Retirement Planning – 403B/457 Plan
There are so many ways to plan for time freedom. If you are an educator or involved in non-profit work or local and state government work, there are a few attractive options beyond putting money in a standard IRA.
A 403(b) plan is similar to a 401(k) but accessible especially to educators and workers in the non-profit sector. A 457(b) Plan is available to state and local government employees, and some non-profits. 457(f) plans are a subset available to executive leaders in non-profit organizations.
Here are some of the features, benefits, contribution limits, and other rules regarding these two defined contribution plans.
What’s in a 403(b)?
If you or your spouse have a 401(k) plan, you will be familiar with the contribution limits, which are identical to the 403(b). The elective deferral for 2021 is $19,500. 403(b)s have some interesting catch-up provisions. One of these is the 15-year rule. If you have at least 15 years of tenure in your place of employment, are allowed an extra $3,000 payment per year. And similar to other retirement plans, there is a standard catch-up provision that allows for added contributions of $6,500 for those over age 50.
You’ll want to find out what kind of matching contributions your employers are making. Note that total contributions yearly from employer and employee cannot exceed $58,000 for 2021.
Employers can also offer Roth contribution options. If you leave the employer where you have a 403(b) plan, you can rollover those plans into a 401(k) or self-directed IRA.
Very similar to 401(k) plans, here is how distributions work:
- You can start taking distributions at age 59½, no matter if you’re still working at that organization or not.
- Distributions taken before age 59½ are subject to a 10% early-withdrawal penalty unless a special exception applies.
- All normal distributions are taxed as ordinary income.
- Roth distributions are tax-free. If you choose this option you’ll either need to contribute to the plan or have a Roth IRA open for at least five years before being able to take tax-free distributions.
- Required minimum distributions (RMDs) must begin at age 72. You can avoid RMDs if you roll the plan into a Roth retirement plan. You’ll want to do one or the other. If you don’t take the required RMD you’ll be subject to a 50% excise tax on the amount that should have been withdrawn.
With a 403(b) you don’t have many. You can invest in an insurance annuity contract or mutual fund through a custodial account.
What’s in a 457 Plan?
I’m going to focus here on the 457(b) plan, offered to state and local government employees since the 457(f) is such a niche product for executives in non-profit work.
Employee contributions are the same as the 403(b) at $19,500 for 2021, with the extra $6,500 catch-up provision for workers age 50 and over. If you are within three years of normal retirement age, you can contribute as much as $39,000 to catch up in a bigger way.
Interestingly, if you leave your employer who provided the 457 plan, there is no 10% early withdrawal penalty to access those funds, though it will then count as part of your taxable income.
Here’s the sadly unsurprising part: few governments provide matching programs within the 457(b) plan. It will likely be up to you to contribute and make sure the 457 and other aspects of your financial plan cover your bases when you are ready for time freedom.
Which to Choose?
You may have the option of choosing one or the other. If you are nearing or over 50 and feel like you really are in “catch-up” mode, a 457 plan has a more aggressive catch-up policy, so that might be a better choice for you.
You may be eligible for both types of plans. If that is the case, you might choose to split contributions between them.