is a deferred compensation retirement plan that is tax-advantaged and non-qualified.
457 Plan Details
When an employee applies for a deferred compensation retirement plan, it suggests that their employer set aside a percentage of the employee’s monthly income as compensation to be paid at retirement. Tax-advantaged means that the retirement plan is subject to a tax benefit—in this case, 457 Plan participants can defer retirement money tax payment until withdrawal.
Lastly, as a non-qualified plan, the 457 Plan falls outside of the Employee Retirement Income Security Act (ERISA) guidelines. This effectively makes 457 Plans exempt from ERISA’s heavy testing and rules to accommodate unique retirement needs, unlike more generally used qualified plans like 401(k). These characteristics make the 457 Plan an attractive choice for workers, yet it’s not for everyone. State and local government workers, as well as some non-profit employees, are eligible for 457 Plans.
Two types of 457 Plans include:
- 457(b) Plans: This is the most common plan used by employees working for the government, either at a local or state level.
- 457(f) Plans: This plan is less common and only used by the highly compensated government or non-government employees who usually work for non-profit institutions.
Both plans have a contribution limit, meaning employees can only contribute a certain amount of money per year. In the case of 457(b) Plans, workers can contribute no more than $19,500 annually. In some cases, however, employees are allowed to contribute more if they reach a certain age. For instance, those aged 50 or above have a more significant contribution limit of $26,000. Participants who have only a few more years before retiring and haven’t contributed to the plan before—even though they were eligible—they can double the contribution limit to $39,000.
Example of 457 Plan
Tommy is a 53-years-old local government employee, and he plans to retire at the age of 60. As a 457(b) Plan participant, usually, Tommy would have a yearly contribution limit of merely $19,500. But, since his age is over 50, he can raise the bar by $6,500 to $26,000. That said, Tommy has already taken advantage of this provision as soon as he reached 50 three years ago. Thus, he can’t double the limit but will still receive a considerable amount of cash when he retires.
Significance of the 457 Plan
As a retirement plan, the 457 Plan has a lot of advantages. One of which is that there’s no penalty when a participant wishes to withdraw funds if they resign or retire before the assigned date. This is a huge plus point compared to other plans like 401(k) that charges participants with a 10% penalty if they quit their company before the promised date.
Another advantage is the tax benefit. If an employee sets aside some of their salaries into the retirement fund, this part of income is not taxable until withdrawal. While a participant of the 457 Plan, taxable income decreases. For example, if Tommy puts $1,500 of his income every month into his plan, his taxable income is also reduced by that amount, possibly lowering his tax rates as well. That said, participants may also have the option to tax their periodic contributions in return for tax-free money withdrawal.
The only noticeable disadvantage to 457 Plans—specifically 457(b) Plans—is the contribution limitations. As mentioned before, employees can only contribute up to a specific amount per year to their plan. Employees can still roll over their unused contributions quota for last year into this year. For instance, assuming the limit is $19,500, if an employee’s contribution last year is $10,000, then the employee can add an additional $9,500 for this year ($19,500 + $9,500 = $29,000). Employers can also choose to contribute to their employees’ plan, but doing this won’t affect the yearly employee contribution limit.