This article has been updated for 2023. 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 $45,000 in total between the 403B and 457B.
What?! Up until this point neither of us had employers who offered a 457B plan. 457Bs are typically used interchangeably with 401Ks and 403Bs 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 403Bs and 401Ks. 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 2023 would be a combined $22,500 to your 401K and 403B, and an additional $22,500 to your 457B ($30,000 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 401Ks and 403Bs, 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 457Bs 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 IRAs, 401Ks, 403Bs) does not apply to the 457B! This differentiating factor makes 457Bs superior to 401Ks and 403Bs.
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: $22,500
- HSA: $7,750
- Wife 403B: $22,500
- Wife 457B: $22,500
Total deferred: $75,250
And that doesn’t even include funds we could contribute to IRAs.
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 457Bs 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 457Bs – who would have known?
Check out the IRS page for more info on 457B rules.
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Might want to add a few disclaimers about the disadvantages of 457b plans for those working for a non-profit with a plan. Unlike 403b plans where the funds are segregated and protected in the event of problems for the business, 457b plan funds are considered employer funds and are available to pay creditors if the business goes bankrupt. That is a big variable as far as risk goes, depending on the employer.
Non-governmental 457b plans also can only be rolled into another 457b plan and not into an IRA or other tax sheltered account, and plans have a lot of latitude to force terminated employees to take distributions shortly after termination. That means if you transfer jobs from a nonprofit to a for profit you can be stuck with the entire balance you deferred being taxable that year. This can be a big tax planning problem, especially if you consider a scenario where an employee is laid off and unable to find work. Much of the traditional safety net, like health insurance with the ACA, considers need based on yearly taxable income, and a layoff forcing a distribution out of a 457b could make someone ineligible right when they need it the most.
Knowing those facts as a 20-somehting looking for places to save my employer’s 457b is near the bottom of the list. The best advice I have heard for 457’s is that they are great for employees at the end of their working career (5-10 years left to retire) who want to shift taxable earnings timing till just after they retire. Your mileage may vary, but I agree with that logic.
Most of these warnings only apply to private 457(b)s, not public/governmental 457(b)s. Public 457(b)s are protected the same way a 403(b) is, where as a private 457(b) could be lost if the company goes under since the holdings are in the company’s name.
Private 457(b)s do restrict transfer to a 403(b)/401(k), but the mandatory withdrawals will depend on the specific plan. This is also true of public 457(b)s. Some will allow you to keep the money there and not distribute it, others will require you to distribute or roll over to a 403(b)/401(k) upon separating. Rolling into a 403(b)/401(k) kind of defeats the purpose of the 457(b) [having earlier withdraws], so that’s something to look into.
The advice about 457(b)s being for people at the end of the working careers (and as such not something for 20-somethings) is kind of meh… If you’re working toward FIRE, a 457(b) can be a great utility to get you from 30/40-something to 59.5 years old when you can finally tap the 403(b)/401(k)/IRA money without incurring fees.
Personally, I wouldn’t invest in a private 457(b) because of the risk (company tanking and those monies being up for grabs), but I am a firm believer than if you have access to a public 457(b) and it’s structured well, then you’re foolish not to use it if you have any desire to retire before 59.5.
I’m one of those lucky people who have access to a well structured public 457(b) with good fund options where I can either start disbursements right upon separation, or leave it alone and start disbursements later. Or if I change my mind and decide a 30/40-something year old retirement is just silly, I could also roll it into a 403(b)/401(k).
A 457 can be an excellent option. The ones for my state do not allow distributions until you leave employment and the fund options are terrible. Index funds with 1% fees!? Yuck. However, if your 457 is good you are very lucky. (And smart to take advantage of it.) Your savings is nearly twice my family take home income. Very impressive. Will you be FIRE soon?
G.E.,
Thanks for the info. I’m happy your family will get to implement this new strategy.
I’ve been following several early retirement blogs for a couple years now, and this touches on a topic I have been puzzling about lately: If you’re planning to retire early, why would you keep maxing out the 401k’s when they have the early withdrawal penalties? Why not just stop at your company match, then put the rest of the nest egg in a taxable brokerage account? Right now I’m 24, getting 4% match on 401k (but no more contributions from me), maxing out Roth IRA, and the rest is either being saved for a house or put in a brokerage account– the goal being to retire early.
I’d imagine that the 10% early withdrawal penalty might still bring you out ahead in the long run, but I haven’t seen any math on this topic. Why should I max out a 401k with money I can’t get to if I plan to retire early?
Thanks!
I also had the same question as Anonymoose! This would be a great article to write about for the future. Also, would love to learn if there are any alternates to 401ks besides Roth IRAs because my company has an awful match policy (You can’t even get a match until the end of the year…if you quit/get fired/laid off before the end of the year you will forfeit the match) and need more alternates just in case something happens.
Always go for the match first.
To your question and Anonymoose’s – there are ways to access funds without penalty. It’s a topic that I don’t want to fully get in to in the comment section and could cover in a future post, but it is possible. The two most common routes are:
1. substantially equal periodic payments: http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Substantially-Equal-Periodic-Payments
2. Traditional to Roth IRA conversion ladder
G.E.,
We would really like to see a blog related to Anonymoose’s question. I routinely max out my 401K but I have also wondered how I could retire early with the bulk of my money in a tax-deferred account. I don’t want to pay no stinkin’ penalties.
Nick,
The Madfientist blog deals with optimizing retirement accounts for people planning to retire early. He personally is planning to do a Roth conversion ladder. Basically once he officially retires well before 59 and 1/2 he will take advantage of his low income by converting portions of his 401k to Roth each year and paying the income taxes at a much lower percentage 0%, 10%, and 15% while living off his long term capital gains and dividends. He will then be able to withdraw the converted money 5 years after the conversion date.
http://www.madfientist.com/traditional-ira-vs-roth-ira/
Never knew something like this even existed. But thanks for talking about it. Will definitely look out for it in the future.
I work for a state government and have a 457b plan (which I max out) but I’ve never received information regarding being able to contribute to a 401k as well. Is it discretionary for my employer to offer the 401k in addition to the 457b plan?
Yes. Employers decide if they will offer more than one plan and restrictions. My employer offers a 457 and a 403; but only to management level staff. All others can only contribute to the 457.