The 403b and 457 Plan Comparison for Public School Employees
As a public school employee, pension plans are an important component of retirement planning. However, your pension alone may not provide enough retirement income to support your desired future lifestyle.
Fortunately, there are additional options available to help you achieve your retirement savings objectives. Contributing to 403b and/or 457 plan offered by your school district affords you the opportunity to supplement your defined benefit pension plan.
How are the 403b and 457 Plans Similar?
403b and 457b plans are both retirement plans offered to public school employees and certain 501(c)(3) tax-exempt organizations. Employees save for retirement by contributing to individual accounts. Employers may also contribute to employees' accounts. Both plans have the following in common:
Tax-deferred Contributions
Both employer sponsored plans allow you make contributions on a pre-tax basis via a Salary Reduction Agreement. Contributions to qualified savings plans, are made on a pre-tax basis, reducing taxable income received by the employee, which typically equates to a keeping you in or lowering you to a lesser tax bracket. For the past 3 years, contribution limits have been the same for both plans.
Tax-deferred growth on earnings
Your taxes are paid at a future date which allows your investment to grow without current tax implications. The use of a tax-deferred investment account is most often a wise decision when you are in a higher tax bracket now compared to the income tax bracket you anticipate to be taxed at in the future when you will be taking withdrawals. This can help you to build wealth quicker because you are reinvesting all growth in your account rather than paying a chunk each year to Uncle Sam.
Portability
If you leave your job, your plan contributions and earnings can be exchanged into your new employer’s plan without tax implications if done properly.
Investment Options
Both plans allow you to select from various investment options like mutual funds and annuities.
ROTH option available
Both plans may have a ROTH option available where you pay income tax on the contributions to the plan, while distributions from the plan (if certain requirements are met) are tax-free. Choosing whether to use the ROTH option is a decision based on your age and when you need access to the funds.
Differences Between the 403b and 457 Plans
While the plans have much in common, they do have a few key differences that may affect your decision to invest in one or the other. The main differences between 403(b) and 457 plans center on how and when you can access the funds.
Early/Premature Withdrawals
403bs are subject to possible 10% penalty (link: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions) (if under age 59½.)
457 does NOT have early withdrawal penalties.
Catchup Provisions*
We recommend you speak to a professional when deciphering which catchup rules may apply to you. Below is a brief summary of the differences in catch up provisions.
403(b) Catchup Provisions:
50 years or older rule. If permitted by the 403(b) plan, employees who are age 50 or over at the end of the calendar year can also make catch-up contributions of $6,000 in 2015 - 2019 beyond the basic limit on elective deferrals.
15-year rule. Employees with 15 years of service with their current employer and an annual average contribution of less than $5,000 per year are eligible for an additional $3,000 contribution per year up to a lifetime maximum catch-up of $15,000.
When both catch-up opportunities are available, the law requires deferrals exceeding the standard limit ($19,000 in 2019 and $18,500 in 2018) to be first applied to the 15-year catch-up (to the extent permitted), and then to the age 50 catch-up.
457 Catchup Provisions: The 457 plan has special catch-up contributions that may be allowed.
If permitted by the plan, this allows a participant for three years prior to the normal retirement age (as specified in the plan) to contribute the lesser of:
Twice the annual limit of $38,000 in 2019 and $37,000 in 2018, or
The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions)
Fees and Expenses
Whether you ultimately choose a 403(b) or 457(b) you will also need to make important decisions regarding the investments within those accounts. Be sure to compare the fees associated with mutual funds and annuities before jumping into either plan. Choosing a plan with even a 1% higher fee could affect your retirement savings nest egg.
Which Plan Should I Choose?
DID YOU KNOW? If eligible, you could contribute to a pension, a 403(b) AND a 457 plan at the same time. Contact Us to find out if you qualify for this savings strategy.
There are many factors to consider when you decide which plan to enroll into, how much to contribute, and how to invest your money. Many of these decisions will also be based on your age, your personal goals for the future, and when you will need to access the money.
Warwick Valley Financial Advisors specializes in helping teachers and school district personnel understand the issues they face. We have become seasoned industry advisors on the 403(b) and 457 plans and can help you make informed decisions early in your financial planning journey.
If you have not yet signed up for a 403(b) or 457 plan, consider doing so as soon as possible. The sooner you begin saving, the more substantial the sum of retirement funds you can potentially save, and the better your chances to be able to afford to live the retirement lifestyle you want to live.
If the idea of picking the right plan intimidates you, contact a financial advisor who specializes in working with teachers and school district personnel to help you make an informed decision.
*Catchup Provision - Source: https://www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.