457 plans

Definition

A 457 plan is a type of employer-sponsored retirement savings plan available to state and local government employees, as well as certain non-profit organizations. These plans allow employees to save a portion of their salary on a tax-deferred basis, meaning taxes on contributions and earnings are postponed until withdrawal. This makes 457 plans a valuable tool for retirement savings, especially for those who may not have access to other retirement plans.

5 Must Know Facts For Your Next Test

1. 457 plans allow participants to defer income taxes on both contributions and investment earnings until funds are withdrawn, typically at retirement.
2. There are two types of 457 plans: 457(b) plans for governmental employees and 457(f) plans for highly compensated individuals at non-profit organizations.
3. Unlike other retirement plans, 457 plans have no early withdrawal penalties if the participant separates from service, making them more flexible in accessing funds.
4. Contributions to 457 plans are subject to annual contribution limits set by the IRS, which can change periodically and are separate from limits on other retirement accounts like 401(k)s.
5. Some employers may offer matching contributions to their employees' 457 plans, providing an additional incentive to save for retirement.

Review Questions

• How do 457 plans differ from other types of employer-sponsored retirement plans, such as 401(k) plans?
  • 457 plans differ from 401(k) plans primarily in terms of their eligibility and withdrawal rules. While both allow for tax-deferred contributions, 457 plans are specifically designed for government employees and certain non-profit workers. A key difference is that 457 plans allow penalty-free withdrawals upon separation from service, regardless of age, whereas 401(k) plans impose penalties for early withdrawals unless specific conditions are met. This makes 457 plans more flexible in terms of accessing funds before retirement.
• Discuss the tax advantages associated with contributing to a 457 plan compared to a traditional IRA.
  • Contributing to a 457 plan offers similar tax advantages as a traditional IRA in that both allow for tax-deferred growth on contributions and earnings until funds are withdrawn. However, 457 plans have higher annual contribution limits compared to IRAs, allowing individuals to save more aggressively for retirement. Additionally, there are no penalties for withdrawing funds from a 457 plan if the participant separates from service, which is not the case with traditional IRAs that impose penalties for early withdrawals. This makes 457 plans particularly appealing for those seeking greater flexibility and higher savings potential.
• Evaluate the importance of understanding the rules and limitations of 457 plans when planning for retirement savings.
  • Understanding the rules and limitations of 457 plans is crucial for effective retirement planning because it helps individuals maximize their savings and navigate potential pitfalls. Knowing the contribution limits allows employees to take full advantage of tax-deferred growth opportunities. Additionally, being aware of withdrawal rules can aid in financial planning during career transitions or unexpected life events. Lastly, understanding how these plans fit into an overall retirement strategy alongside other accounts like IRAs or employer-matching contributions can enhance long-term financial security and ensure that individuals achieve their retirement goals.

Related terms

Deferred Compensation: An arrangement in which a portion of an employee's income is paid out at a later date, typically during retirement, allowing for tax deferral until funds are withdrawn.

IRA:

An Individual Retirement Account is a personal savings plan that offers tax advantages for individuals saving for retirement, which can complement employer-sponsored plans.

Matching Contributions: Additional contributions made by an employer to an employee's retirement plan, often based on the employee's own contributions, helping to increase overall retirement savings.