Are you a physical therapist or occupational therapist who works for an employer that provides you with a 457(b) retirement plan?
This article will go over the important aspects of. . .
- What a 457(b) is
- Who is eligible for a 457(b)
- How much can be contributed to a 457(b)
- When contributions can be made to a 457(b)
- If you can contribute to both a 457(b) and other retirement plans as well
- And so much more. . .
Ready to learn if a 403(b) is right for you?
Let’s get started.
What Is A 457 Plan?
A 457(b) is a type of retirement plan provided by a qualifying employer that can help qualifying employees save and invest for their eventual retirement while also providing tax benefits in the process.
Employees that have access to a 457 plan usually also have access to a pension, so the 457 plan is considered more of a supplemental retirement plan to that already provided pension.
The 457 retirement plan comes in two different varieties:
- The 457(b) plan
- The 457(f) plan
The 457(b) plan is the more common type of 457 plan, so it will be the focus of this article.
Within the 457(b) category, there are two subtypes of 457(b) plans:
- Governmental 457(b)
- Non-Governmental 457(b)
The type of 457(b) plan an employee has access to depends on who their employer is and this has some important implications.
Who Is Eligible For A 457(b)?
To be eligible for 457(b) plan, you must be an employee for either a government entity or for a non-profit.
An employee with a governmental 457(b) plan usually works for a local or state government, while an employee with a non-governmental 457(b) plan often works for a non-profit.
Employees that often qualify to have a 457(b) plan include the following:
- Police officers
But physical therapists and occupational therapists working for a qualifying employer can be included in this group too.
How Do I Open A 457(b)?
When you are first hired, you should ask your employer for a list of vendors to choose from.
A vendor is the financial firm with which your 457(b) account will be with (e.g. Fidelity).
Each employer has different vendors to offer their employees, so they must provide you with a list that informs you of your vendor options.
Your employer may do this by simply providing you with a piece of paper that includes the names of vendors you can choose from.
Do All 457(b)s Have The Same Investment Options And Fees?
The investment types offered with 457s are limited to only two options:
1. Mutual Funds
Mutual funds are like a mixed bag of other investments, such as stocks and bonds.
They have be either loaded or no-load mutual funds. The term loaded is used to describe a mutual fund that comes with a charge each time you trade it, where there is no charge for trading a no-load mutual fund.
Whether the mutual fund is no-load or not, you will still be charged some amount that will go towards maintaining the mutual fund.
Think of an annuity as a pension that is provided by a vendor rather than your employer.
You invest money in an annuity with the expectation that, when you retire, you will be provided with a steady return on that previous investment.
Annuities can be fixed, variable, or indexed.
Fixed annuities provide you with a fixed rate of return on your investment, variable annuities allow you to invest your money in investment options such as mutual funds, and indexed annuities tie your investment returns to a stock market index like the S&P 500.
Variable and indexed can annuities also include other insurance components such as a death benefit for your beneficiaries.
A Quick Word On Fees:
Before deciding how to invest your 457(b) money, make sure you understand the fees you should expect to incur.
These fees will vary by both vendor and investment type, so be sure to compare each vendor and their investment options carefully.
To help you differentiate between fees with investment types, keep in mind that variable annuities have an average fee of 2.30% of the contract value, loaded mutual funds have an average fee of 0.71%, and no-load mutual funds have an average fee of only 0.27%.
Unfortunately, if you review the fees from each vendor and find a lot left to be desired, you can’t use a vendor that your employer doesn’t offer that may have better investment options – you have to you a vendor offered by your employer.
How Do I Contribute To A 457(b)?
Employees contribute to their 457(b) plans by deferring a portion of their salary.
This means that you inform your employer that you would like a certain amount of your salary each pay period to be deposited into your 457(b) account.
What’s the Difference Between The Traditional 457(b) and the Roth 457(b)?
1. Traditional 457(b)
With a traditional 457(b), you don’t pay taxes when you make a contribution to your 457(b). Instead, you receive a tax deduction for making that contribution.
Your contributions are then invested and grow tax-free.
When the time comes for you to make a withdrawal from your 457(b), you will pay taxes then.
2. Roth 457(b)
With a Roth 457(b), you pay do pay taxes on the contribution you make to your 457(b) and you do not receive a tax deduction for making these contributions.
Your contributions are then invested and grow tax-free.
When the time comes to for you to make a withdrawal from your 457(b), you will not pay taxes on that amount.
Of note, just because an employer gives access to a 457(b) plan does not mean they will give access to the Roth version.
Also, only governmental 457(b) plans get access to the Roth option – non-governmental 457(b) plans do not.
How Much Can Be Contributed To A 457(b)?
The IRS allows employees to contribute the lesser of 100% of their income or $22,500 to their 457(b) in year 2023.
This limit is a total contribution limit, meaning it includes both the employee’s and the employer’s contribution.
In other words, if an employee who makes more than $22,500 in year 2023 contributed $20,000 to their 457(b), the employer could then only contribute as much as $2,500 yielding a total maximum allowable contribution of $22,500.
While it may seem disheartening that both the employee’s contribution and the employer’s contribution are lumped together in an aggregate allowable contribution limit, in reality it is not common for an employer to make any contributions to their employee’s 457(b) anyway.
Can More Be Contributed To A 457(b) If I Didn’t Contribute Very Much Early On?
There are two instances when additional contributions can be made to a 457(b). These additional contributions are called “catch-up contributions.”
1. If You Are More Than 50 Years Old
If an employee is more than 50 years old, a catch-up contribution of up to $7,500 in year 2023 can be made.
This $7,500 amount is in addition to the $22,500 in year 2023.
In other words, if you are more than 50 years old, a total contribution of $30,000 can be made to a 457(b).
However, the IRS only allows this catch-up contribution to be made if you have a governmental 457(b) plan by working for a state or local government – if you are an employee at a non-profit with a non-governmental 457(b) plan, you are not allowed to make this type of catch-up contribution.
2. If You Are Close To Retiring
If you are within 3 years of Normal Retirement Age, the IRS allows employees with a 457(b) plan to contribute the following over a consecutive 3-year period: The lesser of either twice the annual contribution limit for that year or the annual contribution limit plus the amount of contributions you didn’t make up to the annual allowable contribution limit from all previous years you had a 457(b).
Option 1: Contribute double the contribution limit
Option 2: Contribute this year’s contribution limit + total amount missed out on from previous years
***Must Pick Whichever Option Is Less
This type of catch-up contribution is often called the Three Year Rule and, unlike the catch-up contribution discussed earlier, can be made by any employees with a 457(b) – not just employees working for a state or local government.
The Normal Retirement Age mentioned earlier is typically defined by your employer’s plan, but usually 65-year-old. If you do make these consecutive 3-year contributions but then you don’t retire by the Normal Retirement Age as expected, you will not be penalized. Instead, you can continue to work and each year you do you can still make contributions to your 457(b) plan up to the annual contribution limit just as you could in the years prior to this special 3-year consecutive catch-up contribution.
Unfortunately, you can’t use both this type of catch-up contribution and the previously covered older-than-50 catch-up contribution together.
Also, although the IRS allows for this type of catch-up contribution, the employer still has to make it available to their employees. If they don’t, then employees can’t perform this type of catch-up contribution. Many employers don’t allow for this type of catch-up contribution because they find it too tedious to calculate.
Here’s an example on how this catch-up contribution works:
Let’s say its currently year 2023 and physical therapist Ross will be retiring in 2025. He didn’t contribute the maximum allowable amount to his 457(b) each year. In fact, after speaking with his employer, he found out that he could have contributed a total of $50,000 more to his 457(b) over his previous years of work. Since $50,000 is more than this year’s (2023) contribution limit of $22,500, he can contribute up to twice this year’s contribution limit for this year. Next year he can also contribute twice next year’s contribution and then also twice the following year’s contribution limit during that following year as well.
Now let’s consider a different scenario. Unlike Ross, occupational therapist Rachel only missed out on a total of $10,000 worth of contributions during her previous years of work. That changes things. Since $10,000 is less than then annual contribution limit (year 2023) of $22,500, then she could only contribute that year’s (2023) contribution limit of $22,500 plus $3,500 (one-third of the $10,000) for that year (2023). Then she can do this again the following year using that year’s contribution limit and then again the year after that as well.
If I Have A 457(b), Can I Also Contribute To A 403(b)?
Employees who have access to a 457(b) plan may very well also have access to a 403(b) plan.
If you are one of these employees, it is important to know that you are allowed to contribute up to the annual limit of both plans.
For example, in year 2023, the annual contribution limit for a 457(b) and for a 403(b) are both $22,500. So an employee with both of these plans can contribute $22,500 to their 457(b) and another $22,500 to their 403(b).
However, you can only contribute the catch-up contribution of up to $7,500 for being more than 50 years old to one of the 403(b) or the 457(b) – not to both.
Being able to contribute up to $22,500 to both accounts allows for a much greater savings opportunity towards your eventual retirement.
If I Have A 457(b), Can I Also Contribute To A 401(k)?
Just like the scenario covered above for a 457(b) and a 403(b), if you happen to have both a 457(b) and a 401(k) then you can contribute the maximum annual limit to both plans.
For example, in year 2023, if you had both a 457(b) and a 401(k) you can make a maximum contribution of $22,500 to your 457(b) and then do the same to your 401(k).
Therefore, having both a 457(b) and a 401(k) allows for a much greater retirement savings opportunity towards your eventual retirement.
Is The Money In My 457(b) Safe?
You would think that the money you worked hard to make and then invested patiently in your 457(b) would be yours.
But it depends on what type of 457(b) plan you have.
1. Governmental 457(b) Plan
If you work for a government entity and thereby have a governmental 457(b) plan, then the money in your 457(b) account is held in a trust backed by the government.
In other words, the government would have to default for you to lose the money you have in your 457(b).
2. Non-Governmental 457(b) Plan
If you work for a non-government entity (eg non-profit), then the money in your 457(b) is considered your employer’s asset until you make withdrawals.
In other words, if the company you work for goes bankrupt, then the parties your employer owes money to have a right to your 457(b) money.
If you have a non-governmental 457(b), make sure you feel strongly about the financial health of the company you work for before investing in it.
Can I Take Out A Loan On My 457(b)?
Yes, the IRS allows you to take out a loan on your 457(b). However, you can only do so for up to 50% of your 457(b) balance and for no more than $50,000.
You must also repay the loan within 5 years by making payments on a quarterly basis.
Can I Rollover My 457(b) Balance?
Yes, you can rollover your 457(b) balance, but your options are limited depending on if your 457(b) plan is governmental or non-governmental.
1. Governmental 457(b) Plan
A governmental 457(b) plan can be rolled over into another governmental 457(b) plan, a 401(k), a 403(b), or an IRA.
Alternatively, it can also be cashed out.
2. Non-Governmental 457(b) Plan
A non-governmental 457(b) plan can only rolled over into another non-governmental 457(b) plan.
Alternatively, it can also be cashed out.
Are There Any Rules For Withdrawing Money From A 457(b)?
There are 3 potential scenarios you may face when deciding if you want to start withdrawing money from your 457(b).
1. When Leaving Your Employer
One of the big advantages a 457(b) plan offers is the ability to withdraw your money right when you stop working without incurring a penalty – no matter what age you are.
That’s why the 457(b) plan can be a very helpful retirement account if you want to retire earlier than your peers.
You will still have to pay income taxes on the money you withdraw, though, unless the contributions you made to your 457(b) were Roth contributions.
2. When Continuing To Work
If you decide to continue working, the IRS won’t let withdraw money from your 457(b) plan unless you demonstrate an unforseen financial hardship.
Examples the IRS provides include:
- An illness or accident
- A property loss or damage caused by a natural disaster not covered by insurance
- Funeral expenses
- Foreclosing in your primary residence
3. When Taking Required Minimum Distributions (RMDs)
Required Minimum Distributions is a phrase used to described that you must withdraw a certain amount of money from your 457(b) account by a certain age.
That age is 72 years old.
The amount you will be required to withdraw depends on several factors including your age and the amount of money you have in your 457(b).
Again, you will have to pay taxes on these distributions unless your 457(b) contributions were Roth contributions.
Final Thoughts. . .
The 457(b) can be a very useful retirement account if you can manage to qualify for one.
One of the biggest perks of a 457(b) is the ability to start withdrawing from it without penalty right after you stop working. This can make the 457(b) a great retirement account if your goal is to retire earlier than most.
Another huge perk is the ability to contribute the maximum allowable amount to your 457(b) and then also do the same to another retirement account like a 401(k) or a 403(b). If you are lucky enough to have two of these accounts, you can effectively double your retirement savings. Unfortunately, though, employers rarely contribute anything towards your 457(b) and if they do then their contributions will count towards your annual contribution limit.
You can increase your contributions even more if you qualify for catch-up contributions, but you can’t use both catch-up contribution options and you must have a governmental 457(b) plan to qualify for the older than 50 years of age catch-up contribution and your employer must make the Three Year Rule catch-up contribution available to you otherwise you can’t use it.
If you have a governmental 457(b), you are allowed to make Roth contributions which can diversify your retirement tax options. However, that’s only if your employer provides you with the Roth option.
While getting money into your 457(b) may not be the challenge, having peace of mind over how it is handled once its in your 457(b) may be a drawback.
First off, you must use of on the vendors provided by your employer. If you don’t like what any of those vendors has to offer, too bad.
Your investment options are also limited to just mutual funds and annuities. If you were hoping to make more creative investments, you’re out of luck with a 457(b).
If your 457(b) is not a governmental plan, then your employer can use that money to pay off its creditors should your employer go bankrupt.
And if you decide you want to move your money, your rollover options are limited if you have a non-governmental 457(b) plan.
Do you have a 457(b) plan? Are you contributing to it for your eventual retirement? Why or why not? Share your thoughts in the comments section below!