A 457(b) plan is a retirement savings account set up by some employers and available to you to save for your retirement on a pre-tax basis. The main perks are:

• You contribute pre-tax dollars, so you lower your current taxes.
• Your savings grow tax-deferred, meaning no taxes on gains until you withdraw the money.
• There’s no limit on how much you can stash away each year.

Who Gets Access to 457(b) Plans?

457(b) plans are typically offered by:

• Government organizations – Federal, state, or local
• Nonprofit employers
• Some private companies – Mostly schools, hospitals, research groups

If you work for a government or nonprofit, talk to your HR office right away to see if you are covered under one of the plans. If you are self-employed, you cannot open your own 457(b), but you can generally contribute to one through an employer under whom you have a contract.

How Do Contributions to a 457(b) Plan Work?

Contributions to a 457(b) plan are astoundingly easy to make – a portion of your paychecks before tax is channeled into a 457(b) account by your employer. This also reduces your tax liability today because you don’t pay taxes on the money invested in the plan.

Suppose that you start off with a pre-tax salary of $50,000 a year and send 10% (or $5,000) of that into a 457(b). When you take out $5,000, you are in effect paying yourself first, and then you pay federal income taxes. Now you pay tax only on the $45,000 you’re actually bringing home, not on the $50,000 before the tax benefit. Hello, tax savings!

There is NO LIMIT on how much you can put into a 457(b)! Max for 2023 if under 50 is $22,500 and if over 50 it’s $30,000. Your employer could add more if they want to a 457(b)!

So if you can swing it, you can turbo-charge your retirement savings!

Can My Employer Contribute Too?

Even better, some employers will match dollars going into your 457(b) too, so that’s an added bonus to the retirement icing.

Employers may make:

• Matching contributions – They match a percentage of what you contribute.
• Profit sharing contributions – You get a cut of the company’s profits.
• Discretionary contributions – They just give you money because they like you!

The kicker is, any money your employer contributes is yours instantly and completely. It vests immediately, none of that death by instalment. All yours. Really!

Is There a Vesting Schedule?

Yes, the earnings made on those contributions can be vested. For example, vested at 20% per year means you’re 20% vested at the end of year 1, 40% at the end of year 2, etc., until you’re fully vested in five years.

Should you leave before full vesting, you forfeit the non-vested earnings. Meanwhile, the dollars you contributed remain yours. Vesting incentivizes employees to stay on and earn full ownership of those bountiful gains, but after about 5 years, you should be golden.

Can I Take My 457(b) Plan with Me If I Leave My Employer?

This is one of the best parts of a 457(b) plan – its portability! If you leave your job, you have choices:

• Roll it over into a new employer’s 457(b) plan.
• Roll it over into an IRA.
• Leave it in your old employer’s plan if they allow it.
• Cash out (but taxes and penalties suck, so I don’t recommend it!).

Now you worked for that retirement money, so you would like to keep it growing. Make sure you do not cash it out or you will lose a chunk of it to taxes and penalties.

How Does Investing Work with a 457(b) Plan?

Most 457(b) plans provide you with an allocation menu of investments (a list) similar to a 401(k) that includes:

• Stock funds – To invest in stocks from various companies.
• Bond funds – For government and corporate bonds.
• Target date funds – Mix of stocks/bonds based on expected retirement date.
• Stable value funds – Like money market funds.
• Annuities – These provide guaranteed income for life.

It’s up to you to decide where to put your dollars, among any combination of those options. It lets you build your own portfolio to your needs and risk tolerance.

Many plans also have easy-to-use online access for selecting investments. Goals for the win! If you don’t choose anything, your money goes into a target date fund, a default fund.

When Can I Access the Money in My 457(b)?

The bright side is that you never get charged an early-withdrawal penalty on a 457(b) plan no matter your age – but there are still rules on when you can take the money out:

• Age 59 1⁄2 – You can withdraw at this age penalty-free.
• Leaving your job – Penalty-free withdrawals once you separate from service.
• Unforeseeable emergency – If you have major unexpected expenses.
• Small balance – Accounts under $5k can usually be cashed out if you leave.

Be sure to check with your plan administrator regarding taxes as well as any restrictions on withdrawing funds first. The last thing you want to deal with are account penalties – they eat into your savings!

How are Withdrawals and Distributions Taxed?

With 457(b) plans, you enjoy tax-deferred growth but all withdrawals in retirement are considered ordinary income, including:

• Your contributions – These were pre-tax, so they get taxed later.
• Employer contributions – Also taxed upon withdrawal.
• Investment earnings – You pay income taxes on interest, dividends, and capital gains.

The good news is you probably have a lower tax rate in retirement, and you can spread out withdrawals.

Good news: you can roll over the traditional IRA into a Roth IRA, at which point the money can be withdrawn tax-free in the future. (You can even take the tax hit now on the conversion in order to clear any legal ownership obligation.) Call a tax lawyer for details.