A 457 plan and a 401(k) plan are both retirement savings vehicles in the United States, but they are designed for different types of employees and have some key differences. It's no surprise that people have a lot of questions when it comes to 457 vs 401k.
This comprehensive guide will explore the differences between these two plans, their pros and cons, and how to decide which one is best for you.
Main sockets
- 401(k) plans and 457 plans are both tax-advantaged retirement savings plans.
- 401(k) plans are provided by private sector employers, which meet the needs of employees in the private sector.
- On the other hand, 457 plans are administered by state and local governments, as well as selected nonprofit organizations.
- 401(k) plans and 457 plans show striking similarities. However, a significant distinction arises from the fact that 457 plans operate outside the scope of ERISA, resulting in differences in the treatment of certain aspects.
- It is worth noting that catch-up contributions, early withdrawal, and hardship distributions are subject to different rules and procedures within 457 plans.
What is a 457(b) plan?
A 457(b) plan is a retirement savings plan typically offered to employees of state and local governments, as well as certain tax-exempt organizations, such as nonprofit hospitals and charities.
What is a 401(k) plan?
A 401(k) plan is a well-known and widely used retirement savings plan offered by private employers.
Employees can contribute a portion of their pre-tax salaries to their 401(k) accounts, and employers often offer a matching contribution up to a certain percentage of the employee's salary. Like 457(b) plans, 401(k) plans also offer various tax benefits and investment options.
457 vs 401k (Key Differences)
Now that we've introduced both plans, let's dive into the main differences between them:
Eligibility
457(b) plans.: Typically available to employees of state and local governments and some tax-exempt organizations.
401(k) plans.: Available to employees of private sector companies.
Contribution limits
457(b) plans.: The maximum annual contribution for 457 plans is $23,000 for 2024. For employees over age 50, the plans have a catch-up provision that allows up to $7,500 in additional contributions in 2024.
Contributions to each plan qualify the employee for the “Saver's Tax Credit.” It is possible to get loans from both 401(k) and 457 plans.
401(k) plans.: It should be noted that 401(k) plans have a maximum annual contribution limit of $23,000 for 2024). For employees over age 50, the plans have a catch-up provision that allows up to $7,500 in 2024.
Employer match
457(b) plans.: Some government employers may offer a match, but it is less common than with 401(k) plans.
401(k) plans.: Many private sector employers offer a matching contribution, which can significantly boost your retirement savings.
Withdrawal penalties
457(b) plans.: If you leave your job before age 59½, you can access your 457(b) funds without the 10% early withdrawal penalty, but you will still owe income taxes on the withdrawals.
401(k) plans.: The same early withdrawal penalty generally applies if you access your 401(k) funds before age 59½, unless you qualify for an exception.
Access to funds
457(b) plans.: Some 457(b) plans may provide more flexible access to funds before retirement, such as allowing penalty-free withdrawals for unexpected emergencies.
401(k) plans.: 401(k) plans often have stricter rules regarding early withdrawal, which may limit your access to the funds.
Which plan is better?
One of the most common questions when it comes to 457 vs 401k is “Which is better?” Let's find out! Suppose you have to choose one of them.
Determining which plan is best for you depends on your individual circumstances, employment situation and financial goals. Here are some factors to consider when making your decision:
Type of the job
If you work for a state or local government or a tax-exempt organization, a 457(b) plan may be your only option. Conversely, if you work in the private sector, a 401(k) plan is the right choice.
Employer match
If your employer offers a matching contribution, a 401(k) plan may be more attractive because of the “free money” you receive when you contribute.
Contribution limits
Both plans have similar contribution limits, so this factor may not be a big difference.
The second part
If you value the ability to access your retirement savings before age 59½ without penalties, a 457(b) plan may be a better fit for you. However, it's important not to use your retirement savings as an emergency fund, because it can put your long-term financial security at risk.
Investment options
Evaluate the investment options available in each plan. The quality and variety of investment options can vary, so consider your investment preferences and risk tolerance.
Mobility
Think about whether you expect to change jobs or careers in the future. 457(b) plans can usually be rolled over to other qualified retirement accounts, but the process may differ slightly from a 401(k) rollover.
Tax considerations
Both 457(b) and 401(k) plans provide tax benefits, but specific tax treatment may vary based on your individual tax situation. Consult a tax professional to understand how each plan fits into your tax strategy.
Overall financial picture
Your retirement savings strategy should be part of your broader financial plan. Consider your other financial goals, such as paying off debt, establishing an emergency fund and saving for large expenses, when making your decision.
Conclusion
In short, the choice between a 457(b) plan and a 401(k) plan ultimately depends on your employment situation, financial goals, and individual preferences. Both plans provide valuable opportunities to save for retirement and take advantage of tax advantages, but they have distinct features and eligibility criteria.
When making your decision, it's essential to weigh factors such as employer matching, early withdrawal options, investment options, and your long-term financial goals. Additionally, consider seeking guidance from a financial advisor or retirement planning professional to ensure that your chosen retirement savings strategy aligns with your overall financial plan.
Remember, the best retirement plan for one person may not be the same for another, so carefully evaluate your unique circumstances to make an informed decision. Finally, regularly review and adjust your retirement savings strategy as your life circumstances change to ensure you're on track to achieve your retirement goals.
