A 457 deferred-compensation retirement plan is a nonqualified, tax-advantaged deferred compensation retirement plan available to certain governmental and nongovernmental employers in the US. Employees may invest their earned income pretax or posttax; earned income includes salaries, hourly wages, bonuses, tips, commissions etc.
Rolling over a 457 can be beneficial in many ways, from consolidating retirement savings and opening up more investment options, to streamlining retirement planning processes. Before embarking on this path, however, some key considerations need to be kept in mind.
Tax-deferred growth
As its name implies, 457 plans allow employees to defer taxes when contributing to investment accounts – unlike the pre-tax option offered by some 401(k) plans. Some employers even offer Roth 457s; these allow employees to make after-tax contributions that will become tax-free once retired if certain criteria are met; individuals may choose to convert pre-tax assets to Roths, though this must be done carefully.
Local and state government employers do not typically match employee contributions to 457 plans like for-profit private employer 401(k) plans or nonprofit 403(b) plans do, unlike for-profit private employer 401(k) plans or nonprofit 403(b) plans. But these plans resemble individual retirement accounts (IRAs), which follow similar rules to tax-deferred retirement plans such as 457s. Roth IRAs offer another tax-deferred method but their distributions will still be taxed as regular income – potentially pushing people into higher tax brackets or even Medicare premium surcharges on Parts B & D premium surcharges due to withdrawals taxation rules.
Taxes on distributions
A 457 plan is a tax-deferred savings account that allows individuals to save for retirement via pretax contributions, with funds and investment earnings growing tax-deferred until taken out in retirement. Also referred to as tax-sheltered annuity or TSA plans, 457 plans are typically offered by government entities and some tax-exempt organizations and differ significantly from 403(b) accounts and Roth IRAs.
Contrary to what some may believe, 457 plans do not waive penalties if withdrawals occur prior to age 59 1/2; however, you can withdraw money penalty-free in case of emergency situations, such as losing your job or suffering damage to your home due to natural disaster.
Changing jobs or retiring can require you to rollover a 457 plan into an IRA; however, the process can be complex and you should ensure you fully understand its rules and repercussions before taking this step. Consulting with a financial planner might help ensure you make an informed decision.
Minimum required distributions
No matter which 457 plan option you select – Roth conversion or not – you must take RMDs once reaching certain ages. RMDs are calculated by dividing the total value of tax-deferred accounts by an IRS life expectancy table; using this calculator you can estimate future RMDs.
RMD rules also apply to IRA-based plans, such as SEP and SIMPLE IRAs; however, they do not pertain to designated Roth accounts in employer-sponsored retirement plans like 401(k), 403(b), and 457(b). For 2024 and later plans using SECURE 2.0 technology do not have lifetime RMD requirements.
If your employer-sponsored plan contains significant funds and you anticipate tax increases in the near future, it might make sense to pay taxes on NDC account contributions now rather than waiting until taxes increase substantially in future years. It would be advisable to seek professional advice regarding your personal situation before taking this decision.
Investment options
Many 457 plans offer a wide variety of investment options. These typically include both pretax and Roth contributions; with pretax deferring your taxes when contributing while earnings become taxable when withdrawing them in retirement. Some employers match your contributions; however, you must first go through a vesting period before you can claim all matching funds.
Some 457 plans provide an “target-date” option that invests your money automatically into funds that shift to more conservative investments as you near retirement, saving time and effort by eliminating the process of selecting individual funds on your own.
Roth 457 plans are an ideal investment option for people who anticipate having lower tax brackets during retirement than now, as it offers tax-free withdrawals upon fulfilling certain criteria, such as holding for five years and reaching age 59 1/2.
