457B: The Mysterious Retirement Plan that could Turbo-charge your Retirement Savings
In the wake of my wife getting a better job, I thought it would be wise to read through all of her new employer’s benefit plan details. Standard fare, when all of a sudden, something jumped off the page…
“Contribute up to $36,000 in total between the 403(b) and 457(b)”
Whaaaa? Up until this point neither of us had employers who offered a 457B plan. 457B’s are typically used interchangeably with 401K’s and 403B’s and always seemed like an either/or proposition to me. In other words, I thought that employers offered one of these plans based on the type of organization that they were.
It turns out I was wrong.
Not only can certain employers (typically governments, state universities, and non-profits) offer both a 403B and 457B plan, but the coordination of benefits between the two was eliminated with the Economic Growth and Tax Reconciliation Act of 2001. That single piece of legislation gave anyone eligible for a 457B plan an opportunity to limit their taxation (and enhance their fortunes) in two ways:
- It removed the coordination of benefits limitation for 457B plans that required you to adhere to one combined maximum contribution that was shared with 403B’s and 401K’s. 401K and 403B plans, however, are still coordinated and share a combined maximum contribution. For example, if your employer offered all three plans, your maximum contribution amount in 2015 would be a combined $18,000 to your 401K and 403B, and an additional $18,000 to your 457B ($24,000 to each with the catch-up contribution for those over 50 years old). That’s huge.
- Despite removing the coordination of benefits, the maximum contribution amount for 457B plans was increased to match that of 401K’s and 403B’s, with annual inflation adjustments and catch-up provisions.
Why was this legislation passed? Well, it was passed by Congress, who are government employees (signed by Bush administration), and 457B’s can greatly benefit governmental employees through their massive additive tax-cutting benefits. That should tell you all you need to know. It was a covert way for Congress to vote to give itself a massive pay increase without any of the public backlash that comes from doing so. If you are eligible for a 457B, you would be wise to take advantage.
Here’s where things get even more interesting for those with a 457B option – despite the removal of coordination of benefits and the increased contribution amounts to match other retirement plans, the IRS 10% penalty for early withdrawals prior to age 59½ (that applies to IRA’s, 401K’s, 403B’s) does not apply to the 457B! This differentiating factor makes 457B’s superior to 401K’s and 403B’s.
Now armed with a 457B for the first time, what are we going to do with it? We gonna max it out!
We now have an additional 401K-equivalent amount of tax savings available to us. And we’ll still aim to max out the other retirement accounts, using savings to cover our living expenses, if we need to. If all goes well, this would reduce our income by:
- My 401K: $18,000
- HSA: $6,650
- Wife 403B: $18,000
- Wife 457B: $18,000
Total deferred: $60,650
And that doesn’t even include funds we could contribute to IRA’s.
If you have decent earnings that push you into a higher tax bracket and are one of the lucky few to also have a 457B, it could make a lot of sense for you to do something similar.
If you don’t have the earnings/savings to take advantage of the additive benefits of 457B’s by contributing to one in addition to another retirement plan, then it could make sense to contribute to your 457B before contributing to the other plan (assuming no matching funds), up to the maximum contribution amount, in order to avoid possible early withdrawal penalties later in life.
The mysterious magic of 457B’s – who would have known?