Individuals often have the option to save for retirement through multiple channels, including 401(k) and 457 plans. Both plans offer tax advantages but differ in some key aspects. For instance, 401(k) plans are typically offered by private businesses, while 457 plans are primarily available to employees of state and local governments or certain nonprofit organizations. Additionally, eligibility requirements may differ between the two plans, and there may be variations in contribution limits and investment options. By understanding the nuances of each plan, individuals can make informed decisions about how to allocate their savings and maximize their retirement contributions.
Eligibility Requirements for 401(k) and 457 Plans
Both 401(k) and 457 plans are retirement savings plans offered by employers. However, there are some key differences between the two plans, including eligibility requirements.
401(k) Plans
To be eligible for a 401(k) plan, you must be an employee of a company that offers the plan. You must also be at least 18 years old and have worked for the company for at least one year.
Some 401(k) plans have additional eligibility requirements. For example, some plans require employees to work a certain number of hours per week or to have been employed by the company for a certain period of time before they can participate in the plan.
If you meet the eligibility requirements, you can contribute up to $22,500 to your 401(k) plan in 2023. If you are age 50 or older, you can make catch-up contributions of up to $7,500 in 2023.
457 Plans
To be eligible for a 457 plan, you must be an employee of a government or tax-exempt organization. You must also be at least 18 years old and have worked for the organization for at least one year.
Some 457 plans have additional eligibility requirements. For example, some plans require employees to work a certain number of hours per week or to have been employed by the organization for a certain period of time before they can participate in the plan.
If you meet the eligibility requirements, you can contribute up to $22,500 to your 457 plan in 2023. If you are age 50 or older, you can make catch-up contributions of up to $7,500 in 2023.
| 401(k) Plan | 457 Plan | |
|---|---|---|
| Eligibility | Employee of a company that offers the plan, at least 18 years old, and worked for the company for at least one year | Employee of a government or tax-exempt organization, at least 18 years old, and worked for the organization for at least one year |
| Contribution Limit | $22,500 in 2023 | $22,500 in 2023 |
| Catch-Up Contributions | $7,500 in 2023 | $7,500 in 2023 |
Contribution Limits
Both 401(k) and 457 plans have contribution limits for each year.
- 401(k) plans: The limit on employee elective deferrals (including catch-up contributions) is the lesser of:
- $22,500 in 2023 ($30,000 for participants who are age 50 or older)
- 100% of compensation (not including elective deferrals)
- 457 plans: The limit on employee elective deferrals is the lesser of:
- $22,500 in 2023 ($30,000 for participants who are age 50 or older)
- 100% of compensation (not including elective deferrals)
- The amount of compensation that remains after 401(k) and 403(b) deferrals
Distribution Rules
The distribution rules for 401(k) and 457 plans are similar.
- 401(k) plans: Distributions are generally subject to ordinary income tax and a 10% penalty if taken before age 59½. There are some exceptions to the penalty, including:
- Distributions made after age 59½
- Distributions made due to disability
- Distributions made to beneficiaries after the participant’s death
- 457 plans: Distributions are generally subject to ordinary income tax and a 10% penalty if taken before age 59½. There are some exceptions to the penalty, including:
- Distributions made after age 59½
- Distributions made due to disability
- Distributions made to beneficiaries after the participant’s death
| 401(k) Plans | 457 Plans | |
|---|---|---|
| Contribution limits | The lesser of $22,500 ($30,000 for participants who are age 50 or older) or 100% of compensation | The lesser of $22,500 ($30,000 for participants who are age 50 or older) or 100% of compensation (not including elective deferrals) |
| Distribution rules | Distributions are generally subject to ordinary income tax and a 10% penalty if taken before age 59½. | Distributions are generally subject to ordinary income tax and a 10% penalty if taken before age 59½. |
Employer Matching vs. Employee Contributions
When it comes to saving for retirement, understanding the differences between employer matching and employee contributions is crucial. This distinction applies to both 401(k) and 457 plans.
Employer Matching:
- Optional for employers.
- Contributions made by the employer on behalf of the employee, typically up to a certain percentage of the employee’s salary.
- Vests over time, meaning the employee gains ownership of the matched funds gradually.
Employee Contributions:
- Voluntary contributions made by the employee from their paycheck.
- Tax-deferred or Roth contributions available.
- No vesting period.
The table below summarizes the key differences between employer matching and employee contributions:
| Employer Matching | Employee Contributions | |
|---|---|---|
| Source | Employer | Employee |
| Voluntary | No | Yes |
| Limits | Employer-determined | Annual contribution limits |
| Vesting | Yes | No |
What Are 401(k) and 457 Plans?
401(k) and 457 plans are both retirement savings plans that offer tax benefits to participants. 401(k) plans are offered by private employers, while 457 plans are offered by state and local governments and other tax-exempt organizations.
Both 401(k) and 457 plans allow participants to contribute pre-tax dollars, which reduces their current taxable income. Earnings on investments in these plans grow tax-deferred until withdrawn in retirement. Withdrawals from 401(k) and 457 plans are taxed as ordinary income.
Contribution Limits
The maximum amount that can be contributed to a 401(k) plan in 2023 is $22,500. The maximum amount that can be contributed to a 457 plan in 2023 is $22,500 for employees under age 50 and $30,000 for employees age 50 and older.
In addition to employee contributions, employers may also make matching contributions to 401(k) plans. Employer matching contributions are not subject to the annual contribution limits.
Eligibility
To be eligible to contribute to a 401(k) plan, you must be an employee of a participating employer. To be eligible to contribute to a 457 plan, you must be an employee of a state or local government or other tax-exempt organization that offers a 457 plan.
## Tax Implications of Combined 401(k) and 457 Contributions
- Contributions to both plans reduce your current taxable income.
- Earnings on investments in both plans grow tax-deferred until withdrawn in retirement.
- Withdrawals from both plans are taxed as ordinary income, so the additional contributions may increase your overall tax burden in retirement.
## Retirement Income Strategies
When planning for retirement, it is important to consider how you will withdraw funds from your 401(k) and 457 plans. Withdrawing too much money too early can result in higher taxes and penalties. Withdrawing too little money can leave you with a shortfall in retirement.
One strategy is to withdraw funds from your 401(k) plan first, since it is likely to have a higher balance than your 457 plan. This will allow you to delay withdrawals from your 457 plan and potentially reduce your overall tax burden in retirement.
Another strategy is to use a Roth 401(k) or Roth 457 plan. Withdrawals from Roth plans are tax-free in retirement, so you can avoid paying taxes on earnings even if you withdraw them early.
Comparison of 401(k) and 457 Plans
| Feature | 401(k) Plan | 457 Plan |
|---|---|---|
| Eligibility | Employees of participating employers | Employees of state and local governments and other tax-exempt organizations |
| Contribution limits (2023) | $22,500 (plus catch-up contributions for employees age 50 and older) | $22,500 ($30,000 for employees age 50 and older) |
| Employer matching contributions | Yes | No |
| Tax implications | Contributions are pre-tax, earnings grow tax-deferred, withdrawals are taxed as ordinary income | Same as 401(k) plans |
| Withdrawals | Subject to early withdrawal penalties if taken before age 59½ | Same as 401(k) plans |
Well, folks, that wraps up our little journey into the world of 401k and 457 plans. I hope you found this article helpful in understanding your options and making smart financial decisions for your future. If you have any further questions, don’t hesitate to reach out. Thanks for taking the time to read, and be sure to check in again soon for more money-saving tips and tricks. Stay tuned, my friends!