How 457(b) Plans work to help you save for retirement

A 457(b) plan is an employer-sponsored, tax-favored retirement savings account. Also known as a deferred compensation plan, it’s offered to state and local government employees such as police officers, firefighters, or other civil servants. Some high-paid executives at certain nonprofits like hospitals, charities, and unions are also able to use 457(b) plans. You can think of the 457(b) plan as a 401(k) for the government-worker or tax-exempt organization worker—but there are a couple of unique differences that make a 457(b) even more attractive.1

Advantages of 457(b) Plans

A 457(b) retirement plan is much like a 401(k) or 403(b) plan. A 457(b) plan is offered through your employer, and contributions are taken from your paycheck on a pre-tax basis, which lowers your taxable income.

Important: After-tax contributions to a 457(b) Plan are tax-deferred, not tax-free.

You may be given the option of investing the contributions in mutual funds that you choose from an array of funds, while the interest and earnings aren’t taxed until you withdraw the funds in retirement.2 457(b) plans typically only offer two types of investments—annuities or mutual funds—both of which are also tax-deferred.

Unlike a 401(k) or 403(b), if you leave a job or retire before age 59 1/2 and need to withdraw your retirement funds from a 457(b), you won’t pay a 10% penalty fee.3 This is a big distinction that makes this type of plan even more attractive than its peers.

Contribution Limits of a 457(b) Plan

Participants in a 457(b) plan can generally contribute as much as 100% of an employee’s includible compensation, or $19,500 in 2020 ($19,000 in 2019)—whichever is less.4 If you’re age 50 or older and your employer allows catch-up contributions, your contribution limit increases by an additional $6,500 in 2020 ($6,000 in 2019).5

Important: There is a Special 457(b) catch-up contribution, which is twice the annual limit or the basic annual limit plus the amount of basic annual limit not used in the previous years. whichever is less.

You may be able to make higher catch-up contributions three years before retirement age if your plan permits. This catch-up strategy allows you to contribute either twice the annual limit, up to $39,000 in 2020 ($38,000 in 2019), or the basic annual limit added to the basic annual limit not used in previous years. The special 457(b) catch-up contributions cannot be used in conjunction with age 50 or over catch-up contributions.6

Another benefit to 457(b) plans is that they work well with other plans.2 Teachers, for example, might be offered both 403(b) and 457(b) plan options. If you have a combination of two plans—a 457(b) and a 403(b) or a 457(b) and a 401(k)—you can contribute the maximum amount to both plans. That brings your annual elective deferral limit up to $39,000 (the maximum contributions allowed in 2020 for 401(k) and 457(b), added together), even if you’re younger than 50. This does not include catch-up contributions or any applicable employer matching.

Note: Contribution limits for 457(b) retirement plans typically increase every one to three years. Check the IRS website to find the most up-to-date information.

457(b) Plans and Employer Matching

Some employers may match the amount that you contribute to a 457(b) plan up to a certain limit.7 If you’re lucky enough to work for such an employer, take advantage of it by contributing to the plan at least as much as the match. If the match is 50% and you put in $1000 per month, your employer is investing $500 a month for you.

If your employer does not currently offer a 457(b), it might pay to lobby for one. As far as retirement plans are concerned, you’d be lucky to have the chance to save in a 457(b).

Melissa Phipps the balance careers