457 Plan

A 457 plan is a retirement savings scheme in which individuals contribute a portion of the income, which is deducted without charging any tax. The tax, however, is applied to this savings amount at the time of withdrawal, mostly after retirement. Therefore, the amount gets enough time to grow before it becomes taxable.

These are tax-advantaged, deferred compensation plans that state and local governments and non-profit organizations offer their employees. The 457 plan is similar to the 401(k) retirement plan except for the latter being available to employees of for-profit organizations as well.

• 457 plan is a tax-deferred retirement scheme that lets employees contribute a total or a portion of their compensation into retirement accounts to financially secure their post-retirement phase.
• It is classified into 457 (b) and 457 (f).
• While the 457 (b) plan is available for the state or local government employees, 457 (f) is meant for non-federal employees like those indirectly associated with the government, employees of NGOs, tax-exempt entities, etc.
• Being tax-advantaged, applicable for non-federal employees, 100% contribution limits, double contribution provision, etc., are some of the features of this plan.

A 457 plan is a deferred compensation scheme classified under a non-qualified retirement savings program. A non-qualified plan are those that do not fulfill the criteria of the Employee Retirement Income Security Act (ERISA). In addition, these are tax-advantaged, which means no taxes are charged until the employees withdraw the amount. 

This is the plan where employers deduct a certain percentage of an employee’s compensation, which becomes their contribution to the retirement funds that secure them financially for the future. The growth in the value of the funds depends on the performance over time. 

Eligible employers like local and state governments give the offer to employees for contribution to 457 plans, and interested employees communicate to the employers for proceeding with the same.

The employer must register with the authority to make contributions to an approved plan and select the type of plan to which it wants to contribute. The employee contributes a certain percentage of their salary, which may exceed 100 percent of the salary, subject to a dollar limit.

Then, the contributions are transferred to the special account and are invested in securities. They may be safe securities or certain risk-bearing securities. In the process, money grows through investment without any tax. The employee can withdraw after retirement. If the amount is withdrawn before retirement, it is taxable at normal rates.

A 457 plan for retirement is classified as 457 (b) and 457 (f). While the 457 (b) plan is available for the state or local government employees, the latter is meant for non-federal employees like employees indirectly associated with the government, employees of NGOs and entities that remain tax-exempted.

For 457 (b), some employees of non-profit organizations are also eligible for this plan. This 457 plan limits the contribution to $20,500 per year for employees. 

On the other hand, the limit of contribution for 457 plan (f) can be up to 100 percent of the salary. There are certain legal and compulsory requirements for this plan. Deviation from the rules leads to problems, penalties, and loss.

The 457 plan is only for eligible employees from state and local government organizations, non-federal or tax-exempted firms, and non-profit or non-governmental organizations directly or indirectly associated with the government.

Taxes do not apply to the amount at the time of making contributions. Instead, the authorities levy them at the time of its withdrawal from the account. The employees can contribute up to 100 percent of the salary, given the contribution does not exceed the applicable dollar limit.

The eligible employees who didn’t contribute to the plan and are near to the age of retirement, i.e., a minimum of three years before the retirement age, have the option to contribute at twice the limit to benefit. Above all, the employees have the liberty to choose the type of investment they want to contribute to. These contributions secure the financial condition of the employees at a later stage, mainly after retirement.

Employees can withdraw the money compounded in section 457 plan at the time of retirement to enjoy the retirement benefits. Early withdrawals are also permissible without any penalty. Normal taxes apply on the withdrawal. One can withdraw at any time at any age from the plan without any penalty.

People can withdraw money only in an emergency and with prior permission from the employer. Emergency withdrawals include only expenses related to medical needs, funeral requirements, or in case of damage to the property.

Let us consider the following examples to understand the concept better:

Example #1

Ryan searches for schemes that would help him save for retirement. He comes across various types of investments but desires to have something which could allow him to withdraw funds in the middle of the investment term, given his bill payment liabilities. Hence, he opts for the 457 plan and saves while withdrawing the required amount without penalty from time to time.

Example #2

The rising consumer prices in 2022 depict the likelihood of the 457 contribution limits rising in 2023. Asset management company Mercer LLC claims that the contribution limits for retirement plans will witness a 10% hike the next year, i.e., 2023.

Currently, the cap on the elective deferral limits is $20,500, which the Internal Revenue Service (IRS) might increase to $22,500 in 2023.

The 457 scheme limits the annual contribution to a certain extent. The amount and other additions that exclude the earnings should not exceed 100% of the employee’s includible compensation for 457 (f) or should be equal to the elective deferral limit of $20,500 as of 2022 for 457 (b). In 2020 and 2021, this limit was $19,500.

However, employees aged 50 or above can contribute an additional $6,500, making the total elective deferral limit $27,000.

Both 457 and 401 (k) are retirement schemes that safeguard the interests of the employees and help them lead a financially independent life after retirement. However, there are a few remarkable differences that employees must know of before investing. 

Let us have a quick look at those differences:

This article has been a guide to 457 Plan and its meaning. Here, we discuss how it works, its benefits and features, its types, and limits with examples and also compare it with 401 (k) plan. You can learn more from the following articles -

• Keogh Plan
• Defined Contribution Plan
• 457 vs 403b