457(b), 401(a), and Roth IRA
The 457(b) is a retirement plan available to employees of state and local governmental agencies, and 501(c) organizations. You may be eligible to contribute to both a 403(b) and a 457(b).
How a 457(b) is Different From a 403(b)
The key differences are:
- Assets in a 403(b) are held directly by employees, while 457(b) assets are held in a trust for the benefit of employees.
- There is no federal 10 percent premature distribution penalty imposed on withdrawals from a 457(b) plan when separating from service.
How Much Can Be Contributed to a 457(b)
Participants may contribute up to $19,500 for year 2020.
Age 50 Catch-Up
Participants age 50 and older at any time during the calendar year are permitted to contribute an additional $6,500 in 2020.
Employees who are three years from normal retirement age (as defined by the plan) are permitted the lesser of:
- two times current year’s normal retirement contribution limit or
- underutilized limits from past years. Note: not all employers make this additional catch-up option available nor are they required to do so. Check with your employer for details.
Investment Products Available in a 457(b)
Mutual funds and annuity products (which can include fixed annuities, equity-indexed annuties and variable annuties) may be offered. See your specific plan for details.
This is a provision that permits employees to irrevocably designate all or a portion of their 457(b) as an after-tax Roth contribution. This type of contribution will not lower the employee's taxable income. However, distribution of Roth designated funds in retirement will not be subject to taxation.
Participants have the option of making pre-tax 457(b) contributions, Roth 457(b) contributions, or as a combination of the two. Total contributions cannot exceed the year's contribution limit. Not all employers offer a Roth 457(b), nor are they required to do so. Check with your employer for details.
- Age 59½ (this is new as of 2020)
- Separation from service (see below)
- Upon retirement
- Unforeseen emergency (see below)
- Divorce (see below)
- Death (see below)
Borrowing Money From Your 457(b)
Subject to availability and any additional conditions applied by individual vendors. IRS limits loans to the lesser of:
- One half of account value
What Happens to Your 457(b) If You Leave Your Employer
- Assets may be transferred to your new employer's plan if permitted by that plan.
- Assets may be moved to a rollover IRA at an institution of your choice. This will permit the money to continue to grow tax-deferred.
- You may leave the money in your current plan and continue to enjoy tax-deferred growth. If your account has less than $5,000, you may be required to transfer assets. Check with your employer for details.
- You may take a lump sum distribution. Unlike the 403(b), there is no 10 percent early withdrawal penalty for withdrawing 457(b) money upon separation of service. Withdrawals will be taxed as ordinary income.
Unforeseen Emergency Withdrawal
Unforeseen emergency withdrawals are permitted from your 457(b) account if the employee is under severe financial distress. The IRS definition of what qualifies as an unforeseen emergency is very specific and more stringent than the definition of hardship under the 403(b) plan. The emergency must be unexpected and unanticipated. Furthermore, the employee must have no other resources available to alleviate the stress, such as selling assets or obtaining a loan from a financial institution. Check with your vendor and employer for more information.
Unlike the 403(b), disability itself is not a distributable event. However, it may be considered an unforeseeable event and you may be able to withdraw money, subject to certain rules and restrictions. Check with your employer and vendor for details.
What Happens to Your 457(b) in the Event of a Divorce
Some or all of the balance in your 457(b) account may be transferred. Distribution to an alternate payee will be permitted if it is made pursuant to a qualified domestic relations order (QDRO). This is a decree, judgment, or order that meets the qualification requirements of the Internal Revenue Code. Those requirements include the following:
- It must have been issued under a state's community property or other domestic relations law.
- It must relate to the provision of alimony, child support, or the property rights of a spouse, former spouse, child, or other dependent (alternate payee).
- It must assign to the alternate payee the right to receive all or a portion of the participant's plan benefits.
- It must clearly specify (1) the names and addresses of each alternate payee, (2) the amount or percentage of the participant's benefit to be paid to each alternate payee, (3) the period of time over which the order applies, and (4) each plan to which the order applies.
- When discussing property distribution in contemplation of a divorce, you should make certain that your attorney ensures that the distribution of your 457(b) assets and all other retirement plan assets meet the requirements of a QDRO.
What Happens to Your 457(b) in the Event of Death
Death benefits are paid to a beneficiary or beneficiaries on file with your vendor. How the proceeds are distributed depends upon the age of the participant upon death and beneficiary's relationship to you. You should review your beneficiary designations annually and update them as necessary through your 457(b) vendor.
Withdrawal Requirements for 457(b) Money
You must begin to take withdrawals from your 457(b) no later than April 1 of the year following the year in which you turn age 70½. If you are still working, you can delay withdrawal from your 457(b) until April 1 following the year in which you retire.
See this IRS story on Required Minimum Distributions (RMD).
Can I also contribute to a 401(a)?
Often called a Money Purchase Plan, a 401(a) is an employer sponsored plan. Contributions are made on a pre-tax basis. Earnings not subject to tax until withdrawal.
2020 Contribution Limits
- For 2020, the lesser of: 100 percent of compensation or $57,000
- Typically, contributions are made by the employer
How Different From Other Defined Contribution Plans
Employer has more control. An employer can customize a 401(a) for a specific employee. Plan eligibility determined by employer (see your employer’s 401(a) plan document for details.
Separation of Service
- Upon separation of service, balance can be transferred to another eligible retirement plan without being taxed.
- May take penalty-free withdrawals at retirement (if age 59 ½).
- May take penalty-free withdrawals at retirement (if age 59 ½).
- After you reach age 70 1⁄2 or separate from service, whichever is later, you will be required to withdraw at least a minimum amount from your account each year, per IRS rules.
Other 401(a) Notes
- Some 401(a) plans are mandatory
- Employer may offer a 401(a) in lieu of participation in a defined benefit plan.
- Can contribute to a 403(b) and a 457(b) in addition to a 401(a).
- Employer not required to offer a 401(a)
More Information on Your Plan
Check your employer’s 401(a) Plan Document
Who is Eligible to Offer a 401(a) Plan?
Under Internal Revenue Code Section 414(d), a governmental plan is an IRC Section 401(a) retirement plan established and maintained for the employees of:
- the United States or its agency or instrumentality;
- a state or political subdivision, or its agency or instrumentality; or
- an Indian tribal government or its subdivision, or its agency or instrumentality (participants must substantially perform services essential to governmental functions rather than commercial activities.)
- IRS 401(a) information
Ideally, eligible participants would contribute the maximum allowable to both a 403(b) and a Roth IRA. If you are stuck with a 403(b) plan with bad choices or only have a limited amount to contribute to a retirement plan, you may want to consider funding a Roth IRA before funding a 403(b). Here's how a Roth IRA works.
Roth IRA Eligibility
- For 2020 single workers (and heads of household) earning up to $124,000. Phases out at $139,000.
- Married couples (filing jointly) earning up to $196,000. Phases out at $206,000.
Roth IRA Contribution Amounts
For 2020 the limit is $6,000. In addition, if you are 50 or older at any time during the year you can contribute an additional $1,000.
Roth IRA Tax Advantages
No pre-tax advantages, however, withdrawals of contributions are never taxed and are always available for withdrawal. Tax free withdrawal of earnings may begin at age 59-1/2 (account must be held at least five years). Tax free withdrawal of earnings prior to age 59-1/2 may be made in case of disability, first-time home purchase and death.
Roth IRA Pros Compared to a 403(b)
- Can invest money in any financial institution
- Can invest in individual stocks
- Withdrawal of contributions are never taxed
- Earnings grow tax-deferred
- Tax free withdrawal of earnings prior to age 59-1/2 may be made in case of disability, first-time home purchase and death
- Job change doesn't affect account status or require changes
- Easy to arrange dollar cost averaging (purchase of a fixed dollar amount at regular intervals)
- No forced withdrawals at age 70-1/2
Roth IRA Cons Compared to a 403(b)
- Smaller contribution limit ($6,000 vs. $19,500 to 403(b) in 2020)
- Does not lower taxable income
- No matching funds
- Not protected from creditors in all states
Other Things to Consider
- As long as you don't exceed the income provisions you can contribute to both plans.
- If you are stuck with lousy investment choices in your 403(b), or are enamored with a particular financial institution, funding a Roth IRA may make more sense.
- If your employer provides matching funds, the 403(b) may be the way to go, at least up to the match.
- Younger workers may be unable to contribute a significant amount to a 403(b), lessening the benefit of pre-tax savings. In this case the lower contribution total and vendor flexibility may make the Roth IRA the best choice.
- One school of thought has investors splitting money between the two plans.
- Uncertainty on future tax rates and policies further complicates the decision.
So which plan is best for you? Only you can make that call. Much of it depends on what you believe your tax bracket will be in the future and whether the deduction is worth more to you today than tax-free income in the future. The real bottom line? Regardless of the plan you choose, get started. Now!