Unlike many retirement plans, the 457b plan allows individuals to choose how much of their income they wish to contribute. Contributions to the retirement plan are withdrawn prior to state and federal taxes.
How Does the 457b Retirement Plan Work?
Employees voluntarily contribute an amount of their choosing into the 457b plan each pay period. The amount withdrawn is then invested by the employer. The total amount is allowed to grow over time, while accruing interest, without being taxed. All contributions are taxed when the individual cashes in the plan. Standard retirement age for the 457b plan is age 59 ½.
The greatest benefit to this system is that by the time the contributor reaches retirement age, there is a high likelihood that retirement itself will place him or her into a lower tax bracket. This lower tax bracket will result in the contributor paying less tax on the withdrawal of retirement funds from the 457b.
If an individual with a 457b plan is no longer employed at age 70 ½ yet has not withdrawn retirement funds from his plan, he will become subject to a required minimum distribution by the government.
There is a set limit to the amount an employee may opt to contribute to his 457b plan each year. The amount varies, but employees are allowed to increase their contributions in the three years prior to retirement.
The guidelines and detailed features of the 457b can be accessed through the IRC 457b Deferred Compensation Plan Fact Sheet.
Who is Eligible for a 457b Plan?
Two divisions are available for 457b plans: Public and Private Plans. Public plans are open to state and federal employees, provided the plan is offered by their employer.
Private plans, however, are not all inclusive. These plans are offered by tax-exempt organizations and businesses such as:
- Hospitals
- Charities
- Unions
- Schools
- Religious Organizations
In order to retain the tax-deferred status enjoyed by the public retirement plan, a private plan must limit the amount of employees that are allowed to benefit from the tax-deferred contributions. This usually results in only management and high ranking personnel having the option to contribute to a private 457b.
Early Withdrawal of a 457b is Permissible
Under certain conditions a 457b may be cashed in early. These conditions include:
- Financial hardship
- Termination of employment
- Disability
- Employer-approved loans
- Early Retirement
Unlike most retirement plans, there is no 10% penalty for withdrawing funds from a 457b early. Although the employee does not pay a penalty for an early withdrawal, withdrawal guidelines tend to be stricter than those associated with other retirement plans.
Rather than opting to withdraw a 457 plan early if employment is terminated, an individual may opt to roll the retirement funds over into a Roth IRA, a new 457b plan, a 401k, or 403b. Once this process is complete, however, should the employee decide to then attempt to withdraw funds, the amount rolled over from the 457 plan will then be subject to a 10% penalty for early withdrawal.
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