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457b plan and how it works: The full breakdown

At a glance:

  • What is a 457 plan?

  • How to contribute to a 457 plan

  • How to take distributions from a 457 plan

  • 457 Rollovers

  • Summary of 457b plans

They're not as well known as their cousins the 401k and 403b, but 457b plans (or 457 for short) work in much the same way that 401k and 403b plans work.

You can divert a part of your salary from your paycheck before taxes are taken out and have those funds put into the plan. Your money grows tax-deferred until you withdraw it.

But there are some things that are unique to 457s when it comes to making contributions and taking withdrawals.

Like 401ks and 403bs, 457 plans are retirement plans for employees of certain types of organizations.

Millennials aren't contributing as much to their retirement. (Graphic: David Foster/Cashay)
Millennials aren't contributing as much to their retirement. (Graphic: David Foster/Cashay)

What is a 457 plan?

A 457 plan is a type of defined contribution retirement plan.

There are two types of them: governmental and non-governmental. They were traditionally offered to state and local public employees (governmental), but were later expanded to include some nonprofit organizations (non-governmental).

Therefore, you must be employed by a state or local government or a tax-exempt 501(c) organization to participate in one. Most non-governmental plans are not available to all employees, however. They are limited to highly compensated employees such as officers. The actual level of compensation is set by the company.

What kinds of organizations participate in 457s?

You can have a 457 set up for you if you work for organizations such as these:

  • Public schools

  • Hospitals

  • Labor unions

  • Certain tax-exempt cooperatives

  • Charitable foundations and organizations

  • Trade associations

You get tax benefits with a 457

There are some tax advantages to having a 457 plan.

You are not taxed on the money that you divert into your plan, making it pre-tax. Also, it grows tax-deferred while it is in the plan. You do not need to pay taxes on any earnings that you gain, as long as they are reinvested into the plan. When it comes time to take withdrawals from your plan, they will be taxed as ordinary income.

An advantage of having a 457 plan is that if your organization also offers a 403b or 401k plan, you can participate in both. As with all other retirement plans, there are various types of investments, such as mutual funds, that are available to fund your plan.

Contribution limits

For 2020, you can contribute up to $19,500. Any future increases will be indexed to inflation.

This contribution amount applies to both governmental and non-governmental plans. If you are 50 or over, you can contribute an additional $6,500 per year. But these catch-up contributions are only allowed in governmental plans.

Roth plans

As a result of recent legislation, a governmental 457b plan may be amended to allow designated Roth contributions and in-plan rollovers to designated Roth accounts.

How to contribute to a 457 plan

As with all retirement plans, how much you can contribute to a 457 plan may rise from year to year, based on indexing by the federal government. It is the same as the contribution limit to 401ks.

Some employees get another catch-up contribution

There is an additional catch-up contribution (called the "three-year catch-up") that is available only to employees who are within three years of their plan's normal retirement age. This type of catch-up is available to both governmental and non-governmental plans.

The amount of the three-year catch-up contribution is the lesser of:

  • Twice that year's regular contribution limit OR

  • The regular contribution limit for that year, PLUS the amount by which you under-contributed in previous years.

Note that if you are eligible for the three-year catch-up contribution, you are not eligible for the 50-or-over catch-up contribution.

You can be automatically enrolled

457 plans are eligible for automatic enrollment of employees.

This means that, unless you deliberately choose otherwise, your employer can automatically enroll you in the plan shortly after you're hired and divert some of your income to the plan from your paycheck. You can also elect to have a different amount contributed. Automatic enrollment plans have shown some success in raising participation rates in retirement plans.

You can also get matching contributions

As with the more well-known 401k plans, your employer can provide a matching contribution to your plan. This can help your plan grow faster than it would if you were funding it alone.

Matching contributions are determined by your company. Employer matches are not common, however.

If you also have a 403b plan, though, there is an additional option: If your employer also offers a 403b plan, you can make contributions to both. You can also contribute the maximum allowed to each plan — a big plus if you have the ability to maximize your contributions.

Review the plan provisions for both in detail and/or consult a financial advisor who specializes in working with employees eligible for these types of plans.

How to take distributions from a 457 plan

Unlike 401ks, 403bs, and IRAs, which allow unrestricted distributions beginning at age 59½, you can generally begin taking distributions from your 457 plan only upon reaching age 70½. These distributions will be taxed as ordinary income, based on your tax rate for the year.

But unlike those plans, you won't be penalized if you take distributions before age 59½ in certain situations. You will owe income tax on them, but there will not be the 10% penalty that characterizes other plans.

When they are allowed

Distributions before age 70½ are allowed for the following situations:

  • Severance from employment. Even if you leave your job voluntarily prior to age 59½, you can take a 457 distribution free of penalty

  • Unforeseeable emergency, as defined by regulations (e.g., an accident or illness). The 457 financial hardship rules are more strict than the 401k financial hardship rules

  • Death or disability

Multi-ethnic businesspeople discussing paperwork
You won't be penalized if you take distributions before age 59½ in certain situations. (Getty)

When you must take distributions

As with many other retirement plans, you are required to begin taking distributions from your 457 at age 70½ or the year you retire, whichever comes later.

Your organization's plan may have additional rules and restrictions beyond those imposed by federal regulations. Also, there are additional rules on distributions beyond those mentioned above. Be sure to study your plan carefully and ask questions.

457 rollovers

There is more than one situation for rollovers.

The basic rules

You can generally roll your 457 plan over into another retirement plan or IRA, or another 457.

Certain types of 457s are not eligible, however. For these cases, rollovers can occur only into another ineligible 457. That is why it is important to consult with your plan sponsor, as there are many nuances in these plans.

The full amount from the original account must be placed into the new plan within 60 days. If a lesser amount is rolled over, a 20% withholding will apply.

Direct rollovers

You can move the funds via a direct rollover (trustee-to-trustee transfer), in which the funds are transferred from the old custodian to a new one without you touching them. This is usually the smoothest method because it doesn't incur tax penalties or withholding by the IRS.

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Self-directed rollovers

You can also remove the money from the old account and put it into the new account yourself.

However, with this method, the IRS requires that 20% of the funds be withheld for tax purposes, even if you intend to roll the money over to a new plan. You will then have to deposit the full rollover amount in order to avoid an early withdrawal penalty.

This means you will need to come up with an amount equal to the 20% that was withheld. Once you have done so, however, the withheld 20% will be returned to you if you apply for a refund.

Summary of 457b lans

457 plans are perhaps the least-known sibling in the family of major retirement plans. Their rules are complex, and there are several varieties of them, but they have changed over the years to become simpler and more in line with other plans.

They offer some attractive advantages that other plans do not, such as the lack of a penalty on early distributions (i.e., if you leave a job before age 59½) and the ability to contribute extra if you are near retirement.

If you work in government or a non-profit organization and are eligible for a 457 plan, it may pay to consult with your employer or human resources department to see whether a 457 plan is a good idea for you.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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