Updated: Apr 27, 2019
Your options for retirement savings can get confusing pretty quick. What is a 401(k), 457(b), 403(b), or IRA anyway? Are the contributions Roth or not, and what does that mean? Is it tax-free or tax-deferred? It is no wonder folks put off retirement investing. It makes you feel like you probably should have learned this stuff in school.
In our what you need to know series, we are going to explain, over time, all the options you may have at your disposal to build wealth for your golden years.
Today's topic is the 457(b) or Deferred Compensation.
Of all the retirement vehicles out there a deferred compensation, or 457(b) plan, may be the most advantageous. It gives you the ability to supercharge your retirement savings on a tax-deferred basis while avoiding penalties for "early" withdrawals.
This plan is often offered to employees of state and local governments or tax-exempt organizations (non-profits). So, if you work for a fire department, there is a good chance you have access to a deferred compensation plan.
457 Plan Contribution Limits
When you examine the contribution limits, you start to see why this plan is so great. In 2019, your contribution limit is set to $19,000. If you also have access to a 401(k) or maybe a 403(b), the 457 plan does not affect the contribution limits for those accounts. The limits are not cumulative. That means it is possible to contribute $38,000 a year of tax-deferred funds towards your financial freedom. That is powerful!
Just like other retirement plans, the 457(b) allows catch-up contributions if you are over age 50. In 2019, this is an additional $6,000 for a total limit of $25,000. The plan may allow a special catch up in the last 3 years before reaching normal retirement age (as defined in your plan). If so, you could contribute twice the annual limit ($38,000) towards retirement. This would be in lieu of the age 50 catch up so it would require some planning.
457 Plan Withdrawals
If you plan to retire early by normal standards, say before 59 and a half, you can receive distributions from your 457(b) without any penalties.
You will have to pay federal income tax, but the 10% penalty that is common with most tax-deferred accounts is not applicable. This gives you the opportunity to draw from your account (if you need to) while letting your other retirement savings continue to grow.
Similar to other plans, required minimum distributions by age 70 and a half are still required.
Roth 457 Contributions
If you are offered a Roth option and are contributing in that manner, you should be aware that some key rules do change. The growth on withdrawals prior to age 59 and a half is taxed, thus taking away the biggest benefit of the Roth contributions. If your assets remain in the original plan, required minimum distributions start at age 70 and a half. However, you can roll your Roth 457 into a Roth IRA and avoid RMDs.
Unlike a lot of careers today, firefighting isn’t something you can do forever. Getting on that truck every day and performing physical work takes a toll on your body. If you do this for 30+ years, even the most physically fit folks will have some rough days. It is important to plan for the next phase of life even if it feels like a long way off. The 457(b), if utilized, can give you a lot of flexibility in your retirement planning. If you are offered the opportunity to use it and are not, you could be making a huge mistake.
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