For many of us, saving for retirement is much like a Sudoku puzzle. Lots of numbers to digest and plenty of options. With 401(k), 457(b), and 403(b) plans out there, what’s a person to do?
While this numbers game can be intimidating, don’t let it overwhelm you. Just know that the potential benefits of contributing to these retirement plans could definitely outweigh the drawbacks.
Most of those who work for private employers have access to employer-sponsored 401(k) plans, while those who work in other industries are able to contribute to other accounts, including 457(b) and 403(b) plans. What’s the difference between a 457(b) and 403(b) plan? Who can contribute to them? Here’s what you need to know.
How 403(b) and 457(b) Plans Are Similar
While all the numbers and letters may confuse you, 457(b)s and 403(b)s are simply different types of employer-sponsored retirement plans named after the sections in the Internal Revenue Code that allow for their establishment.
Employee contributions are made through payroll deductions as a percentage of pre-tax salary. This decreases your take-home pay but also lowers your current taxable income and helps fund your retirement. The investment earnings and contributions won’t be taxed until you withdraw the money, at which point it’s taxed at your ordinary income bracket. The individual contribution limit for each is $19,500 for 2021 with an additional $6,500 available to those over age 50. (1)
All plans are permitted to offer loans to participants, though the requirements are decided by each specific plan. They also all require participants to begin taking distributions at age 72. If your plan is eligible, you can roll over the funds into another type of qualified plan or IRA.
How 403(b) and 457(b) Plans Are Different
Now let’s look at what sets these two plans apart from each other. Perhaps the biggest difference is that for 457(b) plans, there’s no early withdrawal penalty if you’re under age 59½ and have separated from your employer. (2) With a 403(b) plan, you’re taxed at ordinary income rates plus a 10% penalty for any withdrawals under age 59½, with some exceptions. (3)
Another important difference to keep in mind concerns special catch-up contributions. The IRS allows 457(b) plan owners to take advantage of extra catch-up contributions, if permitted by the plan, allowing a participant to contribute the lesser of the following amounts for 3 years prior to the normal retirement age (as specified in the plan):
- Twice the annual limit: $39,000 in 2021, or
- The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions) (4)
For example, if an employee contributed $6,000 in 2020 to their 457(b), they could contribute an additional $13,500 in 2021. If they contributed nothing in 2020, they could contribute an additional $19,500.
That’s for 457(b) plans, but 403(b)s also provide an extra catch-up contribution. (5) Some 403(b) plans provide employees who’ve secured a tenure of 15 years to contribute an extra $3,000 per year if they’ve contributed an average of $5,000 or less for those 15 years prior.
Maximize Your Benefits
Here’s the kicker that many may not know: if your employer offers both plans, you can contribute to both plans and max out both plans if you’re able to save that much. (6) That means you can set aside a total of $52,000 combined between the two plans if over age 50. If you qualify for the special 457(b) catch-up contribution, then you could contribute $26,000 to the 403(b) and $39,000 to the 457(b) for a total of $65,000. This can be a major opportunity to supercharge your retirement savings and get over the finish line!
If you would like help analyzing your retirement options and coming up with a strategy to optimize your contribution, 1on1 Financial would love to help. Reach out to us today by calling 909-981-1720 or simply click here to schedule a free 15-minute introductory phone call!
About 1on1 Financial
1on1 Financial is an independent financial advisory firm specializing in guiding working and retired professionals, executives, and business owners along the path to financial well-being. Founded in 1997, we use a team approach to help our clients accumulate wealth, generate income, preserve their life savings, and strategically plan for the distribution of their estate. With more than 50 years of combined experience in the financial services industry, we remain true to our fundamental mission: to provide personalized guidance, treatment, care, and service so our clients can gain control of their future and feel confident in their financial life.