457 Plan

Detailed Explanation

The 457 plan, similar to 401(k) and 403(b) plans, provides a way for employees to save for retirement by investing a portion of their salary before taxes are deducted. 

These plans are unique to state and local government employees, as well as employees of certain tax-exempt organizations.

Contributions to a 457 plan reduce the participant's taxable income, lowering their current tax burden, and the investment earnings in the account grow tax-deferred until they are withdrawn, typically during retirement.

Unlike 401(k) and 403(b) plans, 457 plans have no 10% early withdrawal penalty for distributions taken before the age of 59½, although withdrawals are subject to regular income taxation. This can provide more flexibility for employees who may need access to their funds before reaching traditional retirement age.

The annual contribution limits for 457 plans are set by the IRS and can change year to year.

Example

Alex, a city employee, opts to contribute $500 a month to his 457 plan. This contribution is made before taxes, reducing his taxable income and therefore, his adjusted gross income for the year. By the time Alex retires, the money he has saved and invested has grown due to compounding interest and earnings, providing a substantial nest egg for his retirement years.

Key Articles Related To 457 Plans

• What's The Difference Between A 403b And 457 Plan?

Related Terms

Compound Interest: The addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest.

Defined Benefit Plan: A retirement plan where employee benefits are calculated using a formula that considers factors such as salary history and duration of employment.

Roth IRA: An individual retirement account allowing a person to set aside after-tax income up to a specified amount each year. Both earnings on the account and withdrawals after retirement are tax-free.

Tax-Deferred Growth: The investment growth that accumulates tax-free until the investor takes a distribution, at which point the growth is taxed at the investor's current income tax rate.

FAQs

Who can participate in a 457 plan?

Employees of state and local governments and some nonprofit organizations are eligible to participate in a 457 plan.

How much can I contribute to a 457 plan?

For 2024, the contribution limit is $20,500, with an additional catch-up contribution allowed for participants nearing retirement.

Can I withdraw my money early from a 457 plan?

Yes, one of the unique features of a 457 plan is that there is no 10% penalty for withdrawals before the age of 59½, although income taxes will still apply.

How does a 457 plan differ from a 401(k) or 403(b) plan?

The primary difference is the lack of early withdrawal penalties and the specific eligibility requirements for employees of state, local government, and certain nonprofit organizations.