Roth individual retirement accounts (Roth 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 considerations.
- A 457 plan is a retirement plan that some state, local government, and nonprofit employers provide for their workers.
- Roth IRAs are available to anyone who meets specific income requirements.
- You can contribute to a 457 plan and a Roth IRA if you qualify.
- The Internal Revenue Service (IRS) limits how much you can contribute to a 457 plan and a Roth IRA account.
- Both accounts come with tax advantages. The 457 plan gives you an up-front tax break, while the Roth IRA provides tax-free income during retirement.
What Is a 457 Plan?
What Is a 457 Plan?
A 457 plan is one of several retirement plans 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 yet another option: the 457 plan. All three of these plans have many of the same tax advantages.
You cannot open your own 457 plan. It must be provided to you by your employer.
How 457 Plans Work
Your contributions to a 457 plan (or a 457(b), as it’s often called) are made with pretax dollars. This means you don’t pay taxes on the money you put into the plan until you withdraw it later in life.
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.
457 Plan Contribution Limits
For 2021, you could contribute up to $19,500. That amount increased 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—the same limit as 401(k)s.
But unlike a 401(k) or 403(b) plan, a 457 plan may allow you to make a special catch-up contribution for three years before your regular 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 make 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 years old—provided the contribution is not more than your annual salary.
When Do You Pay Taxes on 457s and Roth IRAs?
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 earlier, contributions to 457 plans are made with pretax earnings. You enjoy an up-front tax break since the contribution lowers your taxable income for the year. But you pay taxes on the money you withdraw during retirement.
With a Roth IRA, you do not get an up-front tax break, which means you pay your taxes when you make the contribution. But your contributions and earnings grow tax-free and are withdrawn tax-free in retirement.
Roth IRA Contribution Limits
If you’re married and file taxes jointly, you can make the full contribution if your modified adjusted gross income (MAGI) is less than $198,000 for 2021 (or $204,000 for 2022).
Early Withdrawals from 457s and Roth IRAs
Unlike other employer-sponsored retirement plans, you can withdraw money from your 457 plan 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 earnings) at any time and for any reason without any tax or penalties. Withdrawals of earnings are only free from taxes and penalties 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 457 Plans and Roth IRAs Have RMDs?
Required minimum distributions (RMDs) 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 Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 increased the age to 72 from the previous threshold of 70½.
Conversely, Roth IRAs have no RMDs during the account owner's 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 Plan and a Roth IRA?
If you have a 457 plan, 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 substantially higher when you retire, you will significantly benefit from your Roth IRA because your withdrawals will be tax-free. If tax rates are lower when you retire, your 457 will be the more tax-efficient account. Either way, one will help to balance the other.
Can a 457 Plan Be a Roth?
Some employers offer a designated Roth option for their 457 plan. If this is available, you can make after-tax contributions to your 457 plan that you can withdraw later, tax-free. However, unlike a Roth IRA, your designated Roth account will be subject to RMDs, so a separate Roth IRA could still be a better (or additional) choice.
The Bottom Line
With so many ways to build your nest egg, deciding where to put your money can be difficult. However, it's possible to save for retirement in multiple accounts—including 457 plans and Roth IRAs. That way, you can save more for retirement while enjoying more flexibility now—and in the future when it's time to tap those funds.