This guide will discuss the key differences between a 457(b) and a 403(b) retirement savings plan. Employees from:
- Public schools
- State and local government
- Charities and nonprofit organizations
- Churches and religious organizations
- Nonprofit private schools
- University employees
will understand the retirement benefits provided them with one of these 3 plans.
At the end of this post, participants will also learn how to spend their retirement savings efficiently.
A 457 plan is offered to state, local governments, and top-level nonprofit employees. There are two types of these tax-advantaged retirement plans:
- 457(b) for state and local government employees
- 457(f) for C-level executives of nonprofits.
For a 457(b) plan, you can contribute up to $19,500 in 2020 and 2021. You may also contribute an additional $6,500 in 2020 and 2021 if you’re age 50 or older.
If you are within three years of your retirement age, employee contributions can exceed that $18,000 limit. You also have to consider any contributions made in the past, making sure they don’t exceed the maximum annual contribution of $39,000 to the employer plan.
Source: Internal Revenue Service
The 457(f) plan is different from the 457(b) plan. They are tied to how long you work and other performance-based metrics.
- Primarily used to recruit executives from the private sector.
- The compensation plan is deferred from taxation.
- The deferred compensation must be subject to a “substantial risk of forfeiture,” which means the executive is at risk of losing the benefit if they fail to meet the service duration or performance requirements.
- Once the 457(f) plan becomes guaranteed and no longer subject to the risk of forfeiture, it becomes taxable as gross income.
Deferred compensation is not paid to the executive and sheltered from taxation until the services have been performed for at least two consecutive years.
Amounts deferred are subject to the risk of forfeiture, but there’s no limit on how much income can be deferred.
457 Plan Pros
- One of the benefits of 457(b) is that it allows participants to double their retirement plan contributions as early as three years before the normal retirement age. Under this scenario, an individual may contribute up to $39,000 in 2020.
- You can put in an extra $6,500 per year if you’re at least 50 years old.
- Unlike other retirement plans, your 457(b) benefits become available to you without penalties when you no longer work for the employer, even if you are younger than 59½ years old.
- When you leave your job, you can rollover your account into an IRA, 401(k), or IRA annuity. This option is only for the 457(b) plan, not the 457(f) plan.
457 Plan Cons
- Employer contributions count as part of your annual maximum contribution.
- Limited governments provide matching programs within the 457(b) plan. Employees have the responsibility for saving enough to meet their own needs.
The 457(f) requires that employees work two years before being eligible for this plan. If the executive leaves the company before their time is up, they forfeit any rights to the 457(f) plan.
A 403(b) plan is offered to tax-exempt organizations, non-profit employees, and public school employees. This type of retirement account allows participants to set aside money tax-deferred for retirement.
These plans were introduced in 1958, and they have only been able to invest in annuity contracts known as a tax-sheltered annuity (TSA) or tax-deferred annuity (TDA) plans.
Contribution and Elective Deferral Limit
For 2020 and 2021, the annual contribution limit is $19,500. The special catch-up contribution for workers age 50 and over is $6,500.
403(b) plans offer a special additional catch-up contribution provision known as the lifetime catch-up provision or 15-year rule. Employees who have at least 15 years of tenure are eligible for this provision, which allows for an extra $3,000 payment a year. However, this provision also has a lifetime employer-by-employer limit of $15,000.
Employers can match additional contributions, but the total contributions from employer and employee cannot exceed $57,000 for 2020 or $58,000 for 2021.
Employers can opt for after-tax contributions and Roth contributions. Automatic contributions are one of the benefits that 403(b) plans provide, but employers may opt out at their discretion. Participants of eligible plan types may qualify for tax breaks as well.
For 403(b) contributions to an individual, the IRS applies them in a specific order:
- elective deferral
- service catch-up provision (15 years)
- age 50 catch-up contribution
Employees who leave their employers can take their plans with them to other employers. They may roll their balances over into another 403(b), a 401(k), annuity, or in some cases, a self-directed IRA.
One major benefit of a 403(b) plan is that it can be carried over from one job to the next rather than being left behind at a previous employer.
- You can take distributions from your 403b plan without tax penalties once you reach the age of 59½ years.
- The early withdrawal penalty for early withdrawal on an account prior to 59½ years old will be 10%.
- Distributions are taxed as ordinary income.
- Roth distributions are income-tax-free, but employees must either contribute to the plan or have a Roth IRA open for at least five years before being able to take tax-free distributions.
- RMDs are required when you reach age 72. Failure to take an RMD will result in a 50% excise tax on the amount that should have been withdrawn.
- You might be able to get a loan from your 403(b). The loan amount can not be more than $50,000 or half of your retirement plan’s balance. If you don’t pay the loan back in five years, it becomes taxable income.
All distributions are reported to the IRS on Form 1099-R, which is mailed to plan participants.
Limited Investing Options
Investing options in a 403(b) plan are limited depending on the investment provider. Funds can be invested into an annuity or invested into mutual funds via custodial accounts.
How to spend a 457 plan efficiently in retirement
Employees can’t touch their 457 plans until they’ve left their employer. However, after leaving, a 457 plan owner can roll over their retirement accounts into a deferred annuity with a lifetime income rider. The annuity will then equally distribute a percentage of the retirement account for the rest of the retiree’s lifetime or married retirees’ lifetimes, even after the account has run out of money.
How to spend a 403(b) plan efficiently in retirement
Employees can’t touch their 403(b) plans without a tax penalty until they’ve reached the age of 59½ years. At that time, a 403(b) plan owner can roll over their retirement savings plans into a deferred annuity with a lifetime income rider. The annuity will then equally distribute a percentage of the retirement account for the rest of the retiree’s lifetime or married retirees’ lifetimes, even after the account has run out of money.
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