457(b) Retirement Plan

457(b) Retirement Plan

What Is a 457(b) Retirement Plan?

A 457(b) retirement plan refers to a deferred compensation plan. This plan is given in the form of an annuity or mutual fund to two types of employees: state and local government employees and certain nonprofit employees. 

How Does a 457(b) Retirement Plan Work?

457(b) plans are specifically designed for individuals who work for governmental and certain nonprofit entities. These nonprofit groups are tax-exempt under IRC Section 501. 

Eligible employees can elect to automatically deduct money from their paychecks on a pre-tax basis. This money is put into their retirement and investment accounts. 

Employees may be given the option of investing their contributions in mutual funds or annuities. Both are tax-deferred, meaning the interest and earnings are not taxed until employees withdraw their funds during retirement.

What Are the Contribution Limits for a 457(b) Plan?

According to the IRS, employers or employees can contribute annually the lesser of:

• 100% of the employee’s includible compensation, or 

• Up to the IRC 402(g) limit ($19,500 in 2020 and 2021)

Employees aged 50 and over may make annual catch-up contributions ($6,500 in 2020 and 2021). This allows participants to contribute additional money three years before they retire. 

Catch-up contributions must not exceed: 

• Twice the annual limit ($39,000 in 2020 and 2021), or 

• The basic annual limit ($19,500 in 2020 and 2021) plus the amount of basic limits not used in prior years (this is only allowed if the participant did not use catch-up contributions before)

Do Employers Match 457(b) Plans?

Not all employers match the amount their employees contribute to 457(b) plans. Businesses that do match choose the amount and limit. 

For example, if they match 40 percent and their employee contributes $1,000 a month, the employer contributes $400 a month to their account.

What Is the Difference between a 401(k) and a 457(b) Plan?

Here are some key differences between a 401(k) and 457(b) plan: 

• Provider/Participants. While 457(b) plans are provided by governmental and certain non-profit entities, 401(k) plans are provided by private employers.

• ERISA (Employee Retirement Income Security Act of 1974). 457(b) plans are not governed by ERISA, so factors such as catch-up contributions and early withdrawals are handled differently than 401(k) plans.

What Is the Difference Between a 403(b) and a 457(b) Plan?

Though they both are given to public-sector and non-profit employees, 403(b) and 457(b) plans hold key differences employers should be aware of: 

• Contribution limits. 403(b) plans have higher contribution limits than 457(b) plans do. This is done to make more room for contributions made by employers and employees.

• Withdrawal penalties. While participants can withdraw funds at any time with a 457(b) plan without penalty (as long as the funds are taken out due to qualifying hardship or the individual has left their employer), they are subject to a 10 percent withdrawal penalty with a 403(b) plan. 

What Are the Pros and Cons of a 457(b) Plan?

Pros and Cons for Employers

The Pros

• The three-year catch-up contribution is a great benefit that can enhance employers’ recruitment efforts.  

• 457(b) plans are not covered by ERISA and thus, employers are not responsible for providing detailed information regarding their employees’ plans; this can save HR teams time.

The Cons

• Since employers are not required to flesh out all the details of 457(b) plans, they may not be well-equipped to answer questions regarding their employees’ retirement plans. Therefore, this lack of knowledge and accuracy can hurt employer-employee relationships.

Pros and Cons for Employees

The Pros

• There is no 10 percent tax penalty other retirement/investment plans usually have.

• The plan offers catch-up contributions. So an individual who may have had a late start in their career and is 50 or older can contribute additional amounts to help them catch up on their retirement savings. 

The Cons

• Because 457(b) plans are not governed by ERISA, employees miss out on some benefits 401(k) participants have. For example, ERISA provides participants with protection in the event their employer denies their claim for retirement benefits.