By Jenn Pavlick
Updated on June 12, 2023
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With the many retirement investment options available to employees today, it’s vital to understand the ins and outs of each one.
One of the most common types of retirement savings plans is the 401(k). This powerful savings tool offers a variety of tax advantages and often includes employer-matching contributions, thus boosting your retirement account.
Next up, we have the 457(b) retirement plan. Unlike the 401(k) often seen in the private sector, the 457(b) plan is exclusive to state and local governments and some non-profits.
But what are the similarities and differences between them? Many of the critical points are in the fine print. This article will explore how each retirement account works, key differences, FAQs, and more.
A 457(b) plan is a non-qualified, deferred compensation retirement plan. It is commonly offered to state and local government employees and employees of specific tax-exempt organizations. But who exactly qualifies for a 457 plan?
The list generally includes:
The IRS sets specific rules for 457(b) plan enrollment, so make sure you know how these plans work and who might be eligible to enroll in one.
A 457(b) plan operates similarly to a traditional 401(k). Both the employee and the employer can make contributions, which grow tax-deferred, meaning you won’t owe any taxes until you withdraw the funds in retirement.
Moreover, an employer can designate a 457(b) account as a Roth account, allowing for after-tax contributions (similar to a Roth 401(k) or a Roth IRA). Employer contributions to a 457(b) plan are less common than they are with a 401(k).
With a 457(b), account holders can withdraw before the normal retirement age without facing the 10% early withdrawal penalty but will still be subject to a tax penalty.
Unlike the 401(k), employer-matching contributions to a 457(b) plan are less common. But if your employer does offer a match, keep in mind that the total contribution limit (yours plus other additions) can’t exceed the annual contribution limit of $22,500 in 2023. Plan participants 50 and older may be able to make an additional $7,500 catch-up contribution.
For example, if an employer contributes $5,000 to an employee’s plan for 2023, the under-50 employee’s contribution limit would only be $17,500 for the year.
There is also a special catch-up provision for those over 50 and nearing retirement. Members of this group are eligible to contribute greater amounts to their 457 plan account balance as compensation for prior years when they did not contribute to the plan.
In the final three years before retirement, an employee can contribute up to the lesser of:
Note that if you elect the special 457 catch-up provision, you can’t also elect the normal $7,500 catch-up in addition.
A 401(k) is a tax-advantaged, employer-sponsored retirement savings plan (otherwise known as a type of defined contribution plan). Offered primarily by for-profit private employers, it allows employees to make either pre-tax contributions or after-tax (Roth) contributions to amplify their retirement savings.
One of the unique features of a 401(k) plan is that it often includes matching contributions from employers, which can significantly boost employees’ retirement savings account balances.
A 401(k) plan works by allowing employees to set aside a portion of their salary for retirement planning purposes. These contributions, or elective deferrals, can be either pre-tax or after-tax, depending on the 401(k) plan the employer offers.
The contributions made by the employee and the employer are invested in various investment options, mainly comprising mutual funds and company stock — but occasionally ETFs as well.
Like a 457(b) plan, earnings in a traditional 401(k) plan grow tax-deferred, meaning you don’t owe taxes on principal and earnings until you withdraw the money during retirement. This process lowers your taxable income in the year you contribute money and can lead to significant tax benefits for your retirement savings in the future.
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While 401(k) and 457(b) plans share similarities, they differ in crucial ways.
Let’s explore how.
Both 401(k) and 457(b) plans have annual contribution limits set by the IRS, which can change yearly. Employees aged 50 and older can make catch-up contributions, boosting their retirement savings.
For 401(k)s, the employee contribution limit is $22,500, and those 50 and over can contribute another $7,500 to boost their total contribution for the year. However, employers are able to contribute an additional $43,500 to employees’ 401(k) plans, for a total of $66,000 in 2023 ($73,500 if we count the catch-up contribution for those 50 and over).
For 457 plans, the total employee plus employer contribution for 2023 is $22,500, and the same $7,500 is available as a catch-up for employees aged 50 and over. The 457(b) plan does, however, allow for a higher maximum contribution limit for those within three years of retirement — generally speaking, that limit is $45,000 (but could be slightly higher or lower depending on how much the employee contributed to their 457(b) in prior years).
If you take distributions from your 401(k) plan before reaching retirement age at 59½, you’ll typically face a 10% early withdrawal penalty and ordinary income tax.
In contrast, 457(b) plans do not have a 10% early withdrawal penalty, but withdrawals are still subject to income tax as per usual. This can make your funds slightly more flexible in the case of an unforeseeable emergency, but it’s still not recommended to tap your retirement funds early unless absolutely necessary.
Both 401(k) and 457(b) plans allow for rollovers to other retirement accounts like IRAs or other tax-advantaged retirement plans.
However, there may be some process differences for your rollover, especially for non-governmental 457(b) plans. Contact your plan administrator for more information on how to effect a rollover.
While 401(k) plans often include employer matching contributions, 457(b)s offer this feature less frequently. Remember that total contributions, including employee contributions and an employer match, cannot exceed the annual contribution limit of $22,500 ($30,000 for those 50 and older) for a 457 plan in 2023.
Determining which plan is better for you depends on your circumstances, including your retirement goals, tax situation, and employment status. It will also hinge on what kind of retirement plan your employer offers—you may not always have a choice between the two.
Yes, if you have access to both plan types, you can contribute to both a 401(k) and a 457(b) plan. But the annual contribution limits will still apply to the plans taken together.
For instance, as an employee, your maximum elective deferral to a tax-advantaged retirement plan is $22,500 across all of your employment relationships. Depending on your employer, they may contribute well more than that so long as they adhere to IRS-defined limits.
Yes, you can roll over a 457(b) plan to another eligible retirement plan like a 401(k) or an IRA.
However, there may be some restrictions, especially for non-governmental 457(b) plans. It’s best to check with your current plan administrator to see what your options are and what the process will look like for you.
457(b) plans are primarily offered to public sector employees and employees of certain non-profit organizations. You’re much more likely to see a 401(k) offering if you work for a private, for-profit company.
The 401(k) and 457(b) plans are effective vehicles for retirement savings, each with unique features. The best choice for you depends on your specific financial situation, retirement goals, and employment circumstances. It’s essential to carefully consider each plan’s investment options, contribution limits, employer-matching opportunities, and early withdrawal rules.
Given the complexities of retirement planning, it’s highly advisable to partner with a trusted professional who can help guide you toward the retirement savings plan best suited for your needs.
At Capitalize, we’re committed to helping you make the most of your retirement savings and to securing the retirement income you need. We’ll manage your rollover by locating your old retirement accounts and organizing the process from start to finish.
Ready to consolidate your retirement savings plans? Start working with Capitalize today.
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