What are 403b and 457 used for?

Once you start working, you should take advantage of the retirement savings options provided by your employer to grow your retirement savings. Most employers provide tax-favored retirement plans that allow employees to make pre-tax contributions to their retirement savings accounts. Two popular retirement plans available to employees are 403(b) and 457(b) plans.

403(b) and 457 plans are tax-sheltered plans that allow participants to contribute pre-tax money from their paycheck and invest the funds in various investment options. 403(b) plans are available to public schools, churches, hospitals, and other tax-exempt institutions, while 457 plans are available to state and local government employees. Non-profits may also offer 457 plans to top executives to attract and retain top talents.

What is a 403(b) plan?

A 403(b) plan is a tax-advantaged retirement plan offered by public schools, non-profit organizations, religious organizations, and other tax-exempt organizations like hospitals and charities. It allows participants to make contributions to the plan, and the money grows tax-deferred or tax-free until when you take a withdrawal.

An employer can offer either a traditional 403(b) plan or a Roth 403(b) plan. With a traditional 403(b), participants contribute pre-tax money, and the funds are protected from capital gains taxes. Participants owe taxes on the money when they take withdrawals from the 403(b) plan.

On the other hand, a Roth 403(b) plan is funded with post-tax dollars, meaning you pay taxes upfront on the retirement contributions. Participants won’t owe taxes on withdrawals and gains on investments.

An employer may also make matching contributions to a 403(b) plan. While employee contributions become fully vested immediately, employer contributions may have immediate or short vesting periods. Employees do not fully own the employer contributions until they become fully vested.

What is a 457 plan?

A 457 retirement plan is offered to state and local government employees, as well as executive non-profit employees. Here are the two main categories of 457 plans:

457(b)

A 457(b) plan is designed for state and local government employees. This plan puts off paying taxes on contributions until when you withdraw money in retirement.

For 2022, you can contribute up to $20,500 to a 457(b) plan, and an additional $6,500 if you are age 50 or older. If you are three years shy of attaining the normal retirement age, your contributions can exceed the annual contribution limit, but not more than $41,000 in 2022. However, the special catch-up contributions will be limited by previous contributions. 

457(f)

A 457(f) plan is offered by some non-profit organizations to their top-level executives as a way of attracting and retaining top talents. There is no limit on the amount of compensation that can be deferred. However, most plans require executives to provide services for at least two years to receive these benefits.

A 457(f) plan is different from a 457(b) since the former tends to pay higher and more generous benefits than the latter. The benefits are deferred from taxation and are subject to the risk of forfeiture, which means executives risk losing benefits if they do not meet the terms of service and performance. Once the benefits become fully guaranteed and there is no longer a risk of forfeiture, the benefits become taxable as gross income.

403(b) vs. 457(b): How do they compare?

Although 403(b) and 457(b) offer similar tax advantages to participants, they have several differences.

Here are the key differences:

Eligibility

For an employee to be eligible to contribute to a 403(b), they must be working in a public schools system, hospital service organization, 501(c)(3) organization, charitable organization, or other tax-exempt organization.

In comparison, employees are eligible to contribute to a 457(b) plan if they participate in a plan of a state government or tax-exempt entity that establishes the plan.

Employer contributions

Employers can match contributions for both 403(b) and 457(b), but 403(b) has a higher limit than the latter. When you contribute to a 403(b) plan, the annual contribution limit applies to employee elective deferrals only, and not the employer contributions.

For 2022, an employee can contribute up to $20,500 to a 403(b), whereas the total employer and employee contributions can go up to $61,000 in 2022. With a 457(b) plan, if the employer matches employee contributions, the employer contributions count towards the total allowable limit for the year. For 2022, 457(b) allows total contributions of up to $20,500.

Catch-up Contributions

Employees aged 50 or older can contribute an additional $6,500 to both 403(b) and 457(b) in 2022. Additionally, these plans allow special catch-up contributions.

With a 403(b), you can contribute an additional $3,000 each year if you have worked 15 years or more with the same employer. IRS limits these contributions up to $15,000 over your lifetime. In comparison, a 457(b) plan allows employees who are within three years of normal retirement age to contribute up to $41,000 to their plan if they did not max out their contributions in previous years.

Withdrawals

Both 403(b) and 457(b) plans allow participants to make penalty-free withdrawals when they reach age 59 ½. However, if you have a 457(b) plan and leave your employer, you will be eligible to take penalty-free withdrawals at any age. With a 403(b) plan, you will pay a 10% penalty if you take a withdrawal before age 59 ½. 

403(b) vs. 457(b) plans- which plan should you choose?

If you have to choose between 403(b) and 457(b), you should consider each plan’s contribution limits, employer contributions, catch-up contributions, withdrawal options, and plan fees.

If the employer offers a match in one plan and not the other, consider choosing the plan with a match so that you can boost your retirement savings. 

Also, if you have worked with your employer for at least 15 years or more, you should consider if you qualify for the 15-year special catch-up contribution to a 403(b) plan. If you have three years to attain the normal retirement age, you should also consider the additional catch-up contribution you will get in a 457(b).

Can you have both 403(b) and 457 plans?

If your employer has a 403(b) and a 457(b) plan, you can have both retirement plans at the same time. Some non-profit organizations offer both plans to attract and retain top executives.

Since 403(b) and 457(b) have separate contribution limits (PDF), you can max out both retirement plans each year. For 2022, you can contribute up to $20,500 to 403(b) and $20,500 to 457(b). If you are above 50, you can only apply the catch-up contribution once per year.

If you are approaching retirement, and you have at least 15 years with your employer, you can benefit from the special catch-up contributions offered in each plan to boost your retirement savings further.