403(b) and 457(b) plans

403(b) and 457(b) plans are employer-sponsored retirement savings plans often offered to public sector employees and nonprofit organization staff. Both plans provide options for contributing pre-tax and, in some cases, after-tax income for retirement savings. Understanding their workings, similarities, differences, as well as their pros and cons, can help you decide which plan may be best suited for your retirement savings needs.

403(b) Plan Overview

• Eligibility: Generally offered to employees of public schools, hospital services organizations, and nonprofit or tax-exempt entities.
• Investment Options: Initially limited to annuity contracts, most 403(b) plans now also offer mutual funds.
• Contributions: Can be made pre-tax or post-tax (Roth).
• Withdrawal Penalties: Early withdrawal before age 59½ may incur a 10% penalty and regular income taxes.
• Loan Provisions: Similar to 401(k) plans, with certain restrictions.

Pros

• Convenient setup through payroll deduction.
• Tax-deferred savings, reducing annual taxable income.
• Higher contribution limits compared to some other retirement plans like IRAs.

Cons

• Early withdrawal penalties.
• Limited investment options compared to other plans.
• Potentially higher fees.

457(b) Plan Overview

• Eligibility: Typically available to local and state government employees and employees of certain tax-exempt organizations.
• Investment Options: Similar to 403(b) plans, offering annuities and mutual funds.
• Contributions: Can also be made pre-tax or post-tax.
• Withdrawal Penalties: Unique feature of no penalties for withdrawals before age 59½, though income taxes apply.

Pros

• Tax-deferred savings on contributions and earnings.
• Special catch-up contributions allowed.
• Option to rollover to a Roth IRA or 401(k).

Cons

• Possibility of forfeiture of funds if leaving the job before the vesting period.
• Fewer employers offer matching contributions.
• The maximum contribution limit includes employer contributions.

Similarities Between 403(b) and 457(b)

Both plans allow for pre-tax and post-tax contributions and offer similar tax advantages. The annual contribution limits set by the IRS are also generally the same for both plans.

Differences Between 403(b) and 457(b)

• Withdrawal Rules: 457(b) plans do not have the 10% early withdrawal penalty, unlike 403(b) plans.
• Catch-up Contributions: 457(b) plans offer special catch-up contributions, allowing for potentially higher contributions closer to retirement.
• Employer Contributions: 457(b) plans often see fewer employers offering matching contributions.

Deciding Between 403(b) and 457(b)

The choice between a 403(b) and a 457(b) plan depends on individual circumstances, including your employment situation, retirement goals, and the specific features of the plans offered by your employer.

Both plans offer unique benefits and drawbacks. Understanding these can help you make an informed decision that aligns with your long-term financial and retirement objectives.