What Is A 457 Deferred Comp Plan?

A 457 Deferred Compensation Plan is a type of retirement savings plan available to certain employees of state and local governments, as well as non-governmental entities, such as non-profit organizations. This plan is designed to provide participants with an opportunity to set aside a portion of their salary on a pre-tax or after-tax (Roth) basis, similar to other retirement plans such as the 401(k) or 403(b). The 457 plan is a valuable tool for those seeking to enhance their retirement savings and leverage tax advantages specific to their employment category. Below, we explore the features, benefits, and considerations involved with a 457 Deferred Compensation Plan.

Key Features of a 457 Plan

Eligibility and Participation

• Eligibility: Typically offered to employees of state and local governments as well as certain non-profit organizations.
• Participants: Include government workers, public school teachers, and employees of non-governmental entities that sponsor such plans.

Contribution Limits

• Annual Contributions: The maximum contribution limit for 457 plans is subject to IRS regulations. For instance, in recent years, employees could contribute up to $19,500 annually, with an additional catch-up contribution of $6,500 allowed for participants aged 50 and older.
• Special Catch-Up Provision: Unique to 457 plans is a provision allowing certain participants within three years of normal retirement age to make even larger catch-up contributions beyond the standard limit, potentially doubling contributions as they prepare for retirement.

Tax Advantages

• Pre-Tax Contributions: Contributions are typically made with pre-tax dollars, reducing taxable income and deferring taxes on this portion of income until withdrawn.
• Roth 457 Option: Some plans offer a Roth option, allowing participants to contribute after-tax dollars. Although there is no immediate tax advantage, qualified withdrawals are tax-free.

Investment Options

• Variety of Investments: Similar to other retirement plans, participants can choose from a range of investment options, such as mutual funds, target-date funds, and annuities.

How a 457 Plan Works

Contribution Process

1. Enrollment in Plan: Eligible employees enroll in their employer's 457 plan, designating the amount or percentage of their salary they wish to defer.
2. Payroll Deductions: Contributions are automatically deducted from each paycheck, making it a seamless process to save for retirement.
3. Investment Selection: Participants select how their contributions will be invested from the plan’s available options, aligning their investments with risk tolerance and retirement goals.

Withdrawal Guidelines

• No Early Withdrawal Penalty: Unlike 401(k) and 403(b) plans, 457 plans do not impose a 10% early withdrawal penalty on distributions before age 59½. However, taxes are still due on withdrawals of pre-tax contributions.
• Required Minimum Distributions: Like other qualified retirement plans, 457 plans require minimum distributions (RMDs) to begin at age 72.

Benefits of a 457 Plan

Tax Efficiency

• Immediate Tax Benefits: Contributions lower current taxable income, providing immediate tax savings.
• Tax-Deferred Growth: Earnings on investments grow tax-deferred, maximizing growth potential.

Flexibility and Access

• No Age-Based Penalty: The absence of a 10% early withdrawal penalty provides flexibility for early retirees or those needing access to their savings.
• Roth Flexibility: Offers the ability to strategically manage taxable income in retirement by utilizing both tax-deferred and Roth options.

Comprehensive Saving Opportunities

• Stacking with Other Plans: Participants can contribute to both a 457 plan and another qualified retirement plan, like a 403(b) or 401(k), increasing their total savings capacity.

Considerations and Comparisons

Comparing 457 and 401(k)

Potential Drawbacks

• Limited Employer Matching: Some 457 plans may not offer employer matching contributions, unlike many 401(k) plans.
• Investment Fees: Fees associated with investment options can vary, potentially impacting net returns.

Frequently Asked Questions

How does a 457 plan affect my taxes?

Contributions to a 457 plan reduce your taxable income in the year they are made. Taxes on these contributions and the earnings are deferred until withdrawal. Roth contributions do not reduce current taxable income but offer tax-free withdrawals when qualified.

Can I roll over my 457 plan?

Yes, upon separation from service, you can roll over your 457 plan into an IRA or another qualified plan without incurring taxes, preserving tax-deferred growth and diversifying investment options.

What happens if I change jobs?

If you switch to a job with a different employer that offers a 457 plan, you can typically roll over your existing account into the new organization's plan or into an IRA, depending on your new employer’s offerings.

Making the Most of Your 457 Plan

To maximize the benefits of a 457 plan, participants should consider the following strategies:

• Maximize Contributions: Aim to contribute at least the maximum allowable to take full advantage of tax deferral and growth potential.
• Diversify Investments: Select a mix of investments that align with your risk tolerance and retirement timeline.
• Plan for Withdrawals: Develop a plan for distributions based on retirement income needs and tax considerations, especially if utilizing both pre-tax and Roth contributions.

457 Deferred Compensation Plans are a powerful tool for eligible employees looking to boost their retirement savings while benefiting from tax advantages. By understanding the plan’s features and thoughtfully planning contributions and investment strategies, participants can effectively prepare for a financially secure retirement.