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

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Contributing to both a 401(k) and a 457(b) 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). However, it's important to understand how these accounts work before you start contributing to one or both.

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

Contributing to 401(k) and 457(b) Plans

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

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. As government plans, 457(b) plans generally aren't covered by the Employee Retirement Income Security Act of 1974 (ERISA) as 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 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 make catch-up contributions of an additional $6,500 in 2021 if you're age 50 or older, also unchanged from the prior year.

457(b) Plan Limits 

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

You can also make catch-up contributions of up to $6,500 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 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.

401(k) vs. 457(b) Early Withdrawal Penalties

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, and you can be subject to an additional 10% early withdrawal penalty if you take one from a 401(k) plan before age 59.5. In contrast, 457(b) plans aren't subject to the early withdrawal penalty, so you'll pay ordinary income tax on withdrawals but won't get hit with that extra 10% fee.

One exception to the penalty rule says that if you're under age 59.5 and realize that you've exceeded your deferral limit, you can withdraw the excess contributions 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.

Employer Matches

Employers that fund 401(k) plans frequently match contributions made by their employees, putting an equal amount into the employee's plan. They're permitted to do this up to the annual contribution limit, which is the lesser of 100% of the employee's pay or $58,000 for 2021, up from $57,000 in 2020. The 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.

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 59.5 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.