The 457 Plan is a type of tax-advantaged retirement plan with deferred compensation. The plan is non-qualified – it doesn’t meet the guidelines of the Employee Retirement Income Security Act (ERISA). 457 plans are offered by state and local government employers, as well as certain non-profit employers.
A 457 plan is provided by government and local state organizations (and some non-profit organizations), allowing employees to contribute portions of their salary into a tax-advantaged, non-qualified retirement vehicle.
There are two types of 457 plans; 457(b) plans are offered to employees that work for the state or the government and are the most common plans; 457(f) plans are offered to highly compensated government – and some non-government – employees.
A 457 plan differs in several key ways from a 401(k) plan, including who is offered the plan, being considered qualified or non-qualified, and penalties for cashing out early.
How 457 Plans Work
The 457 plan is offered to those who work for the government, though some non-governmental (non-profit) employees may also be offered the plan. Employers provide the plan to employees who then contribute portions of their salary into the plan. They can choose to make contributions on either a pre-tax or an after-tax basis. If they choose the latter, the account compounds tax-free, essentially the same as a Roth IRA. If they opt for the pre-tax contributions version, the plan money is not taxed until the employee withdraws the money.
Types of 457 Plans
1. 457(b) Plan
The 457(b) plan is the most commonly used one. The plan is made available to employees who work for the state or local government.
2. 457(f) Plan
The 457(f) plan is less commonly used. It is a plan made available to employees who work for the government, as well as certain employees who don’t work for the government. Non-government employees who are offered the plan generally work for a non-profit organization. The caveat here is that both the government and non-government employees must be highly compensated in order to be offered the plan.
Regardless of which plan an employee is offered, they can contribute up to 100% of their salary. This is true as long as the amount the employee contributes isn’t in excess of the established dollar limit set for the year. There are statutory requirements for such plans. If either of the plans does not fall in line with the requirements, the balance within the plan may be subjected to rules that differ from what’s been mentioned above.
401(k) Plans vs 457 Plans
401(k) plans and 457 plans are both tax-advantaged forms of retirement plans. While the two plans come with similarities, they are also different in a few key ways.
A 401(k) plan is made available by employers of private companies that work for a profit. This is, arguably, the biggest difference, as 457 plans are offered by government and state organizations. (Note: 401(k) plans are offered by some non-profit employers).
2. Qualified vs non-qualified
Another important difference between the two is that 401(k) plans are considered qualified because they adhere to the ERISA guidelines. This also means that they are subjected to all of the rules that come with ERISA.
Finally, 401(k) plans charge a 10% penalty fee for employees that cash out their plan before the age of 55. On the other hand, 457 plans don’t penalize employees for cashing out early. They are, however, still subject to normal income taxation fees.
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