403(b) & 457(b) Plans

Do you have access to both 403(b) and 457(b) retirement savings plans through your employment at a non-profit or state and local government entity? If so, we at Downshift Financial are a little jealous (you’ll see why!) and we are here to help walk you through the decision-making process to optimize your contributions to each plan.

What is a 403(b)?

Your 403(b) is a tax deferred, defined contribution plan where you can contribute earnings pre-tax, let the earnings grow tax-free, and pay taxes upon withdrawal. There is a 10% penalty assessed on withdrawals made prior to 59.5 (this age is important to note if you are planning for early retirement). In 2022, employees can contribute up to $20,500 of their salaries plus a max $6,500 catch-up contribution for those age 50 and above on an annual basis.

What is a 457(b)?

A 457(b) is a tax-deferred compensation plan which is similar to a 403(b). Contributions from earnings are made pre-tax, earnings grow tax-free, and taxes are paid upon withdrawal. In 2022, employees can contribute up to $20,500 of their salaries and there is often a catch-up provision with special rules. More importantly, unlike the 403(b), withdrawals are not subject to the 10% early withdrawal penalty.

Why are we jealous?

If you have access to both a 403(b) and 457(b), you can make up to $41,000 total pre-tax contributions in 2022 (more for those older than 50). That is twice the amount that can be contributed pre-tax versus those who don’t have a 457 plan. Plus, withdrawn funds from the 457 plan are not subject to an early withdrawal penalty.

457(b): No early withdrawal penalty?! What’s the catch?

457(b) plans come in two flavors: governmental and non-governmental.

If you have a governmental 457(b), then there really isn’t a catch. Your assets are held in a trust that is protected from your employer’s creditors and you are able to roll the assets into an IRA.

However, if you have a non-governmental 457(b), then there are risks to consider. It is possible with non-governmental 457(b) plans that the assets are the property of your employer and are subject to your employer’s general creditors until the assets are paid out to you. If your non-government employer is struggling financially, there is a chance that you may lose a portion of money that is in your 457(b) account. There may also be employer-specific requirements with your 457(b) regarding timing and amounts of withdrawals, especially related to separation of employment. In addition, non-governmental 457(b) assets can only be rolled into another non-governmental 457(b) plan; they cannot be rolled into an IRA.

Actionable steps...

If your employer matches contributions to your 403(b), you should contribute enough to maximize your match as this is “free money.” From there, it depends on whether your 457(b) plan is governmental or non-governmental.

If governmental, then consider contributing amounts above the match to a 457(b) since it allows for penalty-free early withdrawals—a nice benefit if you are planning to access this money during early retirement. After the 457(b) contributions have been maxed, increase your contribution to your 403(b) up to the maximum amount.

If non-governmental, you’ll need to understand your employer’s financial outlook and the withdrawal requirements outlined in the plan documents. And if you’re comfortable with your employer’s financial strength and 457(b) plan-specific requirements, you can follow the steps listed above for a governmental 457(b) plan.

Final words

As always, we are presenting general guidelines and you should discuss your personal situation with your trusted financial professional before implementing any major changes.