When planning for retirement, most people are familiar with 401(k) plans and IRAs, but fewer know the answer to an important question: what is a 457 retirement plan? This tax-advantaged savings vehicle is specifically designed for employees of state and local governments and certain nonprofit organizations, offering unique benefits that set it apart from other retirement plans. If you’re eligible, understanding what is a 457 plan and how it works can help you take full advantage of its flexibility and wealth-building potential. With the right strategy, a 457(b) retirement plan can play a key role in securing your financial future and ensuring a comfortable retirement.
What is a 457 Retirement Plan and How Does It Work?
So, what is a 457 retirement plan, and how does it work? A 457(b) retirement plan is a type of deferred compensation plan that allows employees to contribute pre-tax dollars to an investment account, reducing their taxable income while growing their retirement savings. Unlike a 401(k) or 403(b), a 457(b) has unique withdrawal rules and eligibility criteria, making it an attractive choice for many government and nonprofit workers. Let’s break down who qualifies, how contributions and withdrawals work, a brief history, and the key benefits of saving for retirement with a 457 plan.
What Should You Know About the 457(b) Retirement Plan?
A 457 plan is an employer-sponsored, tax-deferred savings plan primarily available to:
- State and local government employees (such as police officers, firefighters, and public school teachers).
- Employees of certain nonprofit organizations, including hospitals, charities, and unions.
These plans allow participants to defer a portion of their salary before taxes into an investment account. The money grows tax-deferred, meaning taxes are not paid on contributions or earnings until withdrawal, typically in retirement.
They are similar to 401(k)s and 403(b)s but have distinct advantages and considerations, particularly regarding contribution limits and withdrawal rules.
How Did the 457(b) Retirement Plan Begin and How Has it Evolved Over Time?
The 457(b) retirement plan was established as part of the Revenue Act of 1978, which introduced tax-advantaged deferred compensation plans for state and local government employees and certain nonprofit workers. The goal was to provide public sector employees with a retirement savings option similar to the 401(k) plan, which was created for private-sector workers in the same legislation.
Initially, they had fewer contribution limits and restrictions, but they lacked some of the benefits of 401(k) and 403(b) plans, such as employer matching. In 1996, the Small Business Job Protection Act made significant changes, ensuring that 457(b) plans could no longer be used as supplemental executive compensation for high-ranking officials in nonprofits. It also aligned contribution limits more closely with other employer-sponsored plans.
Further reforms came with the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, which increased the contribution limits and introduced the ability for employees to contribute to both a 457(b) and a 401(k) or 403(b) simultaneously – a significant advantage for high earners.
Over the years, the plan evolved into a crucial retirement savings tool for government employees and nonprofit workers, offering tax-deferred growth, flexible withdrawal options, and unique catch-up contributions for those nearing retirement.
What Tax Advantages Does a 457(b) Plan Offer?
One of the biggest reasons employees take advantage of a 457(b) retirement plan is the significant tax benefits it provides. This plan allows you to reduce your taxable income in the present while giving your investments the opportunity to grow tax-deferred until withdrawal. By deferring taxes on contributions and earnings, you can keep more of your money working for you over time. Additionally, some plans offer a Roth 457(b) option, which provides an alternative tax strategy for those who prefer to pay taxes upfront in exchange for tax-free withdrawals in retirement. Here’s how the tax benefits break down:
- Pre-Tax Contributions: Reduces taxable income in the year of contribution.
- Tax-Deferred Growth: Investment earnings are not taxed until funds are withdrawn.
- Potential for Roth Contributions: Some plans offer a Roth 457(b) option, allowing for after-tax contributions with tax-free withdrawals in retirement.
How Do 457(b) Plan Withdrawals Compare to a 401(k)?
When it comes to withdrawing funds in retirement—or sooner if needed—a 457(b) retirement plan has a major advantage over 401(k) plans and IRAs. Unlike those plans, 457(b) accounts do not impose a 10% early withdrawal penalty for taking money out before age 59½. This can be particularly beneficial for individuals who plan to retire early or may need access to funds in case of unexpected circumstances. However, just like with other pre-tax retirement accounts, withdrawals from a traditional 457(b) plan are still subject to income tax. If you have a Roth 457(b) option, you may be able to withdraw funds completely tax-free, provided you meet the necessary conditions.
Here’s how withdrawals work:
- Withdrawals are allowed once you separate from your employer, regardless of age.
- You still owe income taxes on traditional (pre-tax) withdrawals.
- Roth 457(b) withdrawals are tax-free if the account has been held for at least five years and the participant is at least 59½.
Who Should Consider a 457(b) Plan?
Although this plan isn’t available to everyone, for those who qualify, it can be a valuable tool for building long-term financial security. Here are some of the people who may benefit the most:
- Government Employees: With stable, long-term employment, maximizing tax-deferred savings can lead to a robust retirement fund, especially when combined with a pension or other savings vehicles.
- Nonprofit Workers: Many hospitals, educational institutions, and charities offer 457(b) plans, giving employees access to tax-advantaged retirement savings similar to what’s available in the private sector.
- High Earners Nearing Retirement: The catch-up contribution options make it ideal for employees who are within a few years of retirement and looking to accelerate their savings before they stop working.
- Those Who May Need Early Access to Funds: Since there’s no early withdrawal penalty for leaving an employer, a 457(b) plan provides much more flexibility than a 401(k) for individuals who might need to access their funds before age 59½.
What Are the Pros and Cons of a 457(b) Retirement Plan?
Like any retirement savings vehicle, a 457(b) plan comes with its own set of advantages and potential drawbacks. While it offers tax-deferred growth, flexible withdrawal options, and generous catch-up contributions, it also has limitations, such as restricted eligibility and fewer investment choices compared to other retirement plans. Weighing the pros and cons can help you determine whether a 457(b) plan aligns with your long-term financial strategy. Here’s a closer look at the key benefits and considerations:
| Pros | Cons |
| Tax-deferred contributions reduce taxable income | Not available to private-sector employees |
| No early withdrawal penalty for job separation | Limited investment options compared to IRAs |
| Higher contribution limits than traditional IRAs | Employer match is uncommon |
| Special catch-up provisions for those near retirement | Must pay income tax on withdrawals |
What’s the Difference Between a 457(b) and a 401(k)?
At first glance, these plans may seem similar since both offer tax-deferred savings and employer-sponsored retirement benefits. However, there are key differences in eligibility, withdrawal rules, and contribution structures that can significantly impact your retirement strategy. Understanding these differences can help you make an informed decision about which plan, or combination of plans, best suits your financial goals. Here’s a simple table to show how they compare:
| 457(b) Plan | 401(k) Plan | |
| Eligibility | Government and nonprofit employees | Private-sector and some nonprofit employees |
| Early Withdrawal Penalty | No penalty after job separation | 10% penalty before age 59½ |
| Catch-Up Contributions | Special provision within 3 years of retirement | Standard 50+ catch-up limit |
| Employer Matching | Rare | Common in private-sector plans |
For employees eligible for both, contributing to both a 457(b) and a 401(k) could effectively double tax-advantaged retirement savings.
What Are the Most Important Takeaways About a 457(b) Plan?
- It is a tax-advantaged savings option for government and nonprofit employees.
- It allows pre-tax contributions, reducing taxable income while offering tax-deferred growth.
- Unlike a 401(k), withdrawals can be taken without penalty after leaving an employer, regardless of age.
- Contribution limits are generous, with special catch-up provisions for those nearing retirement.
- It can be combined with other retirement plans, allowing high earners to maximize savings.
If you qualify for a 457(b) retirement plan, it’s worth considering as part of your long-term financial strategy. By taking full advantage of its tax benefits and flexibility, you can strengthen your retirement security and create a financial future that aligns with your goals.
At R.W. Rogé & Company, Inc., we know that retirement planning isn’t just about numbers, it’s about creating the life you envision for yourself and your family. Whether you’re just starting to build your nest egg or looking for ways to maximize your savings before retirement, we’re here to help you navigate your options with confidence.
If you’d like to explore how a 457(b) retirement plan fits into your overall financial picture, our team of CERTIFIED FINANCIAL PLANNERTM (CFP®) professionals would be happy to assist. We can show you how our financial planning process can help you stay on track so you can achieve your financial goals. Please contact us for a complimentary discovery call at 631.218.0077. You can also click here to send us a message directly.
R.W. Rogé & Company, Inc. is an independent, fee-only financial planning and investment management firm serving clients locally and virtually across the country, with Long Island, New York, and Beverly, Massachusetts office locations. R.W. Rogé & Company, Inc. was founded on a “client first” culture and proudly commits to acting in your best interest as a fiduciary. We have helped clients Plan, Achieve, and Live® the life they want since 1986. To learn more about how we do this, explore our detailed overview of services and approach.
