Using 401(k) vs. 457(b) Plans to Save for Retirement

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Contributing to both a 401(k) and a 457 retirement plan allows you to double your tax-deferred savings and reduce your taxable income, and the IRS says that's perfectly OK. Having both types of accounts can be helpful if you need to withdraw money because there are no early withdrawal penalties on a 457(b). You'll pay ordinary income tax on withdrawals, but you won't be hit with that extra 10% fee.

A 401(k) retirement plan can be offered by any employer, while a 457(b) plan is offered by state and local governments to their employees.

Contributing to Two Plans

Although 457(b) plans are primarily offered to government employees, certain nonprofit employers can offer these plans as well. And large government employers often offer their employees both 401(k) and 457(b) plans, enabling them to contribute to both and giving them an opportunity to supercharge their retirement savings.

Government employees typically include:

  • Government officials at the state or local levels
  • Public school teachers
  • County and city employees
  • Law enforcement personnel and first responders

Because a 457(b) plan is considered a nonqualified retirement plan, the IRS allows you to contribute to both a 401(k) and 457(b) plan at the same time. 457(b) plans aren't covered by the Employee Retirement Income Security Act of 1974 (ERISA), while 401(k) plans are.

Each type of plan has separate limitations on the amount of money you and your employer can contribute.

401(k) Plan Limits

The salary deferral limit—how much of your pretax pay you're permitted to divert to a 401(k) plan—is $19,500 as of 2020, up from $19,000 in 2019.

You can make catch-up contributions of an additional $6,500 in 2020 if you're age 50 or older, up from $6,000 in 2019.

457(b) Plan Limits 

The annual limit for all contributions made to 457(b) plans is 100% of the employee's includable contribution or the elective deferral limit, whichever is less. The elective deferral limit 457(b) plans for 2020 is $19,500. It was $19,000 in 2019.

You can make catch-up contributions if the plan permits and you're age 50 or older, or you can contribute the lesser of twice the annual limit—$39,000 in 2020—or the basic annual limit plus the amount of the basic limit not used in previous years. This rule applies for the three years leading up to the retirement age specified in the plan, and it's only allowed if you're not making 50 or over catch-up contributions.

You can double up on your contributions beginning in 2020 if your plans' retirement age is 60 and you'll reach age 60 in 2022: in 2020, 2021, and 2022.

The Early Withdrawal Penalty

You won't pay taxes on any tax-deferred retirement savings as long as the money remains in the account, but you must pay taxes on the withdrawals, and you can be subject to a 10% early-withdrawal penalty if you take one from a 401(k) savings plan before age 59½.

An exception to the penalty rule exists if you're under age 59½ and your realize that you've exceeded your deferral limit. You can withdraw the excess contributions up to the tax filing due date deadline, usually April 15. The amount is still includable in your gross income for that year, but you'll be spared the penalty in this case.

Employer Matches

Employers that fund 401(k) plans frequently match contributions made by their employees, paying an equal amount into the employee's plan. They're permitted to do this up to the annual contribution limit, but the limit applies to both employee and employer contributions combined.

For example, you can contribute $9,750 and your employer can contribute $9,750 as of 2020 for total contributions of $19,500.

One caveat with a 457(b) plan is that it's uncommon for the government to offer an employer match. The government treats 457(b) plans as supplemental savings plans because many state and local government employees are also eligible for pensions.

Balancing Your Contributions

The strategy of contributing to both types of plans—and how much you contribute to each—can depend on your age.

Because you can tap into a 457(b) plan before age 59½ without incurring a tax penalty, this might be the focus of your savings when you're younger in case you need access to the money before retirement due to some unforeseen emergency.

By the same token, you might consider leaning toward making 401(k) contributions instead if you're nearing retirement age and your employer does offer matching contributions. You can take full advantage of your employment years and that free money from your employer as the clock ticks down to retirement time.

It can be a complex equation depending on your personal circumstances, so you might do well to seek the advice of a financial advisor.

Always consult with a tax professional for the most up-to-date information and trends. Tax laws and rules can change periodically. This article is not tax advice and is not intended as tax advice.

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