If you're a state or local government employee, or work for a tax-exempt non-profit, you may be saving for retirement with a 457 plan. This is one of the most complex of the employer-sponsored plans available, and there are several variations. As you get close to retirement, make sure you know the options available to you for withdrawing your money.
Types of 457 Plans
Just like a 401(k) or 403(b) retirement savings plan, a 457 plan allows you to invest a portion of your salary on a pretax basis. The money grows, tax-deferred, waiting for you to decide what to do with it when you retire.
You're about to retire. So, what do you do?
Your options depend, in part, on the type of 457 plan you have: Is it a 457(b) or "eligible" plan or is it the 457(f) or "ineligible" variety?
- If you are a government or non-profit employee, you may have a 457(b).
- In this case, your savings in this plan can be rolled over, like assets in a 401(k).
- There is no penalty for early withdrawals but you must take a minimum distribution in the year you turn 72 (or 73, starting in 2023).
- If you have a 457(b) but are not a government employee, the rules are different.
- The 457(f), limited to highly compensated employees, also has different rules.
What Is a 457 Plan?
Eligible 457(b) plans are the most common type and are generally available to all employees of a state or local government entity. The assets you have in these plans are held in trust and have rollover privileges similar to those of a 401(k) or 403(b).
Non-governmental or 501(c) organizations can offer eligible 457(b) plans, but only to certain “highly-compensated employees.” In that case, the assets are not held in trust but remain with the employer until they are distributed. The rollover privileges are much more restricted, too.
Ineligible 457(f) plans are available only to highly-compensated employees of non-governmental organizations such as charities and private non-profits. Here, too, assets are not held in trust but are kept by the employer until they are distributed.
Since contributions to a 457(f) are virtually unlimited, the IRS requires that the funds be at a “substantial risk of forfeiture.” If, for example, you have a 457(f) plan and leave your employer before an agreed-upon date or before reaching normal retirement age, you could risk losing all of the money you've invested in the plan.
That sounds harsh, but it's the price you pay for the sweet deal that allows you to invest as much as you want on a tax-deferred basis and watch it grow tax-free.
How Withdrawals Work
If you have a governmental or non-governmental 457(b) plan, you can withdraw some or all of your funds upon retirement even if you are not yet 59½ years old.
There is no 10% penalty for early withdrawals as there is with most early withdrawals from other types of plans. You will owe the income tax on the amount you withdraw.
However, you will get dinged if you never take any money out. Both governmental and non-governmental 457(b) plans fall under the IRS required minimum distribution (RMD) rule that says you must begin withdrawing a specified portion of the funds when you reach a certain age. For 2022, that age was 72. The SECURE 2.0 Act pushes that age to 73 starting in 2023.
There's a hefty penalty for failing to take a required minimum distribution: a 50% nondeductible excise tax on the portion not distributed. This penalty is decreased to 25% starting in 2023, and it can be reduced to 10% if the error is corrected promptly.
If you have a 457(f) plan at a private non-profit, be prepared for a giant hit when you retire. The entire amount in your account is considered taxable upon your separation from service.
In most cases, the assets will be distributed to you in a lump sum and will be subject to FICA, federal, and state taxes at that time. As noted below, rollovers are not permitted if it is a 457(f) plan.
Rollover and Transfer Options
You can roll over funds in your governmental 457(b) plan to a Roth IRA, 401(k), 403(b), or another 457 governmental plan.
The rules for 457(b) plans at a private tax-exempt organization are much more restrictive. Your funds in such a plan can only be rolled over into another non-governmental 457 plan.
With a 457(f) plan, the limits are similar: You may not roll over funds from a 457(f) plan to any other type of tax-deferred fund.
If you wish to transfer funds from your governmental 457(b) plan, it may be done to another governmental 457(b) plan only. Similarly, your only option for transferring a non-government 457(b) is to another non-government 457(b).
There is no option for transferring a 457(f) fund.
Special Consideration for 403(b) Plan Holders
Some tax-exempt organizations are qualified to offer both 403(b) and 457(b) plans. If such is the case at your job, and you have elected to contribute to both, you need to be aware of differences when it comes to withdrawal, rollover, and transfer of your funds.
But also be aware that contributing to both plans will help you greatly increase your tax-advantaged retirement savings, if you can afford to do so.
The Bottom Line
Although recent legislation has made them easier to understand, 457 retirement plans are complicated. Don't assume that the rules regarding 401(k)s and other tax-advantaged plans offered in the for-profit world apply. Even 403(b) plans—that other vehicle of choice for public-sector and non-profit employees—function differently in some key ways.
If you have a 457 plan of any type, consider consulting with a financial advisor or a tax-planning expert well ahead of your retirement date to make sure you make the best strategic use of those tax-deferred dollars without running afoul of any regulations.