because of the account’s flexibility.

When you retire, your 457 can serve as an additional source of tax-advantaged savings.

Another way to use your 457 plan is as part of planned career change. If your current job offers a 457, but you want to scale back your career and find a less stressful, but lower paying job, you can prepare by saving as much as you can in a 457.

When you do jump ship to your lower paying job, you can use the money in the 457 to supplement your income. You’ll have saved big on taxes by putting the money in a 457 plan while you were getting paid a lot and the taxes you’ll owe on withdrawals will be low thanks to the lower income from your new job.

457 plans are the ultimate tax-advantaged savings plan. You get all of the benefits of a retirement account, but none of the restrictions on accessing your money.

Now that you know all of the Roth IRA’s pros and cons, you should be able to make a well-informed decision when it comes choosing the account to use when planning for your retirement.

 

Photo credit: InvestmentZen Images – Creative Commons Attribution License

TJ Porter

TJ Porter has been sharing his financial expertise through his writing since 2014. He graduated with a degree in business from Northeastern University in 2016. In his spare time, TJ enjoys esports, cooking, and board games.

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