What Are The Differences Between A 403(b) Plan And A 457(b) Plan?
By Nick Fisher, CFP®
In 1875, The American Express Company established the first corporate pension in the United States. At the time, the plan applied for workers age 60 who had put in 20 years for the company. Workers were eligible to receive half of their annual salary in retirement, up to a maximum of $500 per year. (1) That comes out to about $11,732.50 in today’s dollars—certainly not much to write home about, but they didn’t have iPhones to buy and Amazon Prime at their fingertips in that era either.
That was a long time ago, and back then, the average life expectancy in the U.S. was 39.41, (2) so workers who reached age 60 and qualified for the pension were rare. But fast-forward to today where the U.S. life expectancy rate sits at 78.81. (3) We’ve come a long way with science, technology, and healthcare, resulting in longer life expectancies and ultimately a longer period of retirement to plan for. For this, and many other reasons, more and more organizations have moved away from offering pensions and instead require employees to save part of their paycheck in a defined contribution plan. This means the employee must set aside funds to invest how they wish and receive a potential match on a portion of those contributions.
Governments and universities seem to be some of the only industries remaining that offer a pension, and for most people, that pension alone won’t be enough to fund a fulfilling retirement. This is where supplemental contributions to plans like 403(b)s and 457(b)s come into play for those in the public sector. But what’s the difference?
While they may sound like droids from Star Wars, 457(b)s and 403(b)s are 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 2020 with an additional $6,500 available to those over age 50. Keep in mind that the catch-up contribution is only available with governmental 457(b) plans, which does include employees of universities and state and local governments.
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.
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. With a 403(b) plan, you’re taxed at ordinary income rates plus a 10% penalty for any withdrawals under age 59½. This is an underutilized way to bridge an income gap if you retire early.
Another important difference to keep in mind regards 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 2020, 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 2019 to their 457(b), they could contribute an additional $13,500 in 2020. If they contributed nothing in 2019, 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) 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 about: 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. 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 do $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, WealthBridge Capital Management would love to help. We specialize in helping university employees build plans based on their unique life situation so they can better prepare for retirement. Reach out to us to schedule an introductory meeting by booking a consultation, calling 614.964.9600 or emailing Nick.firstname.lastname@example.org today.
Nick Fisher is a CERTIFIED FINANCIAL PLANNER® (CFP®) professional at WealthBridge Capital Management with over eight years of experience in the financial planning industry. Nick specializes in helping retirees, medical professionals, and university employees who want to outsource their financial world to a dedicated professional who will help them achieve their goals and ultimately provide peace of mind for their financial future. Nick graduated from The Ohio State University with a bachelor’s degree in business administration, finance, and insurance. When he’s not working, Nick and his wife enjoy traveling to visit friends and family who live throughout the country. They are active volunteers with their church, Rock City, as well as with the United Way through LINC, a young professional group dedicated to fighting poverty in Columbus. To learn more about Nick, connect with him on LinkedIn.