In a previous post, we discussed the basics of 403(b) and 457(b) retirement plans. 457(b) plans are a great way to make additional tax-deferred contributions beyond the limits of a 403(b). More importantly, withdrawals made prior to age 59.5 are not subject to the 10% early withdrawal penalty. This makes 457(b) plans an excellent option if you are planning for early retirement, but you must consider the potential risks involved.
There are two distinct types of 457(b) plans: governmental and non-governmental. For those who are employed by a state or local government (or political subdivision, instrumentality, agency), you have a governmental 457(b) plan. For those who are employed by a private 501(c) tax-exempt organization (such as private schools, nonprofit hospitals and charities), then your 457(b) plan is likely non-governmental.
Governmental 457(b) Plans
In a governmental 457(b) plan, the funds are held in a trust which is not subject to creditors of the employer. Upon separation from the employer, you can roll the funds over into an IRA or 401(k).
If you have a governmental 457(b) and a 403(b) with employer match, take full advantage of the employer match in your 403(b) first. If early retirement is your goal, you’ll want to turn to the 457(b) next. The savings in your governmental 457(b) are safe from your employer’s creditors and allow for early withdrawals penalty-free. In fact, you may not want to roll the funds from your governmental 457(b) into an IRA or 401(k) until you’re at least 59.5 years old so that you don’t forfeit the penalty-free early withdrawal benefit.
Non-Governmental 457(b) Plans
In a non-governmental 457(b) plan, the funds are not held in a trust. Instead, they’re earmarked for future distribution to you. These assets are subject to the employer’s creditors in the event of bankruptcy or litigation. Upon separation from the employer, you can’t roll the funds over into an IRA or 401(k) plan. You might be able to roll them over into another non-governmental 457(b), or withdrawal may even be required. It’s important to review the Summary Plan Description (SPD) to understand the specifics of each plan including withdrawal options.
If you have a non-governmental 457(b) plan, then you need to weigh the advantages of additional tax deferral and early withdrawals vs the risk of loss. Assess the following:
- Are you currently in a high tax bracket?
- How is your employer’s current financial strength? How do you expect its financials to be up until the point you withdraw from your plan?
- What withdrawal options are available upon your separation? Will you be required to take a lump sum distribution (need to consider tax consequences of this)?
- How close are you to retirement?
- If you’re close to early retirement, what other funding options do you have?
- Have you fully funded other more “secure” pre-tax accounts like a Health Savings Account (HSA) and 403(b)?
Once you’ve explored the benefits and risks of your non-governmental 457(b), you can make a more informed decision about whether or not to participate in it.