Internal Revenue Service (IRS) tax code has created a confusing set of retirement plans centered on numbers. The specific provisions and narrower focus of the 457(b) might give qualified individuals some attractive benefits, though. It is very similar to the better-known 401(k) and 403(b) in that it is a tax-deferred plan, with four principal differences: the tax code creates restrictions on the types of organizations which may participate, a smaller number of employees are designated eligible, actual control of the assets and the absence of early withdrawal penalties.
At first glance, a 457(b) plan appears to be a special variant of the 401(k). The contribution maximums, in particular, are exactly the same. Participating individuals can set aside $16,500 per year, with an additional $5,500 available for persons aged 50 and older as a “catch up” option. And, eligible workers can set funds aside to the allowable limits in both, if an employer makes them available. This means someone nearing retirement could contribute up to $44,000 per year – or, in some cases, up to 200% of the set 457(b) maximums for the last three years of the plan in addition to $22,000 in a 401(k).
What sets a 457(b) apart is the absence of an early withdrawal penalty. A 401(k) imposes a 10% fee when it’s drawn from before the age of 59.5 and the 457(b) does not, though the monies are subject to regular income tax. It’s even possible for a participant to use the plan as back up case of emergency, as long as legal requirements are met and other financial resources are exhausted. There’s also no minimum retirement age, as with the 401(k), but the federal government offsets this by keeping 457(b) participants from putting income into a Roth IRA when moving to another job.
Only state and local governments, as well as certain tax-exempt entities, can offer their employees the 457(b). The law makes provisions for the following groups to carry options for specific Retirement Plannning: charitable or religious organizations, private hospitals or foundations, labor unions, trade associations, fraternal orders, educational organizations and farmers cooperatives. Further, the IRS keeps these not-for-profit employers from matching contributions to 457(b) plans, which is much different than for-profit corporations with the 401(k) alternative.
On top of that, only certain employees can be given the choice of opening a 457(b). Though each organization determines the cut-off, beneficiaries are generally among the highest-compensated in a given organization. This gives individuals in their peak earning years the ability to defer federal and state income tax until later. For this reason, they are often referred to as “top hat plans,” especially when an executive is able to utilize the 457(f) option. (This is a less common case which allows the employer to put back as much it can pay and the employee is willing to allow.)
It is important to remember, though, that these assets remain in the control of the employer. In contrast to a 401(k), which is immediately released to the worker, the 457 Retirement Plan is considered the organization’s property until it is paid out. This means that, in the event the employer defaults on a loan or goes bankrupt, the funds are available to creditors seeking repayment and the employee loses the money altogether.