The Advantage of a 457(b) Retirement Plan

My wife (Kayla) started teaching full-time in August 2019. I knew she would have access to retirement accounts that I knew very little about.

One day I was mowing the lawn, listening to the Mad Fientist podcast and he had the Millionaire Educator on the show. This opened up a whole new world to me. The 457(b) plan.

I remember running into the house and yelling at Kayla, “Do you realize what you’ve done?”

The more we read about her investment options the more excited I became.

The 457(b) plan has a lot of advantages for those interested in the FIRE movement. Let’s take a look!

What is a 457(b) Plan?

A 457(b) plan is a is an employer-sponsored, tax-advantaged, retirement savings account. Sometimes the 457(b) is referred to as a deferred compensation plan.

In the same realm as a 401k or an IRA, it’s a vehicle to hold your retirement investments. Don’t get the 457(b) confused with the 457(f). The latter is typically offered to highly paid government officials.

You would know if you have access to a 457(f), but as always, consult with your HR department to see what you have access to.

Much like the Roth IRA or 401(k) you allocate a percentage of your paycheck to go into the 457(b) account and purchase the investments of your choice (typically mutual funds and or bonds).

Benefits of a 457b Plan

The 457b retirement plan is similar to a 401k, IRA or a 403b plan, but has some strong advantages.

  • Pre-tax allocations lower your taxable income

  • Interest and earnings aren’t taxed until funds are withdrawn

  • No early withdraw fee (typically 10%)

  • Ability to contribute the max ($19k to BOTH 457b and 403b or 401k if available)

No 10% Tax Penalty For Early Withdrawals

With other employer-sponsored retirement plans, the employee is typically assessed a penalty for withdrawing money prior to the defined retirement age. A 457b is not governed by the Employee Retirement Income Security Act of 1974 and therefore doesn’t play by those rules.

There is no 10% penalty for withdrawing your retirement funds prior to retirement age in a 457b retirement plan. The only tax the employee would incur is an income tax. This is a massive advantage to someone looking to retire early.

Drawbacks of a 457(b) Plan

It can’t all be sunshine and rainbows. The 457(b) has a drawback depending if your employer offers a contribution match or not.

Employer matched contributions in a 457(b) Plan count toward the maximum contribution limit. For example, if your employer contributes $5,000 to your 457(b) plan, you can only contribute $14,000 to the plan.

My wife’s school district does not offer an employee match.

Depending on your employer, you may or may not have many options to invest in your 457(b) plan. This isn’t a drawback of the plan itself and more of a drawback to your specific employer.

Who Qualifies for a 457b?

It's available to state and local government employees, including police officers, firefighters, and other civil servants as well as with some nonprofit organizations. Kayla being a teacher was offered a 457b and a 403b plan.

Why Use a 457(b) Plan

The primary reason to use a 457(b) retirement plan is to save for retirement. A 457(b) plan can be used in addition to a Roth IRA and would allow you to contribute $25,000 in tax-advantaged accounts ($19k in 403(b) and $6,000 in Roth IRA).

The ability to pull your money out at any age without penalty is a major advantage to the 457(b) plan, especially if your goal is to reach financial independence prior to the traditional retirement age.

457b Plan vs. 403b Plan

The 403(b) plan is similar to a traditional 401(k) plan. Contributions are collected as pre-tax, and you’ll be taxed when you withdraw funds in retirement, but unlike the 457(b) plan, you’ll be penalized if you withdraw funds prior to age 59.5 (10%).

The 457(b) and 403(b) plans differ in that the 457(b) plan has a “catch up” period for employees who are within 3-years of retirement age. These employees who qualify can contribute twice the annual amount ($38,000 in 2019).

If you want to read more about the drawbacks of the 403(b), it can’t be outlined better than the Millionaire Educator in this article, “Why Your 403b Sucks Beyond Belief.”

Can 457(b) Be Rolled Into a Roth IRA?

According to the International Revenue Service, a governmental 457(b) plan may be amended to allow designated Roth contributions as well as in-in plan rollovers to designated Roth accounts.

Yes, a governmental 457(b) plan may be amended to allow designated Roth contributions and in-plan rollovers to designated Roth accounts.

Can I Have a Roth IRA and a 457(b) Plan?

Anyone with earned income can open and contribute to a Roth IRA as long as the contributions are not higher than the earned income for that year. If you’re offered a 457(b) plan and have earned income, you can contribute to both a 457(b) and a Roth IRA. Both plans are tax-advantaged and are great tools to save for retirement.

Consider the 457(b) Plan if Available

If you have access to the 457(b) plan, give it strong consideration over the 403(b) plan. Consult with a financial professional and your HR department to identify the best solution for your financial goals.

I’m excited that my wife has access to this retirement plan as a teacher. It fits our goals perfectly and will be a great tool in our journey to financial independence.

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