457b Plans

Retirement Plan 457b

A 457b is a state or local government-sponsored(and any entity that is tax-exempt under IRC Section 501), non-qualified, tax-deferred retirement savings plan. It’s primarily designed for

• Civil servants
• Municipal employees
• law enforcement officers
• Public safety personnel
• Executives at hospitals, charities, and unions.
• Managers or highly compensated employees or savers who have more than 5 percent ownership of a business. They have the same limit as governments 457bs
• Independent contractors under state and local government agencies are allowed to participate in 457b plans.

Employees may have the option of choosing between;

Traditional pre-tax contributions

Employees Contribute pre-tax dollars, reducing their taxable income. Earnings and interest accumulate on a tax-deferred basis and will only be taxed when withdrawn (as ordinary income).

Roth 457b

Contributions are from post-tax dollars. Earnings and interest will grow on a tax-deferred basis. Distributions are tax-free (five-year rule applies) for employees who have achieved the 59½-year milestone.

How does 457b work

457b retirement plans are pretty similar to a 401k or 403b plan and are considered important as they supplement pension plans and Social Security.

457b allows employees to save funds into a special retirement account that provides tax advantages. This contribution is taken from your paycheck on a pre-tax basis hence lowering your taxable income.

Funds contributed are invested in an array of funds, with the interest and earnings not taxed until you withdraw the funds in retirement. Typically 457b plans, do offer only—annuities or mutual funds—both of which are tax-deferred.

They do differ from a 401k or 403b, in that, should you retire before the golden age of 59½ and in need of withdrawing your retirement funds, IRA will exempt you from the 10% early access penalty.

Below are the distinct features of 457b;

457b deferred compensation

457b are tax-deferred tax plans. The employer (state or local government) withholds a portion of the workers’ pay on a tax-advantaged basis for retirement. This lump sum owed to an employee is designed to be paid out on this date.

Is 457b pre-tax

Yes. Just like 401k or 403b, Contributions are withheld at the payroll level and before income taxes are applied hence qualifies as pre-tax contributions. In short, you fund the account with pre-tax dollars, which are not taxable until you withdraw the funds.

Is 457b an IRA

Technically, a 457b is not an IRA.

This is so because, in as much as A 457b plan and an IRA both are vehicles for retirement savings, they are allowed under separate sections of the Internal Revenue Code.

A 457 is restricted to employees of state and local governments and agencies and of tax-exempt organizations (501(c) 3 provision) while a traditional IRA is available to almost all taxpayers.

Also, there is a huge income limit for 457b compared to those covered by IRA.

However, Unlike IRAs, the IRS exempts 457b holders with a 10% early access penalty for withdrawing funds before the golden age of 59½.

Is a 457b a qualified retirement plan

The 457b plans are non-qualified plans.

This is so because they don’t adhere to the strict guidelines and limits of the Employee Retirement Income Security Act (ERISA).

457bs do offer extra benefits and flexibility as they are not governed by the same laws and regulations compared to 401k plans and 403b plans.

457b special catch up

 This is a pre-retirement catch-up provision of the Internal Revenue Code (IRC) that allows 457b participants and who are within three calendar years of retirement(as defined by plans rules), to make up for lost years that they were eligible to participate in a 457b plan but never maxed their contributions.

IRS allows (if your plan allows it) you to contribute twice the basic annual limit plus the amount of the basic limit not used in prior years that you were eligible, whichever is less (age restrictions apply- three years within normal retirement age).

Eligibility is based on below:

• You are within three years of your retirement; and
• Contributions were never maxed out in prior years for which you were eligible; and,
• You have never accessed the Special Three-Year Catch-up provision in any 457b and have an unused balance.

Special catchups sound appealing, but the process is a bit complicated –most plan administrators choose not to offer this. It does require a bit of information to work out the special catch up and employers may not always have this data.

An employee may be required to provide payroll records to prove they did not benefit from full contributions over the past years.

457b plan rules

457b max contribution

The maximum contribution to a 457b plan is based on an employee’s taxable compensation as per the Internal Revenue Code. Generally, an employee can save up to 100% of their pay or an annual dollar limit, whichever is less on a pre-tax basis up to the IRS contribution limit.

457b plans do offer two “catch-up” provisions. This allows contributors an opportunity to save more than the normal annual amounts.

457b limits 2022

Employee’s annual contribution limit for 2022 is capped at 100% of the employee’s salary or $20,500 (lesser) for workers under 50 years. This is in line with 401k limits. This limit is for both employer and employee contributions, although employer contributions to 457b plans are very rare.

IRS allows Soon-to-be retirement a ‘’special catchup’’ (if permitted plan permits) which allows you to double the annual limit for three years. You are eligible if;

• Closer to three years to the 457bs “normal retirement age” and
• Not maxed out in terms of contributions in previous years

Special catchup will increase the contribution limits to $41,000 for 2022—or within $123,000 in three years.

Please note, if you are eligible for both catch-up contributions, IRS only allows the saver to take advantage of the one that adds the most to their retirement account.

457b limits for 2021 

The maximum contribution limit for 457b is capped at 100% of the savers’ salary or $19,500 for the year 2021. The cap is inclusive of any employer contributions. (However, most sponsors do not match employee contributions.)

For savers who are 50 or older, the plan allows an additional “catch-up” contribution of $6,500, bringing the total contribution to $26,000. (The limits apply for 2020 as well.)

Special catchup will bring your maximum contribution limits to $39,000 for 2021—or within $117,000 in three years.

What is the maximum 457 b contribution for 2020

This limit is the same as in 2020. IRS limits contributions and other additions (excluding earnings) to a 457b account to the littlest of 100% of the participant’s includible compensation or the dollar limit of ($19,500-same as in 2021).

IRS limits catch-up contributions to $6500 and the age limit is 50 years and above.

Special 457b catch-up contributions (if permitted by the plan) will enable a saver to contribute for 3 years’ arrears prior to the normal retirement age. This will be the lesser of $19,500 in 2020 (and 2021).

The special catch-up has a limit of basic annual limit plus the amount of the basic limit not used in previous years ($39,000 for 2020—or within $117,000 in three years.).

 457b maximum contribution 2019

IRS capped contribution into a 457b to $19,000 in the year 2019. This includes the employer portion.

For savers who are 50 years and older, most 457b plans may allow an additional catch-up contribution of $6,000, summing your total contribution to $25,000.

Special catch-up contribution that benefits soon-to-be retirees, if permitted by the 457 plan can push your contribution level to $38,000—or up to $114,000 over the three years.

403b vs 457b plan

Employer contributions

403b or 457b both permit employer matches, although very rare in comparison to 401ks.

Contribution maximums

403b’s maximum contribution is almost close to double what 457b’s (up to a total of $61,000- to $20,500 from the employee, $40,500 from the employer.). 457b plans only allow an annual maximum contribution of $20,500. Should both plans be available, be sure to max out the worker’s contributions to both plans.

Catch-up contributions

457b has special catchup that allows for double-the-limit contributions (three years to normal retirement age). While the 403bs catchups are time-based, that is catchup is only allowed if you have worked for the same employer for at least 15 years limited to $3,000 a year$(up to $ 15,000-lifetime contribution).

Early withdrawals

457b plans can be withdrawn without penalties as soon as you leave employment, age withstanding. Meanwhile, 403b plans only allow standard, penalty-free withdrawals after the age of 59 ½(unless exempted by IRS)

Early distributions from 457b plans

Early access by 457b pension savers before the golden age of 59 ½ is not subject to the 10 percent penalty.

457bs caters mostly to police and fire departments. After leaving service, a participant has the option of rolling their account into a traditional IRA or another existing qualified retirement plan.

Before withdrawing funds, please be aware that;

• Taxes are applicable on withdrawn amounts only.
• Some plans may allow the retiree to continue directing the investment of the assets remaining in the 457b account.
• In case of death, the balance is available for distribution to designated beneficiaries.
• Direct withdrawals attract a 20% mandatory federal tax withholding even if the funds are en route to an IRA.
• The 10% early withdrawal penalty is not applicable to 457b plan contributions and earnings regardless of the age of the account holder. However, the 10% early withdrawal penalty is the applicable tax for any 457b plan rollover funds to an IRA.
• RMDs are applicable on the attainment of age 70½. And not later than April 1st of the next year

Bottom line

457 is very flexible when it comes to withdrawals. Make sure you familiarize yourself and understand the fine print in regard to withdrawal rules after separation from employment. Some non-governmental plans may force the withdrawal of entire accounts within a short window, leading to difficult tax situations. Enter rollovers. Why a rollover?

• An IRA rollover provides better control over distributions. This avoids accessing the entire amount as a lump sum, hence avoiding pushing you into a higher tax bracket.
• Secondly, the funds can continue growing tax-free and off the reach of creditors.

It’s advisable that if you are approaching retirement ramp up maximum pay deferral into a 457(b) plan and at the same time maximize contributions into your traditional IRA. Please note should you transfer this asset to the Roth IRA, you do lose immediate tax deduction benefits. However, funds accessed after age 59½ will be tax-exempt anyway. This can be of benefit when a saver is on a limited income.