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What is a 457 Plan?

A 457 Plan is a type of deferred compensation arrangement that is available to some government employers and non-profit organizations. These plans are similar to 401(k) and 403(b) plans in that they allow participants to save for retirement on a tax-deferred basis. In this article, we will take a closer look at the key features of 457 plans, including who is eligible to participate, how contributions work, and the contribution limits.

Who is Eligible for a 457 Plan?

457 plans are primarily available to state and local public workers, including teachers, police officers, firefighters, and other government employees. In addition, a few nonprofit organizations also offer 457 plans to their employees. The specific eligibility requirements for a 457 plan will vary depending on the employer and the plan itself.

How Contributions Work in a 457 Plan

Like other retirement savings plans, 457 plans allow participants to make contributions on a tax-deferred basis. This means that the money you contribute to your 457 plan is deducted from your paycheck before taxes are applied, reducing your taxable income. The contributions then grow tax-free within the plan until you withdraw them in retirement.

One key difference between 457 plans and other retirement savings plans is that there are no penalties for withdrawing funds from a 457 plan before age 59 ½. This can be beneficial for participants who may need to access their savings for an unexpected expense or other financial need.

It's important to note, however, that any withdrawals made from a 457 plan before retirement age will still be subject to income taxes. So while there are no penalties for early withdrawals, you may end up owing more in taxes if you withdraw funds before retirement.

Contribution Limits for 457 Plans

Like other retirement savings plans, there are contribution limits for 457 plans. In 2016, the elective deferral limit for 457 plans was $18,000. This means that participants could contribute up to $18,000 of their income to the plan on a tax-deferred basis.

In addition, participants who are age 50 or older are eligible to make catch-up contributions to their 457 plan. In 2016, the catch-up contribution limit was $6,000, which means that participants over age 50 could contribute up to $24,000 to their 457 plan in total.

It's worth noting that 457 plans are technically considered unfunded, non-qualified deferred compensation arrangements. This means that the funds in a 457 plan are not held in a trust or other separate account, but are instead considered part of the employer's general assets. This can be a concern for participants who are worried about the financial stability of their employer.

Benefits of a 457 Plan

Despite the potential concerns around employer solvency, there are several benefits to participating in a 457 plan. Here are a few key advantages of these plans:

  • Tax-Deferred Growth: Perhaps the biggest benefit of a 457 plan is the tax-deferred growth that it offers. By contributing to the plan on a pre-tax basis, you can reduce your taxable income and let your savings grow tax-free until retirement. This can be a powerful tool for building a retirement nest egg.

  • No Early Withdrawal Penalties: Unlike other retirement savings plans, 457 plans do not impose penalties for early withdrawals. While this doesn't mean you should dip into your savings before retirement, it can offer some peace of mind for participants who may need to access their savings in an emergency.

  • Catch-Up Contributions: Participants who are age 50 or older can make catch-up contributions to their 457 plan, allowing them to save even more for retirement.

  • Flexible Investment Options: Most 457 plans offer a range of investment options to choose from, allowing participants to customize their portfolio to their individual risk tolerance and investment goals. This can include a mix of stocks, bonds, mutual funds, and other investment vehicles.

  • Additional Retirement Savings: For participants who are already contributing to a 401(k) or 403(b) plan, a 457 plan can offer an additional opportunity to save for retirement. This can be especially beneficial for individuals who anticipate needing more savings to support their retirement lifestyle.

Potential Drawbacks of a 457 Plan

While there are many benefits to participating in a 457 plan, there are also some potential drawbacks to be aware of. Here are a few potential downsides of these plans:

  • Employer Risk: As mentioned earlier, 457 plans are considered unfunded, non-qualified deferred compensation arrangements. This means that the funds in the plan are not held in a separate account or trust, but are instead considered part of the employer's general assets. If the employer were to experience financial difficulties or bankruptcy, the funds in the 457 plan could be at risk.

  • Limited Eligibility: 457 plans are primarily available to state and local government employees, as well as a few nonprofit organizations. This means that not all workers will have access to these plans.

  • Contribution Limits: While the contribution limits for 457 plans are similar to those of other retirement savings plans, they may not be sufficient for participants who are looking to save a large amount for retirement.

  • No Roth Option: Unlike 401(k) and 403(b) plans, 457 plans do not offer a Roth option. This means that all contributions to the plan are made on a pre-tax basis, which could impact your tax situation in retirement.

  • Withdrawal Restrictions: While there are no penalties for early withdrawals from a 457 plan, there are restrictions on when you can access your funds. Specifically, you cannot withdraw funds from a 457 plan until you separate from service (i.e., retire or leave your job).

Is a 457 Plan Right for You?

If you are a state or local government employee or work for a nonprofit organization that offers a 457 plan, you may be wondering if this type of plan is right for you. Ultimately, the decision will depend on a variety of factors, including your retirement goals, investment strategy, and overall financial situation.

To help you determine whether a 457 plan is a good fit for your needs, consider working with a financial advisor. An advisor can help you evaluate the pros and cons of the plan, assess your risk tolerance and investment goals, and develop a retirement savings strategy that aligns with your individual needs.

A 457 plan is a type of deferred compensation arrangement that is available to some government employers and nonprofit organizations. Like other retirement savings plans, these plans allow participants to save for retirement on a tax-deferred basis. While there are some potential drawbacks to these plans, including employer risk and contribution limits, they offer several benefits, such as no early withdrawal penalties and flexible investment options. If you are considering a 457 plan, be sure to work with a financial advisor to evaluate your options and develop a retirement savings strategy that meets your needs.

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