Both Roth individual retirement accounts (IRAs) and 457 plans are tax-advantaged ways to save for retirement, but they work differently. Anyone with earned income can open and contribute to a Roth IRA, provided they meet the income limits. By comparison, 457 plans are available only to employees of certain types of organizations. If you are eligible for both a Roth IRA and a 457 plan, here are some important things you need to consider.
- A 457 plan is a type of retirement plan that some state, local government, and nonprofit employers provide for their workers.
- Roth IRAs are available to anyone who meets certain income requirements.
- You can contribute to both a 457 plan and a Roth IRA if you qualify.
- The IRS limits how much you can contribute to a 457 and Roth IRA account.
- Both accounts come with tax advantages—the 457 gives you an upfront tax break while the Roth IRA provides you with tax-free income during retirement.
What Is a 457 Plan?
What Is a 457 Plan?
A 457 plan is one of a number of retirement plans that employers can make available to their workers. Private, for-profit companies often sponsor 401(k) plans, while nonprofits, hospitals, and public school systems may use 403(b) plans. Some state, local government, and nonprofit employers offer still another option—the 457 plan. All three of these plans have many of the same tax advantages.
You cannot open up your own 457 plan. It must be provided to you by your employer.
How 457 Plans Work
Your contributions are made with pre-tax dollars to a 457 plan (or a 457(b) as it's often called). This means you don't pay taxes on the money you put into the plan until you withdraw it later in life.
For 2021, you can contribute up to $19,500. That amount increases to $20,500 in 2022. If you are age 50 or older, you can make an additional $6,500 catch-up contribution. That increases your annual limit to $26,000 for 2021 and $27,000 for 2022, which is the same limit as with a 401(k).
But unlike a 401(k) or 403(b) plan, a 457 may allow you to make a special catch-up contribution for three years prior to your normal retirement age. If your plan permits, you can contribute the lesser of the following:
- Twice the annual limit, which equals $39,000 for 2021 and $40,500 in 2022
- The basic annual limit plus the amount of the basic limit not used in prior years (this only applies if you don't the regular age 50-plus catch-up contributions)
So if your plan specifies 65 as your retirement age, you can contribute up to the $39,000 limit in 2021 once you are 62, provided that it’s not more than your annual salary.
As with a 401(k), an employer can match your 457 contributions. If you invest $1,000 per month and your employer matches at 50%, you get $500 of free money every month. Your contributions, including the match (if there is one), can't exceed the total annual contribution limit.
When Do You Pay Taxes?
While both 457 plans and Roth IRAs offer tax advantages, they are the exact opposite in terms of when you get your tax break. As mentioned, contributions to 457 plans are made with pretax earnings. You enjoy an upfront tax break since the contribution lowers your taxable income for the year. But you will pay taxes on any money you withdraw during retirement.
With a Roth IRA, you do not get an upfront tax break, but your contributions and earnings grow tax-free and are withdrawn tax-free in retirement. This means you pay your taxes when you make the contribution.
For 2021 and 2022, you can contribute up to $6,000 per year to a Roth IRA, or $7,000 if you are age 50 or older, as long as you meet the IRS income limits. If you’re married and file taxes jointly, for example, you can make the full contribution if your modified adjusted gross income (MAGI) is less than $198,000 for 2021 ($204,000 for 2022).
Early Withdrawals From 457s and Roth IRAs
Unlike other employer-sponsored retirement plans, you can withdraw money from your 457 before the age of 59½ without incurring a penalty. But remember, the taxes on the withdrawal still apply.
With a Roth IRA, you can withdraw your contributions (but not the income earned on those contributions) at any time and for any reason without any tax or penalties. Withdrawals of earnings are only tax- and penalty-free if your account is at least five years old and you are age 59½ or older.
If you are younger than 59½, you may be able to avoid taxes and penalties if:
- You use the money for a first-time home purchase
- You have a permanent disability
- You pass away and your beneficiary takes the distribution
Do 457s and Roth IRAs Have Required Minimum Distributions?
Required minimum distributions apply to all employer-sponsored retirement plans, including 457s. Once you hit age 72, you have to start taking withdrawals or you risk having to pay a steep 50% tax penalty. The SECURE Act of 2019 increased the age to 72 from the old threshold of 70½.
Roth IRAs, on the other hand, have no RMDs during your lifetime. That can make them a great way to transfer wealth to your beneficiaries, as long as you do not need the money for living expenses.
Can You Max Out Both a 457 and a Roth IRA?
If you have a 457, you can max it out and still make a full contribution to a Roth IRA as long as you meet the income rules. Doing so can make financial sense if you have the money to spare.
In fact, having both types of retirement accounts can serve as a hedge against the unpredictability of future tax rates.
If tax rates are a lot higher when you retire, you will have significantly benefited from your Roth IRA because your withdrawals are tax-free. If tax rates are lower when you retire, your 457 will have been the more tax-efficient account. Either way, one will help to balance the other.
Can You Put a Roth Insider Your 457 Plan?
What if you want the advantages of a Roth-type account inside your 457? Some employers offer a designated Roth option. If this is available, you can make after-tax contributions to your 457 plan that you can withdraw later, tax-free. Unlike a Roth IRA, however, your designated Roth account will be subject to required minimum distributions, so a separate Roth IRA could still be a better choice.