LAST REVIEWED Dec 13 2019 8 MIN READ
By The Human Interest Team
A 457(b) is a type of retirement plan which is offered by either a local or state government agency or a nonprofit organization. They are not as common as 401(k) plans. You’ll find that there are some similarities but also some important differences between these plans too.
There are also differences between a 457(b) that is offered by a nonprofit organization and one from a government entity. A 457(b) offered by a nonprofit is known as a nongovernmental (or tax-exempt) plan, while the other is a governmental plan.
457(b) Plan Eligibility
Only certain professions have access to a 457(b) plan through their employer. Some positions can include:
County and city employees.
Local, county, and state government employees.
Public school teachers.
Emergency services and firefighters.
Eligibility varies between a governmental and a nongovernmental plan. Not all employees will be eligible to join a nongovernmental 457(b) plan. Only those who are highly-compensated executives, management staff, and other key employees will be eligible.
401(k) plans are listed as qualified retirement plans under the Employee Retirement Income Security Act of 1974, known as ERISA. The act of limiting participation in a 457(b) plan deviates from ERISA rules, but they are not qualified ERISA plans and therefore are not subject to the rules. If nongovernmental 457(b) plans didn’t limit eligibility, they would be required to adhere to ERISA rules.
Similarities Between a 457(b) and a 401(k)
One main similarity between a 457(b) retirement plan and a 401(k) plan is that both allow you to defer a portion of your taxable income toward your retirement. These types of contributions will reduce your taxable income. You are allowed to invest in mutual funds, which will allow the returns to increase tax-free. When the time comes to take a distribution, it will be taxed at ordinary federal income rates.
Before taking a closer look at the differences between these two plans, it’s important to point out that a 457(b) is typically used together with a 401(k) rather than replacing it. The reason for this is that the 457(b) limits of contribution do not count against the ones placed upon standard 401(k) retirement plans or 403(b) plans. You are also allowed to max out contributions to your 401(k) and still contribute to your 457(b). These contributions also qualify you for a “Saver’s Tax Credit,” and you’re allowed to take loans from both types of plans.
Both plans have an annual contribution limit, and if you are aged 50 or older, there is a catch-up provision you may be eligible for.
Important Differences Between 457(b) and 401(k) Plans
In general, a 457(b) plan can be easier to administer than a 401(k). However, the attention to detail is stricter, as you must adhere to all compliance guidelines. Your 457(b) plan has to establish clearly defined eligibility requirements, it cannot exceed contribution limits, it must be operated in accordance with the plan’s document, and there has to be a clear procedure in place for how submitting records to third-party providers is handled.
With a 401(k) retirement plan, your earnings will accrue on a tax-deferred basis. They also offer a variety of investment options, which are all prescreened by your sponsor. As a plan participant, you choose how to invest your money. You are also subject to an annual contribution limit. For 2020, that limit is $19,500. If you are an employee who has reached at least 50 years of age, you are entitled to catch-up provisions that allow you to contribute another $6,500.
If your employer offers matching contributions, it’s quite likely associated with a 401(k) plan, as this is less commonly seen with 457(b) plans. Any matching contributions made by your employer cannot exceed your total annual contribution limit. For example, if your employer contributes $6,000 to your plan, it leaves $13,000 as your contribution amount left. In the event you are aged 50 or older, the amount will increase.
Another difference between these plans is that the 457(b) plan has a “Double Limit Catch-up” feature that is not available with a 401(k). The reason the 457(b) plan has this option is to allow employees who are near retirement to contribute more as a way of making up for the years they were not eligible or could not contribute.
With either type of 457(b), you are allowed to make withdrawals for retirement, even if you have not reached 59 1/2 years old yet. You’ll also find that the 457(b) plan doesn’t place a 10% penalty on you for withdrawals like a 401(k) does. This applies even in situations such as if you are leaving the plan because you got offered another job elsewhere. If you go to make a withdrawal, you’ll still pay federal income tax.
You can rollover your 401(k) or governmental 457(b) when you change jobs; however, it is not allowed with 457(b) nongovernmental plans.
What Is a Hardship Withdrawal?
Hardship withdrawals involve accessing your funds before retirement for a reason covered under the hardship provisions of your plan. With a 401(k) hardship withdrawal, the IRS will allow you to take funds for heavy and immediate financial need. These expenses can include things like medical bills, your college tuition, and even homeownership in some cases. The downside is that the withdrawal is taxed as a distribution and is also subject to a 10% penalty.
For a hardship withdrawal under a 457(b) plan, the criteria are far more strict. It requires that the funds be used for an unforeseen medical emergency. This would mean that your new home purchase or college tuition would not be covered. For those in a financial jam, borrowing against the account balance might be a better option for employees. You can take a loan in a 401(k) as well as a 457(b) governmental plan, but you are prohibited from doing so in a 457(b) nongovernmental plan.
Learn More About 457(b) and 401(k) Plans
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The Human Interest Team
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