457(b) vs. 401(k): Which Should You Choose?

Your choice may depend on your age and your employer

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Both 401(k) and a 457(b) retirement plans are retirement accounts that will help you save enough money to fund your golden years. The main difference is that a 401(k) retirement plan can be offered by any employer, but a 457(b) plan is offered primarily by state and local governments to their employees.

It's important to understand how these accounts work before you start contributing to one or both, however.

What's the Difference Between 457(b) and 401(k) Plans?

 457(b) Plans  401(k) Plans
Primarily offered by state and local governments to their employees  May be offered by any eligible employer
Contribution limit is 100% of employee's includable compensation or $19,500, whichever is less Salary deferral limit is $19,500 for 2021
No early withdrawal penalty Penalty of 10% applies on early withdrawals

Eligibility

Although 457(b) plans are primarily offered to government employees, certain nonprofit employers can offer these plans as well. Some large government employers also 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

On the other hand, 401(k) plans may be offered by nonprofit and for-profit companies, as well as by some government bodies that adopted the plans before May 6, 1986.

As government plans, 457(b) plans generally aren't covered by the Employee Retirement Income Security Act of 1974 (ERISA). However, 401(k) plans are.

Plan Limits

401(k) limits: The salary deferral limit—how much of your pre-tax pay you're permitted to divert to a 401(k) plan—is $19,500 as of 2021, which is unchanged from 2020.

You can also make catch-up contributions of up to $6,500 if the plan permits and if you're age 50 or older.

457(b) limits: The annual limit for all contributions made to 457(b) plans is the lesser of 100% of the employee's includable compensation or the elective deferral limit. The elective deferral limit for 457(b) plans for 2021 is $19,500, unchanged from 2020.

Or you can contribute the lesser of twice the annual limit—$39,000 in 2021, as in the year prior—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 catch-up contributions.

The IRS allows you to contribute to both a 401(k) and 457(b) plan at the same time because a 457(b) plan is considered a nonqualified retirement plan.

Early Withdrawal Penalties

Contributing to both types of plans 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 won't pay taxes on any tax-deferred retirement savings as long as the money remains in the account, but you must pay ordinary income taxes on the withdrawals from a traditional 401(k) account. You also can be subject to a 10% early withdrawal penalty on top of any regular tax if you make a withdrawal from a 401(k) plan before age 59 1/2.

In contrast, 457(b) plans aren't subject to the early withdrawal penalty, so you'll pay ordinary income tax on withdrawals, but you won't be hit with that extra 10% fee.

One exception to the penalty rule says that if you're under age 59 1/2, and you realize that you've exceeded your deferral limit, you can withdraw the excess contributions from your 401(k) up to the tax filing 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.

The tax filing deadline for 2021 was extended to May 17 due to the ongoing coronavirus pandemic.

Special Considerations

Employers that fund 401(k) plans frequently match a portion of the contributions made by their employees. They're permitted to do this up to the annual contribution limit, which is the lesser of 100% of an employee's pay or $58,000 for 2021, up from $57,000 in 2020. This limit includes both the employee and employer contributions combined.

For example, you can contribute $19,500, and your employer can contribute $38,500 as of 2021 for total contributions of $58,000.

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.

Which Is Right For You?

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 59 1/2 without incurring a tax penalty, this might be the focus of your savings when you're younger, in case you have an emergency and you need access to the money before retirement.

By the same token, you might consider making 401(k) contributions instead if you're nearing retirement age, especially if your employer offers 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 seek the advice of a financial advisor or tax professional. Tax laws and rules change frequently, so consult an expert before making a big decision.