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Are They Airplanes or Retirement Plans? The Difference Between a 457 and 401(k)

There is a Boeing 457, but that’s not the same as a 457 retirement plan. A 457 retirement plan is also different than a 401(k) plan. Which one you can participate in, depends on where you work.

The world of Independent Retirement Accounts, known collectively as IRAs, includes a number of different accounts, all of which have different names. The most common are 401(k) plans. The 457 plan is similar, in that it is also a retirement account for workers to deposit pre-tax dollars, which grows without being taxed until withdrawals are taken.

Investopedia’s recent article asks: “401(k) Plan vs. 457 Plan: What’s the Difference?”

These retirement savings accounts were designed to serve as one leg of a three-legged stool of retirement: workplace pension, Social Security, and personal retirement savings. As workplace pensions become obsolete, however, personal retirement savings has increasingly come to be most people’s primary retirement plan, along with Social Security.

401(k) plans are the most common type of defined contribution retirement plan. Employers sponsoring 401(k) plans may make matching or non-elective contributions for eligible employees. Earnings in a 401(k) plan accrue on a tax-deferred basis. These plans offer a menu of investment options, pre-screened by the sponsor and participants choose how to invest their money. They have an annual maximum contribution limit of $19,000, as of 2019. For employees over 50, both plans have a “catch-up” provision that allow up to $6,000 in additional contributions. Premature withdrawals from a 401(k), before age 59½, can trigger a 10% tax penalty. Plan participants can make early withdrawals from a 401(k) under “financial hardships,” which are defined by each 401(k) plan.

457(b) plans are IRS-sanctioned, tax-advantaged employee retirement plans offered by state and local public employers and some nonprofit employers. They’re among the least common forms of defined contribution retirement plans. As defined contribution plans, both of these plans are funded, when employees contribute through payroll deductions. The plan participants set aside a percentage of their salary to put into their retirement account, without being taxed (unless the participant opens a Roth account, and any subsequent growth in the accounts is not taxed). In 2019, 457 plans have an annual maximum contribution limit of $19,000. For employees over 50, both plans contain a “catch-up” provision that allows up to $6,000 in additional contributions. Contributions to each plan qualify the employee for a “Saver’s Tax Credit.” It’s possible to take loans from both 401(k) and 457 plans.

However, 457 plans are a type of tax-advantaged non-qualified retirement plan and aren’t governed by ERISA. Since ERISA rules don’t apply to 457 accounts, the IRS doesn’t assess a “premature withdrawal” penalty to 457 participants who take withdrawals before age 59½. Those withdrawals are still subject to normal income taxes.

457 plans also have a “Double Limit Catch-up” provision that 401(k) plans don’t. This is designed to allow participants who are near retirement to compensate for years when they didn’t contribute to the plan but were eligible to do so.

Both plans permit early withdrawals, but the qualifying circumstances for early withdrawal eligibility are different. With 457 accounts, hardship distributions are allowed after an “unforeseeable emergency,” which must be specifically laid out in the plan’s language. Both public government 457 plans and nonprofit 457 plans allow independent contractors to participate. Independent contractors aren’t eligible to participate in 401(k) plans. Because 457 plans are nonqualified retirement plans, you can contribute to both a 401(k) and 457 plan at the same time.

The key concept here is that 401(k) plans are offered by private employers, and 457 plans are offered by state and local governments and some nonprofits. The differences between the two are the result of the 457 not being governed by ERISA. That means hardship distributions, catch up contributions and early withdrawals are treated differently.

Regardless of which type of tax-advantaged saving plan you have, the important thing is to start making contributions as early in your working career as possible, and continue to make them throughout your working years, so that you are better positioned at retirement.

Reference: Investopedia (March 7, 2019) “401(k) Plan vs. 457 Plan: What’s the Difference?”

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