It’s never too early to start saving for retirement. Whether you’ve just started working for a company or have been employed for a while, you should take advantage of retirement savings options as early in your career as possible. One of the ways to do this is through employer-sponsored and tax-favored retirement savings plans. Employers offer these contribution plans which allow you to defer a percentage of your salary toward retirement. Two popular options are 403(b) and 457(b) retirement plans. A financial advisor can help you answer questions about your retirement planning needs.
What Is a 403(b) Plan?
A 403(b) plan is a tax-advantaged retirement savings plan that’s typically offered to public employees and workers for non-governmental organizations. The plan is required for some workers, but it’s optional for others. Additionally, 403(b) plans closely resembles 401(k) plans in that both collect pre-tax contributions and you’re taxed once you make withdrawals in retirement. The contributions for a 403(b) plan can be made by both the employer and the employees.
Also like a 401(k) you will face penalties if you make withdrawals from a 403(b) before age 59.5.
What Is a 457(b) Plan?
The 457(b) plan is also a tax-advantaged contribution plan for public employees that allows you to defer a portion of your money into retirement savings. These plans are funded with pre-tax money and once you make withdrawals in retirement, it’s taxed as regular income. Both the 457(b) and the 403(b) are similar in this regard, but the 457(b) doesn’t charge you an early withdrawal penalty if you decide to withdraw money from it when you leave your job. This lack of an early withdrawal penalty is one of the main differences between 403(b) vs. 457 (b) plans.
403(b) vs. 457(b) Plans: Eligibility
The Internal Revenue Service (IRS) gives 403(b) contribution rights to public school employees who participate in the daily operations of their schools, employees of public school systems managed by Indian tribal governments, employees of hospital service organizations, employees involved in 501(c)(3) organizations, certain ministers and civilian faculty and staff of the Uniformed Services University of the Health Sciences. Charitable and tax-exempt organizations fall under the IRS 501(c)(3) category. Employees must meet these conditions to be eligible.
State and local government employees are eligible to open a 457(b) plan as long as they fall under the plan of a state government that establishes a 457(b) plan, or a tax-exempt entity that establishes a 457(b) plan.
403(b) vs. 457(b) Plans: Contributions
You must consult with your employer to make contributions to your 403(b) plan. Because this plan allows you to invest pre-tax money from your wages, it’s important that you tell your employer the amount you want deferred and deposited into your 403(b) account. This process is sometimes called an elective deferral. Through an elective deferral you are designating a percentage of your paycheck into your 403(b) account. This automatically decreases your take-home pay, but it lowers your taxable income and, most importantly, it boosts your future retirement fund.
Some employers will also contribute to their employees’ 403(b) accounts. Many employees will make contributions based on what you contribute to your own plan, called a matching contribution. However, employers may also contribute without asking for anything in return. With the 457(b) plan employees can similarly deduct pre-tax money from their wages as contribution toward their plan.
Though understanding the contribution process is important, you should also be aware of the contribution limits for both plans. A contribution limit is the maximum amount of money you can defer per year through a retirement plan.
As of 2021, the contribution limit for a 403(b) plan is $19,500. The contribution limit for a 457(b) plan is also $19,500 for 2021. Both plans allow employees aged 50 and older to benefit from an additional “catch-up” contribution. The 403(b) plan allows employees to save an additional $6,500 toward their yearly fund.
The 403(b) and 457(b) plans differ in that the 457(b) plan lets workers who are within three years of normal retirement age as specified in the plan to make special catch-up contributions. In 2021, workers who qualify can contribute up to $39,000 to their 457(b) plans.
While the 403(b) plan doesn’t offer this provision, it does provide employees who’ve secured a tenure of 15 years with certain provisions. These employees can contribute an extra $3,000 per year as long as they’ve contributed an average of $5,000 or less for those 15 years prior.
403(b) vs. 457(b) Plans: Taxes
When you withdraw money from a 403(b) or a 457(b) in retirement, you’ll pay taxes on those withdrawals, though in some states retirement plan income is exempt from state income taxes.
The 457(b) plan rules state that you don’t have to pay a 10% tax penalty if you resign or retire before age 59.5 and need to withdraw money from your account. The 403(b) plan charges the 10% early withdrawal penalty. However, under the CARES Act, those over age 55 who have lost their job could also take out money without penalty.
Who Offers 403(b) and 457(b) Plans?
The IRS only allows public schools or 501(c)(3) organizations to establish and offer 403(b) plans. State and local government employers offer 457(b) plans. An employer doesn’t have to offer a 457(b) plan to all employees.
Overall, the type of plan you can choose depends largely on the type of company or organization you work for. You won’t have control over the plan your employer provides, but you will have control over the knowledge you bring to managing and saving retirement money. Although the 403(b) and 457(b) retirement savings plans are similar in many ways, it’s crucial that you take advantage of either of these tax-favored plans if you meet the eligibility requirements.
Planning ahead is crucial when it comes to retirement. Despite the plans you have access to, the resources and information you utilize in your approach to retirement will ultimately be instrumental in your life after work.
Retirement Planning Tips
- A financial advisor can help answer all the questions you have when it comes to retirement savings. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Brainstorm and map out what you hope to financially accomplish before retirement. Make sure to research the different types of employer-sponsored accounts offered to determine whether you’re eligible. It’s likely that you are.
- After you’ve done the planning and research for your retirement savings goals, it’s important that you implement your enhanced financial awareness into your approach toward saving.
Photo credit: ©istock.com/designer491, ©istock.com/designer491, ©istock.com/lovelyday12