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

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plans, participants are allowed to deposit pretax money that then compounds without being taxed until it is withdrawn.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

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

Key Takeaways

  • 401(k) plans and 457 plans are both tax-advantaged retirement savings plans.
  • 401(k) plans are offered by private employers, while 457 plans are offered by state and local governments and some nonprofits.
  • The two plans are very similar, but because 457 plans are not governed by ERISA, some aspects, such as catch-up contributions, early withdrawals, and hardship distributions, are handled differently.

401(k) Plans

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

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. 401(k) plans offer a menu of investment options that are prescreened by the sponsor, and participants choose how to invest their money. As of 2019 the plans have an annual maximum contribution limit of $19,000. For employees over the age of 50, both plans contain a catch-up provision that allows up to $6,000 in additional contributions. (Those figures rise to $19,500 and $6,500 in 2020.)

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

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.

As of 2019 the annual maximum contribution limit for 457 plans is $19,000. For employees over the age of 50, both plans contain a catch-up provision that allows up to $6,000 in additional contributions. (Allowable contributions to "most 457 plans" will rise to $19,500 and $6,500, like 401(k) plans, in 2020.) 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.

457 plans, however, 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.

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. In 2019 this provision would allow an employee to contribute up to $38,000 to a plan; in 2020, that would be $39,000.

Under the right conditions, a 457 plan participant may be able to contribute as much as $38,000 to his or her plan in one year in 2019—and $39,000 in 2020.

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. Independent contractors are not eligible to participate in 401(k) plans, however.

Special Considerations

As 457 plans are nonqualified retirement plans, it is possible to contribute to both a 401(k) and 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.

Advisor Insight

Emma Muhleman, CFA, CPA
Junior PM, Equity L/S, and Global Macro Strategist at Ascend Capital Mgmt. LLC, Boston, Mass.

Both plans allow employees to save money for retirement by deducting from pretax income that employees contribute to the plan, which is then invested and taxed only upon withdrawal in retirement, at which point the retiree’s ordinary income tax rate is applied.

As we have no active earnings in retirement, our ordinary income tax rate is generally very low compared to a much higher rate when we are still part of the workforce. Accordingly, the tax deferral associated with 401(k)s and 457 plans can provide meaningful tax savings. The key difference between the two pertains to distribution rules. 457 plans permit individuals to withdraw funds early without having to pay the 10% early withdrawal penalty imposed on 401(k) plan holders—but only in the event that they switch employers.