Today we’re going to be talking about the Jean Claude Van Damme of retirement accounts – the 457(b) (also called the 457). The 457(b) is a flexible retirement vehicle that allows penalty-free early withdrawals, along with some pretty great catch-up options. Much like Jean Claude Van Damme, the 457 kicks some serious ass, but it’s not for everyone.
Before you get too excited and start doing the splits you should check to see if a 457 account is available to you. If you’re a state or government employee you probably have access to it. If you’re not, you probably don’t.
What Is a 457(b) Account?
Think of it as another retirement account similar to a 401(k) or a 403(b). There are several key differences between those retirement accounts and a 457, though. The main difference is with a 457 you can withdraw your money before age 59 1/2 without being hit with a 10% early withdrawal penalty.
Just as with a 401(k) or Traditional IRA, contributions to regular 457 accounts are tax-deductible. This means they lower your taxable income, and may even put you in a lower tax bracket. Just like with other pretax retirement accounts, this doesn’t mean the money is tax-free. You still have to pay taxes when you take the money out.
Types of 457(b) Retirement Accounts
Governmental 457(b) retirement accounts are held in trust, which means if the company you work for goes bankrupt they cannot pillage money from your account to help pay their debts. This seems like an obvious rule that you’d assume is just understood with all retirement plans. Unfortunately not all 457(b) accounts are governmental.
Another benefit to a governmental 457(b) account is when you leave your employer you are allowed to roll the money over into an IRA. There is a catch, though. If you roll the money over into a Traditional IRA you lose the ability to withdraw the money penalty-free.
Non-Governmental 457(b) accounts are NOT held in trust, which, as you can probably guess, is the exact opposite of governmental 457 accounts. If your 457(b) account is the non-governmental variety it means the company you work for can take your money to pay for their debts on the off chance they go bankrupt. This is super not ideal and the main potential downside to including the 457(b) into your retirement plan.
It should be noted that this is an incredibly rare occurrence. My wife has a non-governmental 457(b) and we still do our best to contribute the maximum amount allowed each year. Having a non-governmental 457(b) is not a good excuse to not set aside part of your income for retirement savings. Knowledge is power, so it’s good to be aware of the rules.
Bottom Line: Talk to your HR department to find out if your 457(b) is governmental or non-governmental.
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How Much Can You Contribute to a 457(b) Account?
In 2019, if you’re under the age of 50, the maximum contribution limit for a 457 is $19,000. If you’re 50 years old or above you’re allowed catch-up contributions of an additional $6,000. This is similar to a 401(k) or 403(b). Having a $6,000 catch-up option is a pretty standard retirement account perk, but the 457 goes one step further.
Where the 457 stands out is when you near the traditional retirement age. Those who are within three years of retirement are allowed to double the standard contribution limit from $19,000 to $38,000. This is huge for someone trying to put money away later in their working career.
Another benefit of the 457 is you’re allowed to contribute to it as well as another employer-sponsored retirement plan.
For instance: If your employer offers a 403(b) and a 457(b), you can contribute $19,000 to each account, for a total of $38,000 per year. This is regardless of your age. Boom.
Is there such a thing as a Roth 457(b) account?
Yes, it is possible to make Roth contributions. If you’re someone who would rather pay the taxes now there is the option to open a Roth 457(b) account. Similar to a Roth IRA or a Roth 401(k), a Roth 457 is funded with after-tax contributions. You’ll be taxed now, but you’ll be eligible to take out your money tax-free later. Talk to your financial advisor to see which is better for you.
Getting the Money Out
The main benefit of the 457(b) is when it’s time to withdraw your money. Unlike a 401(k) or 403(b), you can withdraw your money from a 457 before age 59 1/2, without incurring a 10% early withdrawal penalty. This is a pleasant surprise if you’re interested in early retirement. My wife and I plan to use her 457 to fund the first five years of our early retirement while we’re waiting on our Roth conversion ladder to mature.
To be clear, you still have to pay taxes on the money you withdraw, but you’re not hit with the extra 10% early withdrawal penalty.
You can take the money out of your 457(b) account before age 59 1/2 without incurring a 10% early withdrawal penalty. Beat that, 401(k)!Tweet This
Transferring the Money Upon Separation From Your Employer
Technically, until you physically take the money out of your 457(b) account, it belongs to your employer, not you. Once you perform a Jean-Claude Van Damme style rollover into an IRA it belongs to you.
If you have a governmental 457(b) account you can choose to roll your money over into a Traditional IRA. If you do this you’ll lose the ability to withdraw your money before the age of 59 1/2 without incurring a penalty. That is unless you do the Roth conversion ladder mentioned above.
This option isn’t available if you have a non-governmental 457(b) plan.
Whether you have a governmental or non-governmental 457 plan here are your main options once you leave your employer.
- Leave the money with your employer until you’re ready for retirement. Remember, if you have a non-governmental 457 plan you’re taking a slight risk that your employer goes bankrupt and you lose the money.
- Take the money as a lump sum payment. It’ll be taxed as regular income.
- Roll the funds over into a Traditional IRA. This option is not available on non-governmental 457 plans.
- Take the money as distributions starting at a time of your choosing. Each plan is different, check with your provider to find out if this is an option for you.
Example: With my wife’s non-governmental 457 plan she is able to elect the amount she wants distributed each month and the year she wants the distributions to start. She’s allowed to change her set-up one time.
If we plan on retiring early in 2025, she can elect to start taking distributions of $30,000/year in 2025 and continue that until the money runs out. If we change our minds and decide we’d rather wait until 2030 to receive the distributions she has the ability to change the schedule, but only once. This is a great option, but you have to make sure to carefully plan when you want to receive your money.
Downsides to the 457(b) Retirement Account
Okay. So the 457 account isn’t all high-fives and nun-chucks, there are some downsides too.
One downside to the 457, when compared to other standard retirement accounts, is the elected deferral limit. Although on paper they’re both $19,000, with a 457 any contributions made by your employer count towards your contribution limit. Employer contributions do NOT count towards your limit for a 403(b) or 401(k).
The IRS defines “contributions” differently for a 457 than it does with other pre-tax retirement accounts. With a 457 the total dollar amount both you and your employer collectively can contribute per year is $19,000.
With a 401(k), you get to contribute $19,000 and your employer can contribute however much they want ON TOP of your contributions. Depending on how much your employer match is, your total dollar amount could theoretically be much higher with a 401(k) or 403(b).
Example using a 457(b) account: If your employer contributes $3,000, you are ONLY able to contribute $16,000 for a TOTAL of $19,000.
Example using a 401(k) account: If your employer contributes $3,000 you are STILL able to contribute the full $19,000 for a TOTAL of $22,000.
Non-Governmental 457 plans: Another downside is the possibility that all your savings could be swindled away from you if your employer goes bankrupt and you happen to have a non-governmental 457 account. This is a super rare occurrence. I won’t go into more detail since we touched on this above, but it is a downside to be aware of.
If you have the option to contribute to a 457 retirement account it can be a great boost to your financial goals.
Talk to your HR department to find out if it’s an option for you. While you’re there make sure to ask if it’s governmental or non-governmental.
Our 457 retirement account is a huge part of our overall savings plan. We use it to lower our taxable income and put money away for retirement. Whether you want to use it as standard retirement income, or as a gateway to starting your Roth IRA conversion ladder, the 457 is an excellent retirement account.