Did you know that if you have a 403(b) and a 457 plan, you can contribute to both of them to maximize your retirement savings? Your options will depend on how much you can afford to contribute, but this is a fantastic strategy to turbocharge your retirement and use tax advantages. This is especially true for high-net worth families where one partner works in public education or the non-profit sector.
Both the 403(b) and 457 have attractive features for retirement savers. The contribution limits are high, and the tax benefits are great. If you can afford to max out your contributions, doing so in both a 403(b) and 457 could be a smart move. In this article, we'll go through the differences between 403(b) and 457 plans and reveal how you can make the most money out of each.
Depending on your occupation, there may be several different kinds of retirement plans to which you may be entitled. Teachers can have more decisions to make than employees in the private sector! The variety on offer can sometimes seem like an alphabet soup: 401(k)s, 403(b)s, 457s, IRAs, Roth IRAs, Solo 401(k)s. Historically, these plans were made throughout the decades for distinct reasons and aimed to help people get the best benefits in different situations. In the past, employees in the public sector viewed retirement savings as a nice supplement to generous retirement incomes. However, as employers continue to adjust pensions and health care coverage, employees increasingly have to rely on investment plans to finance their retirement.
What are the Benefits of a 403(b) Plan?
A 403(b) plan is a retirement savings plan offered to employees of public schools, churches, and other tax-exempt organizations. When it was first introduced, annuities were the only option, so it is sometimes known as a tax-sheltered annuity (TSA). Since then, options have expanded to include mutual funds and other investments.
In 2022, the annual contribution limit for 403(b) plans is $20,500. Contributions are made from your paycheck, avoiding being included in your taxable income. However, withdrawals in retirement are taxed as though it was regular income. Employees who will be 50 years old or older by the end of the year may invest an extra $6,500 in catch-up contributions, making a maximum annual contribution amount of $27,000.
Employers may match employee contributions, making these types of plans especially valuable. The combined total of annual additions cannot exceed $61,000 or 100% of eligible compensation for the employee's most recent year of service (whichever is the lesser). Importantly, this does not include the $6,500 catch-up contribution, so in 2022 the maximum potential annual total for someone over 50 could hypothetically reach as high as $67,500!
Catch-up contributions for employees with 15-years of service
If you've worked for the same employer for at least 15 years, you can boost your limit by $3,000 a year – up to a lifetime total of $15,000. Importantly, this does not replace the federal catch-up contribution, so you could push that elective limit up even higher if you have the excess funds to invest.
How About a 457 Retirement Plan?
A 457 plan is a retirement savings plan offered to state and local government employees and some highly paid employees of tax-exempt organizations. A 457 generally has more investment options than a 403(b) in which to invest contributions – including annuities and mutual funds – but both are typically more limited than 401(k)s.
Similar to the 403(b), the contribution limit for 457 plans is $20,500 for 2022. The intricacies of the 457 catch-up contributions are interesting. Again, like the 403(b), participants over 50 may invest an extra $6,500. However, if you choose not to use the standard over 50 catch-up contribution – and are within three years of normal retirement age (NRA) – you may make a Special 457(b) catch-up contribution. This is equal to the annual limit, or the previous year's unused annual limit (whichever is less).
This is an attractive option for late investors, effectively doubling how much they can contribute immediately before retirement! Because it is intended as a catch-up, it has no use if you have already maxed out contributions to your 457(b) plan each year. But if you have missed making deferrals in a prior year, you can carry it forward and get your savings back on the right track.
Withdrawing from 403(b) and 457 plans
One major difference is how the plans evaluate and penalize withdrawals. With a 403(b), there is no penalty if you retire (or are laid off, or fired) after 55. However, if you are still employed, you will need a hardship distribution and have pay a 10% withdrawal penalty (in addition to any ordinary tax owing on pre-tax funds). Because of this, it's advisable to only seek early withdrawal in extreme and immediate financial stress. With a 457 plan, you may withdraw upon termination of employment at any age without suffering the early 10% penalty (although you still have to pay any ordinary tax). You can keep the funds where they are, or move them to a new employer's retirement plans (it doesn't have to be a 457), or roll them into an Individual Retirement Account (IRA). Note: If you change jobs, be sure to inform your new employer how much you've already put into retirement savings for the year. Otherwise, if you've contributed too much, and your employer does not withdraw the excess before your tax-filing deadline, you could end up being taxed for it twice!
403(b) and 457 in Combination
If your employer offers both a 403(b) and 457, then good news: you don't have to choose one or the other. It can make sense to invest in both. This gives you a special advantage: the contribution limits for 457(b) and 403(b) plans are completely separate, as are their catch-up contributions. So you can double up and contribute the maximum amount to both accounts. In addition, your employer may be able to assist you to get the most out of this powerful combo. While not everyone will be able to afford to hit both limits, many high-net-worth couples manage to do this when one of them is a teacher or public employee. Some high paid executives in nonprofits are also offered both a 403(b) and 457 as a way of recruiting top-tier talent.
Strategize with Complementary Retirement Plans
As you can see, there are many benefits to contributing to a 403(b) and a 457 retirement account while you're working. These complementary plans can get you closer to your financial goals. You may want to consult with a financial planning professional before choosing where to invest or deciding how to split up your contributions. Talk to your HR department to find if your company offers a 457 plan, and consult a financial planner to determine if this is the best strategy for you. Make sure to speak to a certified fiduciary, which means they work in your best interests and provide the best advice!