457(b) plans are one of the most powerful retirement accounts out there, but I found that many people aren't aware of the unique advantages. If you have access to a 457(b) plan, you need to watch this video.

We're going to get into the nuts and bolts of how these plans work and why they can be better than your typical retirement plan. Let's jump in.

What is a 457(b) Plan?

A 457(b) plan is a tax-advantaged account very similar to a 401k or a 403b. Technically, it's considered deferred compensation rather than a qualified retirement plan, which actually has some important advantages that we'll touch on later.

A 457(b) plan has to be offered by your employer. You can't open one on your own.

There are two types of 457 plans. You have governmental plans and non-governmental plans. In this video, I'm going to focus on governmental 457 plans, but if you have a non-governmental plan, there are some important differences that make them less valuable.

For instance, if your employer goes bankrupt, your assets could be at risk. For non-governmental plans, you need to do some additional research to be aware of those risks.

Who Has Access to Governmental 457(b) Plans?

Governmental 457(b) plans, which is our focus, are those offered to state and local government employees, such as firefighters and police officers, and also employees of public universities.

Tax Treatment of 457(b) Plans

Governmental 457(b) plans are like the public sector's 401k. Traditional 457(b) contributions are deducted from your pay before taxes, so you're investing with pre-tax money.

Your investments within the plan grow tax-deferred, meaning you don't get taxed until you withdraw money from the account. When the time comes to withdraw, you'll pay ordinary income taxes on the withdrawal.

There are Roth 457 accounts as well. And with a Roth 457, your contributions are made with after-tax dollars, but your withdrawals in retirement are tax-free.

There is one big disadvantage that's unique to Roth 457(b) plans, and I'm going to touch on that later, so stay tuned.

Contribution Limits

The contribution limit for a 457(b) plan in 2024 is $23,000. And if you're 50 or older, you can make a catch-up contribution of $7,500, bringing the total limit to $30,500.

There's also a rule with 457(b) plans where you can double the contribution limit in the last three years before retirement. The rules on this are complicated and depend on how much you've contributed in previous years. This is a rarely used feature in my experience, but if you want to take advantage of this aspect of a 457 plan, then I'd recommend talking to a fiduciary financial planner first to help you navigate the rules.

Employer Matching In a 457(b)

Some employers will match contributions to 457(b) plans, but these are treated differently than 401(k) matches.

If your employer makes a matching contribution into the 457 plan, that match counts against your maximum contribution for the year, which again is $23,000 in 2024.

So this is different than a 401(k) where the match doesn't impact the employee deferral contribution limit.

Where I've seen employers match on 457 plans, the employer actually puts their matching contribution in a different retirement account, such as a 401(a) plan. In that case, it would not count against your 457 contribution limit, so it's important to know the details on your specific plan.

Required Minimum Distributions (RMDs)

Like other retirement accounts, 457(b) plans require you to start taking money out of your account at the age of 72 (or later depending on your date of birth). This RMD, as it's called, is figured on your total account balance at the end of the previous year.

If you don't take your RMD, it's heavily penalized by the IRS so it's very important to take these each year once they're required. RMDs are the government's way of ensuring that you eventually pay taxes on your tax-deferred retirement plans.

By planning ahead, you can manage your RMDs in a way that minimizes your tax burden and aligns with your retirement income needs.

Investing in a 457(b) Account

When it comes to investing with a 457 plan, the options are similar to other workplace retirement plans. You'll typically have a menu of investment options to choose from, and you can create an allocation from those funds or use an all-in-one solution like a target date fund.

At this point, 457(b) plans sound basically like 401(k) plans. So why did I hype them up so much?

457(b) Penalty-Free Withdrawals

Let's get into the major advantages of these plans. The first one is that you have the ability to withdraw money from a 457(b) plan penalty-free after you leave your employer, even if you're younger than 59.5, which is the required age for other qualified retirement plans.

This flexibility makes the 457 unique and a great option for those planning to retire early or who just want some extra funds to tap into before 60. Whether you want to travel or start a new business or quit working altogether, having penalty-free access to your 457 savings can be a game changer.

With that in mind, you need to be careful about rolling these funds into another account, whether it's an IRA or 401(k) because you would lose this valuable benefit.

I mentioned earlier that Roth 457(b) plans have a big disadvantage, and this is where that comes into play. Roth 457s don't have quite the same treatment as pre-tax 457s for early retirees.

If you withdraw funds out of a Roth 457 after you leave your employer, but before reaching 59.5, you won't be penalized on the withdrawal, but your earnings will be taxed and that defeats the whole purpose of the Roth.

So if you're planning to use a 457 for early retirement, pre-tax is probably the way to go.

Contributing to a 457(b) With Another Retirement Plan

The second big advantage of 457(b) plans is that you can contribute to it along with another qualified plan like a 401(k) or 403(b), effectively doubling your maximum contribution limits. This means you can put away a ton of tax-deferred money for retirement.

The setup I see most often is an employer will offer a 457(b) plan and a 403b plan. You can contribute up to $23,000 to each plan in 2024 for a total contribution limit of $46,000.

This combination of a 457 plus another retirement plan is an extremely valuable tool for high income earners because you can put more money away for retirement and save more money on taxes today.

How To Prioritize Contributions With Multiple Plans

If you have a 457(b) and another qualified plan, whether that be a 403(b), 401(k), or something else, then you need to think about how to prioritize your contributions among the different options.

When planning for early retirement, the 457(b) is hard to beat. However, you should factor in the investment options and fees of each plan along with employer matching contributions.

If you need help knowing how to best fit a 457(b) into your retirement plan, we can help. At Trek Wealth Planning, we create custom financial plans for our clients to help them get to retirement as soon as possible and minimize taxes along the way. Schedule a free consultation using the link below.