What is a 457 Plan
457 plan refers to a non-qualified, tax-advantaged deferred compensation retirement plan. Eligible employees are allowed to make salary deferral contributions to the 457 plan. Earnings grow on a tax-deferred basis and contributions are not taxed until the assets are distributed from the plan.
BREAKING DOWN 457 Plan
There are two types of 457 plans:
- A 457(b): This is the most common 457 plan and offered to state and local government employees
- A 457(f): A plan offered to highly compensated government and select non-government employees. (To learn more about lesser known retirement plans, see: 5 Lesser-Known Retirement Plans and Benefit Plans.)
Employees are allowed to defer up to 100% of compensation not exceeding the applicable dollar limit for the year. If the plan does not meet statutory requirements, the assets may be subject to different rules.
457(b) Plan Contributions
As of 2017, employees can contribute up to $18,000 per year. If an employer permits catch-up contributions, employees over age 50 may contribute an additional $6,000 making their maximum contribution limit $24,000 ($18,000 + $6,000). Employees who are within three years of retirement age (as specified in their plan), may contribute $36,000, which is double the annual contribution limit. A lesser-known feature of the 457(b) plan is that the Internal Revenue Service (IRS) allows unused contribution rollovers for employees who are not using the age 50 or over catch-up option. For example, if an employee contributes $12,000 to his or her 457(b) plan in year1, the maximum contribution limit for year2 is $24,000 ($6,000 + $18,000).
Advantages of a 457(b) Plan
Contributions deduct from an employee's wage before tax, which lowers taxable income. For example, if Tim was earning $4,000 per month and contributing $700 to his 457(b) plan, his taxable income for the moth is $3,300. Employees have the option to invest their contributions in a selection of mutual funds; any interest and earnings earned do not get taxed until funds are withdrawn. If an employee resigns, or retires before age 59.5 and needs to withdraw their funds, they do not have to pay a 10% penalty fee, unlike 401(k) and 403(b) plans. (For more, see: What is the Difference Between a 401(k) plan and a 457 Plan?)
Limitations of a 457(b) Plan
Employer matched contributions count toward the maximum contribution limit. For instance, if an employer contributes $10,000 to the plan, the employee can only add $8,000 until the $18,000 contribution limit is reached (unless they are permitted to use the catch-up option). In practice, most government employers don't offer contribution matching.