If you’re a state or local government employee with a 457(b) deferred compensation plan, here’s a primer on plan basics, benefits, and financial considerations.
THE BASICS OF 457(b) PLANS:
Under Section 457 of the Internal Revenue Code you can defer compensation each year up to the IRS annual dollar limit, $19,000 plus a $6,000 catch up for those over age 50 in 2019. This contribution cannot exceed 100% of your compensation. Like most retirement plans, loans are usually permitted and hardship withdrawals for unforeseen emergencies that meet specific requirements are allowed. This might lead you to think, how exactly is this different from any other retirement account? The answer is: a 457(b) account is NOT a retirement account, it is “deferred compensation,” which comes with unique rules that may help accelerate your retirement savings and help prepare for an unexpected separation from service.
BENEFITS OF 457(b) PLANS:
Deferring compensation into your account allows you to reduce your current income, which can reduce your income taxes now. Federal and state income taxes (in most cases) are also deferred until the funds are withdrawn during retirement. This is beneficial because most people are in a lower tax bracket after retirement.
457(b)s are considered separate and distinct plans, and not aggregated with other retirement accounts, which allow you to defer additional retirement funds. Most retirement plans have annual deferral limits; for example, this year the 401(k) contribution limit is $19,000 plus a $6,000 catch up for those over age 50. If you are approaching retirement this factor limits your maximum saving opportunity, however, because 457(b) plans are considered deferred compensation, you can defer an additional $19,000. This can really super charge your retirement savings, especially if you were a late starter.
These plans are also portable. The account is yours and can be rolled over into another public sector 457, into an IRA, or other eligible qualified retirement plan upon separation of service.
When you retire or leave service the 457(b) funds are yours to keep, in comparison to most retirement plans that usually bring a 10% penalty if you decide to withdraw funds after separation of service. Because the funds are deferred compensation that you actually earned, you can take the entire distribution upon separation of service and pay no penalty. This can function as a nice parachute of savings if your position is subject to political risk or another factor that could cause an abrupt separation of service. Most government positions do not offer severance packages like the corporate world, so this is an excellent option for hedging against that risk.
OTHER CONSIDERATIONS FOR 457 PLAN PARTICIPANTS:
While Government 457(b) plans have many benefits, it’s important to consider the opportunity cost of such an investment and consult with a qualified Financial Planner. Here are some points to contemplate with your advisor:
- Consider your future tax liability. Will your taxes go up in retirement? Most people assume they will be in a lower income tax bracket upon retirement, however this is not always the case.
- Do you have sufficient risk capacity to optimize this benefit? Most want to defer as much as possible into this plan, however, it is important to consider your resources and what is needed to fund current goals.
- How should you invest in this plan? 457(b) plans usually come with self-managed investment options. Professional guidance can optimize your investment strategy, taking into account your goals and risk tolerance.
Are you a government employee with questions regarding a 457 plan? Our team has decades of experience working with government employees on retirement planning. Feel free to contact a Cary Stamp & Co. advisor for a review of your individual situation.