If you work for a private company, a 401(k) plan with matching contributions may be best. If you work for a government agency or non-profit organization, a 457 plan with more flexible withdrawals may be more suitable.
Saving for retirement is an important financial goal for everyone. Two popular retirement savings plans that many people have access to are the 401(k) plan and the 457 plan. Both plans offer tax advantages and help individuals save for their future, but there are some key differences between the two. So, which retirement plan is better for you? Review key characteristics of 401(k) and 457 accounts to find the best mix for your financial goals.
Is 401K or 457 Better For You?
Choosing the right retirement savings plan is crucial for your financial future. Whether you're a public sector employee with access to a 457 plan or a private sector employee with a 401(k), it's important to weigh the pros and cons of each option to determine which one is the best fit for your individual circumstances. Both plans offer tax advantages and can help individuals save for the future, but each has its own unique features that may make one plan more suitable for your individual situation. It is best to consult with a financial advisor to choose the plan that aligns best with your retirement goals and start saving for retirement early.
401(k) Plan vs. 457 Plan: An Overview
401(k) Plans
The most popular form of a qualified retirement plan that employers offer their employees is a 401(k) plan. One reason is that there are no restrictions on the type of employer who can offer these plans.
Here are some important things to know about the 401(k) plans.
- 401(k) contribution limits for 2024 are $23,000. Enrolled participants who are 50 or older can make an additional catch-up contribution of $7,500.
- Employers often provide matching contributions. These contributions do not count toward the plan maximums and have no limits whatsoever.
- Investment accounts can grow tax-deferred, meaning taxes are paid at withdrawal. There is a 10% penalty for early withdrawals, and some employers offer Roth 401(k) options for after-tax contributions.
- Depending on the rules your employer sets for the account, you may be able to take a loan from your 401(k) of up to $50,000 or 50% of the total vested balance, whichever is less. If you fail to make regular payments on the loan, you’ll be taxed on the money as a withdrawal from the account plus the 10% early withdrawal penalty if you are younger than 59½.
Pros and Cons of 401(k) Plans
Review these pros and cons of contributing to a 401(k) plan to find the best way to invest for retirement based on your unique needs.
Pros
- More flexibility for employer matching contributions compared to 457 plans
- Fewer fees than other retirement savings accounts
- A wide array of investment options
Cons
- Fees will depend on the provider your employer chooses and could cut into your returns.
- Investment options might not be what you’re interested in having as part of your portfolio.
457 Plans
A 457 plan is nonqualified deferred compensation plan, meaning there are no penalties for withdrawing the money early. The plans are available to state and local government employees and qualifying tax-exempt organizations. Some examples of types of employees who might be offered this plan through their employer include public school teachers, law enforcement personnel, firefighters, emergency service workers, employees with local jurisdictions and government officials.
Here are some important things to know about the 457 plans.
- 2024 contribution limits are $23,000 and catch-up contribution limits for those over 50 are $7,500.
- The money in the account grows tax-deferred, which means you won’t pay taxes on it until you withdraw it from your account.
- Employers can set up the 457 plan as a Roth account, which allows workers enrolled in the plan to make after-tax contributions. In that case, the money is first taxed at the employee’s current tax rates and then goes into the account. Distributions from the account would be tax-free.
- It is rare for employers to make matching contributions in these accounts and any amount that the employer contributes counts toward the worker’s maximum for the year.
Pros and Cons of a 457 Plan
Opting for a 457 plan offers many advantages. You should also be aware of a few drawbacks before enrolling.
Pros
- Nonqualified plan allowing for early withdrawals without penalties
- Possible loan options of up to $50,000 or half the vested account balance if your employer has set up the account that way
- Option to make after-tax contributions if your employer opts for a Roth account
Cons
- Might come with higher administrative and management fees compared to other workplace retirement plans
- Investment options are often more limited
- Employer contributions are rare
457 vs. 401k: Similarities and Differences
Learn the largest similarities and differences between a 457 plan versus a 401(k).
Eligibility
One major difference in eligibility between the plans is that state and local governments cannot maintain a 401(k) plan unless it was adopted before May 5, 1986.
Additionally, 457 plans are unique because independent contractors who offer services to the employer can be eligible to participate in the retirement plan. In contrast, 401(k) plans are only for employees.
Purpose
Both plans offer pretax contributions to help participants save toward retirement. However, 475(b) plans are specifically designed for state and local employees as well as eligible nonprofit organizations. In contrast, 401(k) plans are open to a wide range of employers.
Taxation
Both accounts provide tax-deferred investment options. That means that you won’t pay taxes on the funds before they go into the account and you won’t pay taxes on the money’s earnings until you withdraw the funds from your account. You’ll pay your standard tax rate on the funds at the time of withdrawal.
Contribution Limits
Contribution limits for 2024 are the same between the plans: $23,000 with an additional $7,500 catch-up contribution option for people who are 50 and older.
Employer Matching Contributions
Both plans permit employer contributions. Contributions are less common in 457 plans, and they count toward the employee’s annual maximum contribution. Contributions are more common in 401(k) plans and contributions do not count toward the annual maximum the employee can contribute.
Withdrawals
A big difference between the accounts is the withdrawal options. Because a 457 account is a non-qualified account, the account holder can withdraw money from the account without paying any penalties. They will just need to pay taxes on the money at their current tax rates.
In contrast, participants must wait until they are 59.5 years old or older to withdraw money from their 401(k) account or face early withdrawal penalties of an additional 10% in addition to their standard tax rates. Some unique situations allow the penalty to be waived, such as the employee facing a serious hardship, death or disability.
Investment Options
The options you’ll have for retirement investments in your account will vary based on what provider your employer selects and what options it provides you. As a general rule, most 401(k) plans offer a more robust investment option, allowing you to diversify your portfolio with greater ease.
Choosing the Best Retirement Plan Based on Your Needs
As you explore whether a 401(k) or 457 account is best for you based on your retirement goals, you might want to seek counsel from your financial adviser to learn more about how you’re saving for retirement and what steps you should be taking to prepare. Making smart retirement decisions from a young age will help prepare you for the large financial change retirement provides.
Frequently Asked Questions
Is a 457 better than a 401k?
It depends on your age, needs and your employer’s matching program. A 401(k) is better if your employer makes matching contributions because those contributions don’t count toward your annual limits. But a 457 plan is better for people who are three years from retirement and need to make special catch-up contributions.
At what age can you withdraw from a 457 without penalty?
Once you leave the job that provided your 457 plan, you can take withdrawals from it at any age.
Can I roll my 401(k) into my 457 plan?
While you can roll your 401(k) into your 457 plan, you’ll likely pay the 10% early withdrawal fee if you are not 59½ years old.
Can a 457 be converted to a Roth IRA?
If your Roth IRA accepts rollovers, you can convert your 457 into a Roth IRA after paying tax on the money.
About Rebekah Brately
Rebekah Brately is an investment writer passionate about helping people learn more about how to grow their wealth. She has more than 12 years of writing experience, focused on technology, travel, family and finance. Her work has been published in Benzinga, Hearst Bay Area, FreightWaves and Dallas Observer publications.