457 Plan vs. 403(b) Plan: An Overview
The public sector may be the last bastion in America of the defined-benefit plan—that old-fashioned pension, calculated by the employer that came to employees automatically after they retired.
But nowadays, no single source of income may be enough to ensure a comfortable retirement. People need to save on their own, too. Public-sector and non-profit organizations don't offer 401(k) plans that employees can contribute to. But they can and do offer other employer-sponsored plans: the 403(b) and the 457.
- A 457 plan has two types. A 457(b) is offered to state and local government employees, while a 457(f) is for top executives in non-profits.
- A 403(b) plan is typically offered to employees of private nonprofits and government workers, including public school employees.
- There’s a potential third option as well: If you’re eligible for both plans, you can split your contributions between them.
The 457 Plan
A 457 plan has two types. A 457(b) is offered to state and local government employees, while a 457(f) is for top-level non-profit employees.
For a 457(b) plan, you can contribute up to $19,000 in 2019 ($19,500 in 2020) and an additional $6,000 ($6,500 in 2020) if you’re age 50 or older. If you’re within three years of normal retirement age (according to your plan) then you may contribute the lesser of $38,000 in 2019 ($39,000 in 2020), or, according to the IRS, "The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions).”
The 457(f) plan requires that the employee work until an agreed-upon date. If the employee leaves before that date, the 457(f) plan is forfeited.
This plan is usually only offered to top executives of an organization. Because the employee has to fulfill certain requirements to receive the 457(f) at retirement, the plan remains in the hands of the company. This is primarily used as a recruiting tool to lure talent that would otherwise stay in the private sector.
If you have a 457(f) plan, you’re eligible to contribute up to 100% of your income.
Unless you become the head of a non-profit organization, you’re unlikely to run into the 457(f) plan.
One of the best benefits of the 457(b) is that it allows participants to put double the amount into the retirement plan. If you’re within three years of normal retirement age (according to your plan), you may contribute up to $38,000 in 2019 ($39,000 in 2020).
This is a greater catch-up provision than even 403(b)s provide. You can also put in an extra $6,000 per year ($6,500 in 2020) if you’re at least 50 years old.
If you’re still working at a job where you have a 457(b), you can’t take any withdrawals until you’re at least 70½ years old. However, if you are no longer working there, you can take the distributions at any time no matter your age.
“You can take your money before you are 59½ years old with a 457 without any penalties, unlike any other retirement plan out there,” said Assistant Professor of Finance and Financial Planning Inga Chira, of California State University, Northridge. “That’s a big deal.”
If you leave your job, you can also roll over your account into an IRA or 401(k), though this is only an option for the 457(b) plan, not the 457(f) plan.
Unlike the 401(k), whatever match your employer contributes will count as part of your maximum contribution. That means, in 2019, if your employer contributes $9,000, you can only contribute $10,000 (unless you’re participating in a catch-up strategy).
If you’re used to a 401(k), you might already be aware that the $19,000 limit there applies only to employee contributions.
It should be noted, though, that few governments provide matching programs within the 457(b) plan. It’s mostly up to the employees to make sure they’re saving an adequate amount.
The 457(f) plan requires that the employee work until an agreed-upon time. If the employee leaves before that date, they forfeit their right to the 457(f) plan.
The 403(b) Plan
A 403(b) plan is typically offered to employees of private nonprofits and government workers, including public school employees. Like the 401(k), 403(b) plans are a type of defined-contribution plan that allows participants to shelter money on a tax-deferred basis for retirement.
These plans were created in 1958 and were originally known as tax-sheltered annuities (TSA), or tax-deferred annuities (TDA) plans because they could only be invested in annuity contracts at that time.
These plans are most commonly used by educational institutions, although any entity that qualifies under IRS Section 501(c)(3) can adopt it.
Contribution and deferral limits
The contribution limits for 403(b) plans are now identical to those of 401(k) plans. All employee deferrals are made on a pretax basis and reduce the participant's adjusted gross income accordingly.
For 2019, the annual contribution limit (called the elective deferral) is $19,000 ($19,500 in 2020). An additional catch-up contribution of $6,000 ($6,500 in 2020) is allowed for workers age 50 and above.
Notably, 403(b) plans offer a special additional catch-up contribution provision known as the lifetime catch-up provision or 15-year rule. Employees who have at least 15 years of tenure are eligible for this provision, which allows for an extra $3,000 payment a year (up to a lifetime employer-by-employer limit of $15,000). For more information on the 15-year rule, consult IRS Publication 571.
Employers are allowed to make matching contributions, but the total contributions from employer and employee cannot exceed $56,000 for 2019 ($57,000 for 2020). After-tax contributions are allowed in some cases, and Roth contributions are also available for employers who opt for this feature. Recent legislation has also allowed employers to institute automatic 403(b) plan contributions for all employees, although they may opt-out of this at their discretion. Eligible participants may also qualify for the Retirement Saver's Credit.
When calculating 403(b) contribution limits for an individual, the IRS applies the limits in the following order: first, the elective deferral; second, the 15-year service catch-up provision; and third, the age 50 catch-up contribution. It is an employer's responsibility to limit contributions to the correct amounts.
The rules for rolling over 403(b) plan balances have been loosened considerably over the past few years, and employees who leave their employers can now take their plans with them to another employer if they don't roll their plans over into a self-directed IRA. They can roll them over into another 403(b) plan, a 401(k), or another qualified plan.
This allows employees to maintain one retirement plan over their lifetimes instead of having to open a separate IRA account or leave their plan with their old employer.
Notably, 403(b) plan distributions resemble those of 401(k) plans in most respects:
- You can start taking distributions at age 59½, no matter if you’re still working at that organization or not.
- Distributions taken before age 59½ are subject to a 10% early withdrawal penalty unless a special exception applies.
- All normal distributions are taxed as ordinary income.
- Roth distributions are tax-free, although employees must either contribute to the plan or have a Roth IRA open for at least five years before being able to take tax-free distributions.
- Mandatory minimum distributions, which are calculated according to the recipient's life expectancy, must begin at age 70½ unless the plan is rolled over into a Roth IRA or other Roth retirement plan before then. Failure to take a mandatory minimum distribution will result in a 50% excise tax on the amount that should have been withdrawn. Loan provisions may also be available at the employer's discretion. The rules for loans are also largely the same as for 401(k) plans. Participants cannot access more than the lesser of $50,000 or half of their plan balance, and any outstanding loan balance that is not repaid within five years is treated as a taxable or premature distribution.
All distributions are reported each year on Form 1099-R, which is mailed to plan participants.
Many 403(b) plans are still funded with annuity contracts, despite the fact that the Employee Retirement Income Security Act (ERISA) permits these plans to invest directly in mutual funds. This is, in fact, a source of ongoing debate in the financial and retirement planning community, since annuities are tax-deferred vehicles in and of themselves, and there is no such thing as double tax-deferral.
Most plans now offer mutual fund choices as well, albeit inside a variable annuity contract in most cases. But fixed and variable contracts and mutual funds are the only types of investments permitted inside these plans.
Importantly, 403(b) plans differ from their 401(k) counterparts in that they have no vesting provisions. However, they do now provide the same level of protection from creditors as qualified plans.
Plan participants should also be aware of all of the costs and fees being charged by their plan and investment providers. The plan administrator must provide a complete breakdown of these fees to all plan participants.
How to Choose
If you need more time to put aside money for retirement, a 457 plan is best for you. It has a better catch-up policy and will allow you to stash away more money for retirement.
However, if you want a larger array of investment options to choose from, a 403(b) is likely to be your best bet. “Although a 457 can also have multiple providers, usually, the choice of providers is not as wide as a 403(b),” Chira says.
There’s a potential third option as well: If you’re eligible for both plans, you can contribute to both.
That means you can put away $38,000 in 2019 ($39,000 in 2020), not including any catch-up contributions if you’re eligible. “This is especially appealing to employees who have a great income and are trying to minimize their taxes,” notes Chira.