The governmental 457 Deferred Compensation Plan is a supplemental retirement plan exclusively offered to state and governmental employees. For example, in New Jersey, a physician employed by Robert Wood Johnson University Hospital or a professor employed by Rutgers University, both have access to the 457 plan. As the name implies, this plan allows you to “defer” portions of your salary towards your retirement savings without having to pay income taxes until distributions are needed. The 457 plan is similar to the 403(b) retirement plan in regards to contribution limits, but it has some important differences and can be an invaluable tool to supplement one’s retirement income.
From a savings perspective, what is unique about incorporating the 457 alongside the 403(b) retirement plan?
Many academics don’t realize that they can “max” out both their contributions to their 403(b) plan AND their 457 plan. This is a huge opportunity many miss to further reduce their taxable income for the year while simultaneously saving for their retirement. For 2021, participants over the age of 50 can defer a total of $52,000 ($26,000 each) between their 403(b) and 457 plan. In addition, many state and local government employees are unaware the 457 deferred compensation plan even exists!
Another unique aspect to the 457 plan is that it offers a special provision that allows savers to defer up to $39,000 in pre-tax or after-tax contributions. This feature, called a “double limit catch-up” provision, essentially allows participants who are nearing retirement to compensate for years in which they did not contribute to the plan, but were eligible to do so. This can be implemented during the last three years of employment prior the plan’s normal retirement age. Participants who are eligible for this special provision would be remiss not to take advantage of this feature.
Who are the carriers that offer the 457 plan? What are some of the investment options?
The 457 deferred compensation plan in New Jersey is only offered by Prudential. A participant in this plan can make pre-tax or after-tax contributions if they wish to diversify the taxability of their retirement income. Rollovers from other retirement accounts are also accepted into this plan. Prudential asset allocation programs are offered for those who would like help with constructing their investment portfolio or participants can choose their own investments. The investment menu contains popular investment managers like Vanguard or PIMCO.
The 457 deferred compensation plan offered in New York is through Nationwide. This plan is very similar to the 457 plan offered in New Jersey. The investment menu is arguably more robust as participants can take advantage of collective investment trusts (lower expense ratio costs comparted to similar mutual funds) and custom choices that include environmental, social, and governance (ESG) factors.
What are some drawbacks to the 457 plan?
Generally speaking, 457 plans can be harder to access for emergency withdrawals while employed. Most 403(b) plans can be accessed through certain hardship withdrawals. However, there can be stricter definitions with 457 plans. For example, you may have to experience unexpected medical events to be able to qualify for an unforeseeable emergency withdrawal. Make sure to check these rules with the corresponding plan documents as they may vary from plan to plan.
Are there any other special tax planning considerations?
Similar to the 403(b) plan, 457 plan contributions are subject to state income tax for contributory plans. Therefore, during your retirement when you plan to take distributions from your 457 plan, you may want to consult with your tax advisor so you are not double taxed at the state income level (your contributions were already taxed through payroll deductions). Depending upon if the state you worked in and retire in is subject to state income tax, you will need to figure out your lifetime contributions to the 457 plan so your tax advisor can determine what percentage of your withdrawal that will be excluded from state income tax. Generally speaking, you only pay state income tax on the amount that exceeds what you contributed to the plan.
In summary, the 457 plan can be a game changer for many prospective retirees. The additional savings capacity of the plan and investment options can really complement the 403(b) plan. High-Income earners need to consider how the 457 plan can fit into their overall financial plan.
Please email me at ggiardino@jmfranklincompany.com or call our firm at 929-427-0347 to learn more.
J.M. Franklin & Company LLC, Stratos Wealth Partners and LPL Financial are not affiliated with any of the other referenced entities.
Contributions to a 457(b) plan may be tax deductible in the contribution year. Distributions are taxed at withdrawal, unless rolled into a new employer’s plan or an IRA within 60 days of the distribution. A mandatory 20% federal withholding tax applies directly to distributions taken that could be eligible for rollover.
Contributions to a traditional 403(b) may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
