Good news: You can have both
- Roth IRAs and 457 plans both offer tax-advantaged growth for retirement savers.
- Individual investors set up Roth IRAs, but 457 plans are administered by certain state, local government, and nonprofit employers.
- You can contribute to both plans if you qualify.
Roth IRAs and 457 plans are tax-advantaged ways to save for retirement—but they’re structured differently. Anyone with “earned income” can open and contribute to a Roth IRA, provided they meet the income limits. In comparison, 457 plans are only available to employees of certain types of employers.
If you’re a state or local government employee—or you work for a non-profit—you may be eligible for a 457 retirement plan. So how does a 457 plan compare to a Roth IRA? And should you contribute to both?
What Is a 457 Plan?
Many employees of private, for-profit companies have access to a 401(k) plan through their employer. A 403(b) plan is simliar to a 401(k), but they’re available to employees of some nonprofits, hospitals, and public school systems.
But some state, local government, and nonprofit employers offer another option: the 457 plan. At their core, all three of these plans offer many of the same tax advantages.
With a 457—or a 457(b), as it’s often called—your contributions are made with pre-tax dollars. So, you’re not paying taxes on the money you put into the plan until you withdraw it later in life.
For 2019, you can contribute up to $19,000. If you’re age 50 or older, you can make an additional $6,000 catch-up contribution. That increases your annual limit to $25,000. That’s the same as a 401(k).
But unlike a 401(k) or 403(b) plan, a 457 may allow a special pre-retirement contribution for three years prior to your normal retirement age. If permitted by the plan, you can contribute the lesser of:
- Twice the annual limit, which equals $38,000 for 2019, or
- The basic annual limit plus the amount of the basic limit not used in prior years (this only applies if you’re not using age 50+ catch-up contributions).
This means that if your plan specifies 65 as your retirement age, you can contribute up to $38,000 a year once you’re age 62, provided that it’s not higher than your annual salary.
As with a 401(k), an employer can match your 457 contributions. If you invest $1,000 per month and your employer matches at 50%, you’re getting $500 of free money.
When Do I Pay Taxes on 457 Plans and Roth IRAs?
While both plans offer tax advantages, they differ in when you get the tax break. Contributions to 457 plans are made with pre-tax dollars. That means you get an upfront tax break since the contribution lowers your taxable income for the year. But you’ll pay taxes on any money you withdraw during retirement.
With a Roth, you can contribute up to $6,000 a year, or $7,000 if you’re age 50 or older. And you have to meet IRS income limits. If you’re married filing jointly, for example, you can make the full contribution if your modified adjusted gross income (MAGI) is less than $193,000.
You don’t get an upfront tax break. But your contributions and earnings grow tax-free. You effectively pay your taxes when you make the contribution—and then you’re done.
Important: Consider whether you’ll be in a higher tax bracket now than in retirement.
Early Withdrawals from 457s and Roth IRAs
Unlike other employer-sponsored retirement plans, you can withdraw money from your 457 before age 59 1/2 without penalty. But remember, you’ll still owe taxes.
With a Roth IRA, your money comes out tax-free (and penalty-free) if your account is at least five years old and you’re age 59 1/2 or older. You can withdraw your contributions at any time, for any reason, with no tax or penalty.
Do 457s and Roth IRAs Have Required Minimum Distributions?
Required minimum distributions (RMDs) apply to all employer-sponsored retirement plans, including 457s. Once you hit age 70 1/2, you have to start taking withdrawals or risk paying a steep penalty.
Roth IRAs, on the other hand, have no RMDs. That means you can keep your money in the account for as long as you live. This offers a great way to transfer wealth to your beneficiaries.
Important: RMDs are serious business. If you don’t take an RMD, you’ll be on the hook for a 50% penalty on the amount you should have withdrawn.
You Can Max Out a 457 and a Roth IRA
Another big advantage of the 457 plan is that it works well with other plans. You can max out your 401(k) or your 403(b), and still max out your 457 (you can’t max out all three). So, you can contribute $19,000 to both plans, for a total of $38,000 each year.
And if you have a 457, you can still make a full contribution to a Roth IRAs, as long as you’re eligible to. Each plan offers a tax-advantaged way to save for retirement—and you can max out each of them. It can make sense to fully fund both a 457 and a Roth IRA if you have the money to do so.
Because you have to pay taxes on your Roth IRA contributions at the time of deposit (which means you don’t pay taxes when you later withdraw the funds), having two types of retirement accounts can serve as a hedge—protection against the unknowns of the future.
If tax rates are astronomically higher when you retire, you got a great deal on your Roth IRA. If they’re lower, your 457 will be the more tax-efficient account. Either way, one will help to balance out the other—a hedge in the investing world.
Roth IRA in a 457
What if you want the advantage of a Roth IRA inside of your 457? Some employers offer a Roth option. If available, you can designate all or a portion of your contributions to be after-tax contributions that you later withdraw tax-free.
It might still be a good idea to have a separate Roth IRA account so you can save even more. If you’re behind on contributions, the separate Roth gives you a higher maximum for the year.