401(k) Plan vs. 457 Plan: What’s the Difference?

401(k) Plan vs. 457 Plan: An Overview

Two types of Internal Revenue Service-sanctioned, tax-advantaged employee retirement savings plans are the 401(k) plan and the 457 plan. As tax-advantaged plans, participants are allowed to deposit pretax money that then compounds without being taxed until it is withdrawn.

These retirement savings accounts were designed to serve as one leg of the famous three-legged stool of retirement: workplace pension, Social Security, and personal retirement savings. As workplace pensions become obsolete, however, personal retirement savings have increasingly come to serve as most people’s primary retirement plan, along with Social Security.

Notably, 401(k) plans and 457 plans operate similarly, with the main difference being who is allowed to participate in each one.

401(k) Plans

Generally, 401(k) plans are offered by private, for-profit employers and some nonprofit employers and are the most common type of defined-contribution retirement plans. Notably, 401(k) plans are considered qualified retirement plans and are therefore subject to the Employee Retirement Income Security Act (ERISA) of 1974.

Employers sponsoring 401(k) plans may make matching or nonelective contributions to the plan on behalf of eligible employees. Earnings in a 401(k) plan accrue on a tax-deferred basis. At the same time, 401(k) plans offer a menu of investment options that are prescreened by the sponsor, and participants choose how to invest their money.

The plans have an annual maximum contribution limit of $20,500 for 2022 ($22,500 for 2023). For employees over the age of 50, both plans contain a catch-up provision that allows up to $6,500 in additional contributions ($7,500 for 2023).

Withdrawals from a 401(k) taken before age 59½ result in a 10% early withdrawal tax penalty. However, plan participants can make early withdrawals without a penalty from a 401(k) under “financial hardships,” which are defined by each 401(k) plan.

457 Plans

By comparison, 457(b) plans are IRS-sanctioned, tax-advantaged employee retirement plans offered by state and local public employers and some nonprofit employers. They are among the least common forms of defined-contribution retirement plans.

As defined-contribution plans, both 401(k) and 457 plans are funded when employees contribute through payroll deductions; participants of each plan set aside a percentage of their salary to put into their retirement account. These funds pass to the retirement account without being taxed, unless the participant opens a Roth account, and any subsequent growth in the accounts is not taxed.

The annual maximum contribution limit for 457 plans is $20,500 for 2022 ($22,500 for 2023). For employees over the age of 50, both plans contain a catch-up provision that allows up to $6,500 in additional contributions ($7,500 for 2023). Contributions to each plan qualify the employee for a “saver’s tax credit." It is possible to take loans from both 401(k) and 457 plans.

However, 457 plans are a type of tax-advantaged nonqualified retirement plan and are not governed by ERISA. As ERISA rules do not apply to 457 accounts, the IRS does not assess an early withdrawal penalty to 457 participants who take money out before age 59½, though the amount taken is still subject to normal income taxes.

Notably, 457 plans feature a double limit catch-up provision that 401(k) plans do not have. This provision is designed to allow participants who are nearing retirement to compensate for years in which they did not contribute to the plan but were eligible to do so. This provision would allow an employee to contribute up to $41,000 to a plan for 2022 and for 2023, up to $45,000.

While both plans allow for early withdrawals, the qualifying circumstances for early withdrawal eligibility are different. With 457 accounts, hardship distributions are allowed after an “unforeseeable emergency,” which must be specifically laid out in the plan’s language.

Both public government 457 plans and nonprofit 457 plans allow independent contractors to participate.

Special Considerations

As 457 plans are nonqualified retirement plans, it is possible to contribute to both a 401(k) and a 457 plan at the same time. Many large government employers offer both plans. In such cases, the joint participant is able to contribute maximum amounts to both.