What are 457 Retirement plans?
There are two kinds of 457 Retirement plans in Internal Revenue Code (IRC) — the 457(f) which is for top executives in NPOs. Also, the 457(b), which is provided to state and local government employees.
For the most part, 457 plans work similarly to a 401(k) or 403(b) plan and are available for governmental and certain nongovernmental employers in the United States.
The primal difference between 457 and 401(k) is that – 457 plans have no penalties if they’re withdrawn before the age of 55 or 59½ for IRA accounts. Furthermore, 457 plans (both b and f) allow independent contractors to participate in the plan unlike 401(k) and 403(b) plans.
457 plans, be it 457(b) or 457(f), become the best retirement savings option if the person works for the state or local government, or for some NPOs like a church.
The employer offers the plan and the employee adheres compensation to it on a pretax or post-tax (Roth) basis. After retirement, a person can withdraw funds, leave them as they are, transfer them to a 457, 403(b) or 401(k) of a new employer. Further to roll them into an Individual Retirement Account (IRA).
Contributions Rules and Limits
- Employees may contribute up to 100% of their salary, up to the annual IRS limit, which is adjusted each year for inflation.
- Individuals who are 50 and over may make additional catch-up contributions. Enhanced “super catch-up” contributions can be made by participants aged 60–63 under the SECURE 2.0 Act.
- A special provision with the 457 retirement plan allows participants to contribute up to twice the annual limit during the three calendar years. Also, before normal retirement age; this rule is often referred to as the “double limit.”
Withdrawals and Tax Treatment
Contributions are subtracted from taxable income, and the investment growth is not taxed until withdrawal. Unlike most retirement plans, 457(b) retirement plans have penalty-free withdrawals upon separation from service or due to unforeseen emergencies. However, in the case of rolling funds into other retirement plans, there may be a penalty involved. The RMDs generally begin at age 73.
Advantages and Disadvantages of 457 Plan
Below given is the advantages and disadvantages for 457 plan-
| Advantages | Disadvantages |
|---|---|
| Flexible withdrawal rules allow easier access to funds | Employer matching contributions are rare |
| No early withdrawal penalty after separation from employment | Any employer contribution counts toward the annual contribution limit |
| Useful for employees who retire early or change jobs | Investment options are often limited |
| Tax-deferred growth until withdrawal | Fewer choices compared to private-sector retirement plans |
Other Plans Comparison
Like 401(k) and 403(b) plans, 457(b) plans offer the same contribution limit and same valuable tax advantages, but with a unique flexibility in withdrawals. The 457(f), on the other hand, is a supplemental plan for high-ranking executives in nonprofit organizations. Further, it comes under different tax rules.
Conclusion
From an HR and payroll software perspective, managing 457(b) retirement plan requires accurate handling of contribution limits, catch-up rules, tax treatments, and ever-evolving regulations. A robust payroll software streamlines plan administration through automation of deductions, eligibility tracking, and compliance. Also, get clarity to the employee on their retirement benefits—ultimately enhancing accuracy, efficiency, and employee trust.
FAQs
What is the definition of a 457 plan?
A 457 plan is a tax-Deferred Retirement Savings plan for certain State or local governments and tax-exempt employers that allow their employees to save money for retirement prior to taxation
What are the disadvantages of a 457?
Disadvantages include the lack of an employer match in most plans and the minefield of complex catch-up rules. The possibility that non-governmental 457 retirement plan could jeopardize the money if the plan sponsor encounters financial difficulties.
What is the difference between a 401(k) and a 457 plan?
Both are retirement savings plans with relatively similar tax-deferred savings provisions, although 457 plans exclusively address employees within the public or nonprofit sector. In addition to permitting penalty-free withdrawals upon cessation of employment, unlike 401(k) plans.
Is a 457 better than a Roth IRA?
A 457 plan may offer the possibility of higher cumulative contributions and without income limitations, whereas a Roth IRA allows tax-free withdrawals for qualified expenditures, and this “will depend on individual tax goals and needs.
