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403b vs 457 Plans?

Employees of nonprofit organizations and state and local governments benefit from tax-advantaged retirement savings in 403(b) and 457(b) plans.

Many workers employed by government entities and nonprofits get either a 403(b) account or a 457(b) account, but in some cases they may have access to both types.

What Is a 403(b) Plan?

403(b) is a tax-advantaged retirement plan for nonprofit employers, like schools and churches. Similar to other tax-advantaged retirement plans, 403(b) accounts let your investments grow over time either tax deferred or tax free using the ROTH provision.

With a traditional 403(b), contributions come out of your paycheck before income taxes, lowering your tax liability in the near term. Funds invested in your account are sheltered from capital gains taxes, and you owe regular income tax on withdrawals—usually when you retire.

With a Roth 403(b), you contribute money after taxes have already been taken out of your paycheck. This means that your withdrawals in retirement are generally tax free, including any gains your investments have made over time.

The 403(b) features the same withdrawal requirements as other employer-sponsored retirement plans: You may take penalty-free withdrawals once you turn 59 ½, except under certain circumstances.  Once you turn 72, required minimum distributions (RMDs) kick in, unless you are still employed by the entity that runs your 403(b) plan. With all withdrawals, you will typically must pay taxes on any funds that haven’t been taxed before.

403(b) Contribution Limits

For 2022, the standard contribution limit for a 403(b) is the lesser of 100% of your compensation or $20,500. However, there are two cases where you might be to exceed that limit:

•  You Are 50 or Older. Employees 50 and older can contribute an additional $6,500 per year for 2022.

•  You Have Been With Your Employer for 15 Years. If you qualify, you may contribute an extra $3,000 per year, up to a lifetime total of $15,000.

Your employer may add money to your 403(b) account, via matching or non-matching contributions. You may own employer contributions immediately or there may be a vesting period. 

In 2022, the maximum total 403(b) contributions for both you and your employer is the lesser of $61,000 or your total compensation. This rises to $67,500 for those 50 and older.

How Does a 457(b) Plan Work?

The 457(b) plan is offered by state and local government agencies as well as certain nonprofits. Contributions are deducted from your paycheck and grow tax free while they’re held in the account. As with 403(b)s, you may be able to contribute to a traditional or Roth 457(b) account.

Employers have the option to contribute to their employees’ 457(b) accounts, but most choose not to. With a 457(b), you’ll probably be entirely responsible for saving for retirement on your own.  The 457(b) differs substantially from other tax-advantaged retirement plans when it comes to withdrawals. It’s very challenging to withdraw funds from a 457(b) account while you still work for the plan sponsor, regardless of your age. Once you’ve left your job, however, you can take out funds free of the 10% early withdrawal penalty common to other retirement plans.

RMDs are required the April after the year you turn 72, unless you are still working for the company that holds your 457(b). With all withdrawals, you will generally have to pay taxes on any money that hasn’t been taxed before.

457(b) Contribution Limits

With a 457(b) account, you can contribute up to the lesser of $20,500 or 100% of your compensation in 2022. This limit is inclusive of any employer contributions. If you are 50 or older, you can contribute an additional $6,500 per year toward your retirement, bringing the total 457(b) contribution limit to $27,000.

457(b) plans also include a special catch-up provision. During the three years leading up to federal retirement age, you can contribute up to double the annual contribution limit each year. For 2021, a worker approaching retirement could contribute a total of $39,000.

A couple of important things to keep in mind: If you use this double-limit contribution, you cannot also use the $6,500 federal catch-up contribution as well. You also are limited to contributing no more than the difference between the maximum you previously could have contributed to your 457(b) and the amount you actually did. If you previously maxed out your 457(b) contributions each year, you could not take advantage of this benefit.

Differences Between the 403(b) and the 457(b)

The 457(b) and 403(b) offer identical tax advantages for your retirement savings. Here are their key differences:

•  Employer Contributions. Employers may contribute to their employees’ 403(b) and 457(b) accounts. That said, employer contributions are much less common than with 401(k) accounts. The 403(b) has a much higher limit than the 457(b), which lacks a separate contribution limit for employers. 457(b)s only allow $20,500 in contributions from any source, whereas 403(b)s allows total contributions of $61,000, including $20,500 from an employee.

•  Catch-up Contributions. Both plans allow special catch-up contributions. You may be able to contribute up to an additional $15,000 over five years to a 403(b) if you’ve worked for the same employer for at least 15 years. Meanwhile, you may be able to effectively double your annual contribution limits for 457(b)s during the three years leading up to federal retirement age, assuming you previously didn’t max out your 457(b) contributions.

•  Withdrawals. Both 403(b) and 457(b) plans feature the same general withdrawal rules: you can only access your money penalty free once you reach 59 ½. If you leave the employer sponsoring your 457(b), though, you become eligible to start taking penalty-free withdrawals at any age.

•  Investment Options. Both plans generally investment options similar to 401(k)s. Typically, fixed, indexed and variable annuities are the options most commonly seen, but mutual funds are seeing an increase in usage. 

Can You Have Both a 403(b) and a 457(b)?

Yes!  Public education groups, and certain non-profits can offer both types of plans.  You may open and fund both accounts, which grants you a special advantage: 457(b) and 403(b) plan contribution limits are totally separate.

By maxing out contributions to both accounts, you could contribute up to $41,000 per year in both plans. If you’re a long-tenured employee or approaching retirement, you’ll be able to benefit from enhanced catch-up contributions in each account, though you can only apply the federal $6,500 catch-up contribution once per year.

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