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What is a 457(b) plan used for?

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When it comes to workplace retirement plans, the widely used 401(k) and 403(b) plans tend to grab the spotlight. But there's also a third type of plan that many workers may not be aware of: the 457(b).

These tax-advantaged plans boast a number of similarities to their counterparts and enable individuals to save toward their financial goals, but they also have several features all their own. Among them is a catch-up provision that allows older employees to quickly boost their retirement assets before leaving the workforce and pursuing their other passions.

Here are the key details to know about this option.

What is a 457(b) plan?

Like other workplace plans, the 457(b) plan is named after the section of the IRS code that governs its use. It's a retirement vehicle that's available to two categories of employees:

  • Employees of state and local governments or public schools
  • Managers or highly compensated employees at tax-exempt organizations (excluding religious organizations)

As with 401(k)s and 403(b)s, employees generally contribute pre-tax money, and their account balance grows on a tax-deferred basis. That means individuals don't have to pay taxes on their money until they withdraw it from the plan, which generally happens in retirement. Any disbursements that aren't rolled over into another retirement account are subject to ordinary income tax.

What is a Roth 457(b)?

As with its retirement plan cousins, employers may offer a Roth version of a 457(b) that provides a back-loaded tax benefit. Roth 457(b)s are funded with dollars that have already been taxed so when comes time to withdraw funds, you don't have to pay taxes on it as long as it's a qualified distribution. This option may make sense if you believe you are not yet in your peak earning years and believe you may be in a higher tax bracket in retirement.

Investment options in a 457(b)

If you work for a government or nonprofit entity that offers a 457(b), you may notice that your investment options look similar to other employer-sponsored plans. Typically, the organization will offer a select menu of mutual funds and—for those seeking a more hands-off investment choice—target-date funds. Some also include annuities, which typically carry higher fees but can offer a stream of income that lasts throughout your retirement.

Contribution limits for 457(b) plans

The IRS sets annual contribution limits for 457(b) plans.

  • 2022 contribution limit: $20,500
  • 2023 contribution limit: $22,500

These limits include employer and employee contributions, although relatively few sponsors contribute to a 457(b).
One aspect that makes 457(b) plans different is that the contribution limit is separate from those of any other plan you might have through your employer. Your employer can stipulate which plan or plans you can or cannot participate in, but if you also are able to contribute to a 403(b) plan, you can invest up to $20,500 in that plan—plus an additional $20,500 into the 457(b) in 2022. That can add up to an incredibly powerful way to increase your tax-advantaged retirement contributions.

457(b) catch-up contributions

Like other workplace plans, employees aged 50 and older can make catch-up contributions as a way to boost their retirement savings beyond the typical contribution limits.

  • 2022 catch-up limit: $6,500
  • 2023 catch-up limit: $7,500

However, 457(b) plans provide a separate catch-up provision for participants within three years of their normal retirement age as defined by their plan. Workers nearing retirement can contribute up to two times the usual under-age-50 limit as long as they don't exceed the amount of the unused contributions they were eligible to make in prior years. These special 457(b) catch-up contributions also cannot be more than the employee's compensation in a given year.

These more generous limits offer a great second chance for employees who couldn't afford to maximize retirement contributions when they were younger but are looking for a way to boost their investment balance prior to retirement. Just be aware that it's a one-or-the-other proposition: If you take advantage of the special 457(b) catch-up rules, you can't use the over-age-50 catch-up amount, too. The catch-up rules for a 457(b) are more complicated than other retirement plans, so you may want to consult with a tax professional or financial advisor to know for sure how much you can contribute.

457(b) withdrawal rules and exceptions

One potential downside for individuals with a 457(b) is that it can be difficult to access funds before retirement. For example, you're generally not allowed to make a withdrawal while still working for the plan sponsor. And often you can't take out a loan like you can with many 401(k) plans. But in certain cases, your employer and plan may offer what's called a hardship distribution in the event that an unforeseeable emergency arises related to you or your family's health and well-being, such as:

  • You, your spouse or your dependents are affected by an illness or injury.
  • You incur property loss due to an event outside your control, such as severe weather.
  • You need to pay funeral costs following the death of your spouse or dependent.

You can also take an early distribution if you leave your job or your employer terminates the plan. Like with other retirement plans, 457(b)s are also subject to required minimum distributions, or RMDs.

SECURE Act 2.0 increases the required beginning date age to 75 in an incremental phase-in approach over the next 10 years.

· In the case of an individual who attains age 72 after 2022 and age 73 before 2033, the age for starting RMD is age 73.

· In the case of an individual who attains age 74 after 2032, the applicable age is 75.

The amount of your RMD is based on your account balance and your actuarial life expectancy. The IRS has worksheets you can use to determine this amount.

Unlike 401(k)s and 403(b)s, there's no 10% withdrawal penalty if you qualify for one of the aforementioned exceptions and take money out before age 59½. That can make drawing from your retirement account an enticing proposition if you face financial hardship. Just remember that doing so can erode a source of income that you likely will need for retirement and prevent those funds from potentially growing over time.

Distributions from a 457(b) during retirement

Depending on the individual plan, you may be able to access your funds any time after you end your employment with the plan sponsor. You often can do this through a lump-sum payout, a series of installments or a combination of both. Some plans also allow you to convert your balance into an annuity that provides a guaranteed income stream for the remainder of your life and potentially the life of your spouse.

Options for 457(b) accounts if you leave your job

Should you separate from the employer sponsoring your 457(b) plan, you have a few options. Among them are withdrawing your funds or simply leaving them in the plan.

You also may be able to roll the account into an individual retirement account (IRA) or a new employer's plan, such as a 401(k) or 403(b). However, this option is only available to qualified plan participants—that is, employees of state or local governments. Nongovernmental 457(b) plans are considered nonqualified because they're only available to certain employees. Therefore, the IRS doesn't allow you to roll those funds into another retirement plan unless it's also a 457(b).

The bottom line

Having a well-planned savings strategy is vital to securing your financial future and enabling you to give back in retirement. Connect with a local financial advisor to learn more about the retirement plan options that are best suited to your long-term goals.

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Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.
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