Does a 457 plan make sense for you?

If you work for a state or local government, public school, or a 501(c)(3) nonprofit hospital, you may be eligible to contribute to a 457 retirement plan.

Whether you should contribute to such an account depends on a number of factors.

First, a 457 plan is a retirement savings vehicle that is very similar to a 401k or 403b. For governmental plans, contributions can likely be made to a pretax (tax deduction today, taxable distributions) 457 or Roth (no tax deduction today, tax-free distributions) 457 plan.

One of the main benefits of contributing to your 457 plan is that your deferrals have no coordination with the 402(g) limits subject to your 401k/403b, meaning you can do both in the same year.

For example, you could contribute the maximum salary deferral to your 401k/403b ($20,500 for 2022 if under age 50) and also contribute $20,500 to your 457 plan in the same year. A person over the age of 50 with access to a governmental 457 could, in theory, contribute $27,000 to his/her Roth 401k and also contribute to a Roth 457 plan in the same year. This amount of Roth retirement savings could make a huge impact on your financial independence planning and could ultimately be extra savings needed to achieve your financial goals.

Another advantage to a 457 plan is that, unlike a 401k or 403b, there is no 10% penalty for early withdrawals before 59.5. Early distributions are still subject to ordinary income tax, but there is more flexibility if you require an early distribution than a typical retirement plan would offer.

However, unlike a 401k/403b, employer matching contributions to a 457 plan count towards the total contribution limit. For example, if you contributed $10,000 to your Roth 457 plan, then your employer match is limited to $10,500 (to satisfy the annual limit of $20,500 for 2022). In your 401k, you can contribute the full $20,500 salary deferral and receive any employer match on top of that, as the 415(c) limit allows for up to $61,000 per year of contributions (salary deferral + employer match + after-tax contributions) inside of your 401k or 403b.

Perhaps the biggest drawback to a 457 plan is that it is coded as a deferred compensation plan, meaning it is not “your money” the way money held in a 401k, or 403b plan is. Money inside of a typical retirement plan or IRA is not subject to solvency issues with your employer. If your employer goes bankrupt, any funds inside of a 401k/403b are protected, but funds inside of a 457 plan are subject to creditors and would be paid out to clear any outstanding issues. In theory, your 457 balance could be completely liquidated and sacrificed to solve a bankruptcy issue.

Does a 457 plan make sense for you?

If you are young and it is not a governmental plan, we tend to find there are more efficient ways to save for financial independence.

But if you work for a financially strong and stable institution, have a short runway for financial independence, and want to accelerate retirement savings, then a 457 plan (particularly maxing out your Roth 457 with catch-up contributions) could make sense.

If you have a long runway towards financial independence and are deciding between contributing to your 401k/403b and your 457, then it would generally be advantageous to max out your 401k/403b before any contributions are made to a 457.

Before making any contributions to a 457 plan, it is worth the time to consult with a financial advisor to discuss all implications and how they impact your personal financial plan.

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Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.

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