457 plan

Definition

A 457 plan is a type of deferred compensation retirement plan offered to state and local government employees, as well as certain non-profit organizations. This plan allows participants to set aside a portion of their salary for retirement on a pre-tax basis, which can help lower their taxable income in the year contributions are made. Additionally, 457 plans often come with flexible withdrawal options and do not have an early withdrawal penalty, making them a unique choice among defined contribution plans.

5 Must Know Facts For Your Next Test

1. 457 plans are unique because they allow participants to withdraw funds without penalties after leaving the job, unlike many other retirement plans.
2. There are two main types of 457 plans: 457(b) for governmental employers and 457(f) for non-governmental employers, each with different rules and features.
3. Contributions to a 457 plan can be made on a pre-tax or after-tax (Roth) basis, giving participants flexibility in how they want to manage their tax liabilities.
4. The contribution limits for 457 plans are similar to those of 401(k) plans, but participants may be eligible for additional catch-up contributions as they approach retirement age.
5. Unlike some other retirement plans, 457 plans do not have a required minimum distribution until the participant reaches age 72, allowing for greater flexibility in retirement planning.

Review Questions

• How does the tax treatment of contributions to a 457 plan compare with that of a 401(k) plan?
  • Both 457 plans and 401(k) plans allow for pre-tax contributions, which reduce taxable income in the year contributions are made. However, while both offer tax-deferred growth on investments until withdrawal, the major difference lies in withdrawal flexibility. A 457 plan allows penalty-free withdrawals once you separate from your employer, whereas a 401(k) may impose penalties if withdrawals are taken before age 59½ unless certain conditions are met.
• Analyze the advantages of using a 457 plan over other types of defined contribution plans for employees of state and local governments.
  • A significant advantage of a 457 plan is its flexibility in withdrawals; employees can access their funds without penalties after leaving their job, which is particularly beneficial for public sector workers who may change jobs frequently. Additionally, the contribution limits are generous and allow for catch-up contributions as employees near retirement age. This combination of features makes the 457 plan an attractive option for government employees looking to maximize their retirement savings.
• Evaluate the impact of having no early withdrawal penalties on the financial planning strategies of individuals participating in a 457 plan.
  • The absence of early withdrawal penalties in a 457 plan significantly alters financial planning strategies for participants. This feature provides individuals with greater liquidity and flexibility, enabling them to access funds in case of emergencies or unexpected expenses without incurring extra costs. It allows participants to align their savings strategies more closely with personal financial goals rather than rigidly adhering to traditional retirement age rules. This flexibility can be particularly advantageous for those transitioning between jobs or considering early retirement.

Related terms

Defined Contribution Plan: A retirement plan where contributions are made by the employer, employee, or both, and the final benefit received at retirement depends on the investment performance of those contributions.

401(k) Plan: A popular employer-sponsored retirement savings plan that allows employees to save a portion of their paycheck before taxes are taken out, with tax-deferred growth until withdrawal.

IRA: An Individual Retirement Account that allows individuals to save for retirement with tax-free growth or on a tax-deferred basis, depending on the type of IRA.