457(b) and 403(b) Plans: A Deeper Dive
Both are defined contribution retirement savings plans that allow employees to defer part of their earnings to save for retirement. These plans, like 401(k) plans, allow money to grow tax-deferred over time.
There are two types of 457 plans: 457(b) and 457(f). a 457(b) plan is more common and is offered to municipal employees of local governments. A 457(f) plan, on the other hand is available for executives of non-profit organizations.
Plan participants can contribute up to $19,500 of earnings for 2020 on a pre-tax basis. For participants over the age of 50 the maximum contribution is $26,000 for 2020 – thanks to the “Catch-Up” contribution rule. Even more – A 457(b) plan has a special rule allowing participants to contribute additional funds to their plans for a total of up to $39,000 in contributions if they are within three years of retirement and satisfy other requirements. According to the IRS this limit is, "The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions).” *
These plans are very different than 457(b) plans. 457(f) plans are used to recruit high earners from the private sector into the non-profit world. In a 457(f) plan, compensation is deferred from taxation. However, there is a catch, in the form of a “substantial risk of forfeiture.” To summarize, the participant must meet pre-determined service requirements for their compensation to be guaranteed. Some additional nuances live within these plans such as minimum work hour requirements and sometimes work performance benchmarks. If you have access to a 457(f) plan, there is no limit on the amount of income which can be deferred.
457(b) – The Good
One of the most power benefits of a 457(b) plan is the option for participants within three years of retirement age to double their contributions. For 2020 this $39,000!
Another unique characteristic of the 457(b) plan is regarding distributions. Most defined contribution plans do not allow for penalty-free distributions until the participant is at least 59 ½ years old. In a 457(b) plan however, assets can become accessible once the participant no longer works for the employer sponsoring the 457(b) plans.
Additionally, 457(b) plan assets can be rolled over into 401(k) plan or even an IRA account.
457(b) – The Bad
A major difference between the 457(b) and other defined contribution plans such as 401(k)s regards contributions. Any employer matching contributions in a 457(b) will count as part of the maximum contribution. This differs from a 401(k) plan where the max contribution limit of $19,500 only applies to employee contributions. In other words, the total contribution limit for 401(k) plans (including catch-up) is $63,500.
403(b) plans are a type of defined contribution plan that offers participants the opportunity to defer their compensation for retirement. 403(b) plans are usually made available to employees of nonprofits or public schools. Most 403(b) plans offered by an educational institution will be referred to as a “tax-deferred annuity” plan. This is because when 403(b) plans were first created, they were restricted to invest in only annuities. This is now changing, however.
403(b) Plan Specifics
When it comes to contribution limits, 403(b) plans are very similar to 401(k) plans in fact, they are identical. For 2020 this number is $19,500 with the "catch-up” contribution limit of $6,500.
403(b) plans do offer an additional contribution known as the “lifetime catch-up provision” or “15-year rule.” Essentially, employees with at least 15 years of service are eligible for an extra $3,000 contribution per year.
Like 401(k) plans, 403(b) plans allow for Employers to make matching contributions on behalf of their employees. The total contribution for both employee and employers is $57,000 for 2020. Depending on the sponsoring employer’s discretion other features can be made available such as automatic enrollment, automatic escalation, and Roth contribution types.
In recent years, the regulations governing 403(b) rollovers have been loosened. Employees can now choose to move their assets in a 403(b) plan from an old employer into a 403(b) (or even 401(k)) with a current employer. Even better, 403(b) assets can also be rolled into self-directed IRA accounts. This is great news for individuals because they now have greater control over the organization of their own monies.
Similar to 401(k) plans, 403(b) plans allow for penalty free distributions starting at age 59 ½ regardless of your work status. Any distributions taken before 59 ½ are subject to a 10% penalty unless:
· A severance from employment.
· become disabled.
· die; or
· encounter a financial hardship.
As expected, normal distributions are then taxed as ordinary income. Roth distributions on the other hand are tax-free.
A participant at the age of 72 must begin to take money out of their 403(b) plans if they are not doing so already. This is commonly referred to as Required Minimum Distributions (RMDs). The IRS provides resources for individuals to best calculate what their RMDs are for any given year, and most service providers also provide information so that individuals stay compliant. If an RMD is not taken, then a 50% excise tax is levied against the amount that should have been withdrawn. Special to note for 2020 is that the government has waived all RMD requirements considering the COVID-19 pandemic, so be sure to stay abreast for developments as we turn the calendar to 2021.
Final Word on 403(b) Plans
Plan participants should do their best to accumulate as much information regarding their plan as possible. Of particular importance are all the fees associated with their plan, and just as important, who is receiving these fees and for what services. Your plans administrator is required to provide you all this information – so this is the best place to start.
SPEAK WITH A FIDUCIARY
If you would like to learn more about retirement plans or other personal finance topics, you can email your inquiries at email@example.com.
Eric Hahn, IAR, is a Registered Investment Advisor Representative for NS Capital based in the Stamford, CT office. Eric provides investment advisory and portfolio management services for investors and savers.
Note: None of the above should be considered tax or investment advice. Please contact your tax or investment professional to determine the best course of action for your situation.