Debating on a Roth or traditional retirement plan is usually as involved as choosing a retirement account gets. But, last year I was thrown for a loop. I found out my employer offered the holy grail of retirement plans. The 457b deferred compensation plan. This plan isn’t anything like an IRA, 401k, or 403b. The 457b is a different beast entirely, made up of everything that makes other retirement accounts great without the added penalties.
What Benefits Come With a 457b Plan?
A 457b plan allows for contributions of up to $18,500 (2018 numbers), the same as a 401k or 403b. However, there are two main distinctions from these more traditional retirement options. For one, you can contribute to the 457b even after maxing out both an IRA and 401k. That’s over $40,000 in tax-sheltered investing.
Now if that wasn’t enough, the 457b plan allows for a traditional or Roth option, but there is no early withdrawal penalty. Accessing retirement savings before 59.5 without penalty is a common dilemma for early retirees. The lack of a penalty makes the 457b plan a perfect fit for early retirement hopefuls.
So to tally up the benefits column:
- Tax-deferred investing
- Roth or traditional options
- No early withdrawal penalty
- High limit, $18,500 for 2018
- Can be used in combination with a 401k or 403b for an even bigger limit
Roth or Traditional 457b
For my employer’s plan, I was given the option of a traditional or Roth 457b. Currently, my qualified retirement accounts are split 50/50 between Roth and traditional options. I have my 403b contributions set up as a Roth and the employer match set up as traditional.
Under other qualified retirement plan circumstances, I would choose the Roth option so that I could pull the money out without penalty and not have the gamble on tax rates changing. However, since there is no penalty for early withdraw, I chose the traditional option. I’ll have to pay taxes when I withdraw, but I won’t have any issue accessing these funds before 59.5.
Thankfully there are Fidelity index funds available through this plan so I can continue the joy of low expense investing.
Choosing a 403b or 457b
Both the 403b and the 457b are quality retirement choices for employees. The 457b offers all the benefits of a 403b and then some added bonuses. Because of this, given the choice, the 457b is the best move. However, some organizations have specific requirements regarding matching or access to the 457b plan.
For example, an employer may only base match contributions on amounts contributed to the 403b. In this case, adding to the 457b eliminates any employer match benefits. Other employers may require a minimum percentage or amount contributed to the 403b before allowing employees to access the 457b plan.
Yes, these rules are weird.
Yes, it shouldn’t matter.
However, there are many things that employers do with retirement plans that don’t make sense. Many still don’t even offer index funds.
Seek the Grail
I had read about the 457b plan and other more rare retirement plans when I studied for the Series 65 exam, but I never appreciated the benefits it provides until I took this new job and started making financial independence and early retirement a priority. Unfortunately, a 457b plan is rare and only available to state and local governments and tax-exempt organizations.
If you have the opportunity to work for one of these organizations, don’t assume your only retirement option is a 403b. Do your research and contact human resources, ideally before applying.
Even with its many benefits, many of my coworkers have no idea that they have this glorious plan available to them, much less know what it is. Even fewer take advantage of this benefit. I guess this comes as no surprise since many along the traditional finance path don’t max out their 403b.
photo credit: youtube Monty Python and the Holy Grail