If you work for a non-profit organization, or a state or local government, you may have a 457(b) plan with your employer. A 457(b) plan works like a 401(k) plan, and it allows employees to make tax-deferred contributions to the plan. However, once you start making withdrawals, you will owe certain taxes.
You can withdraw funds from your 457(b) plan penalty-free at any age once you leave your employer or retire. You won't owe an early withdrawal penalty even if you are not yet 59 ½, but you will pay federal and state income taxes on the withdrawal. You can also roll over 457(b) funds to a qualified retirement plan such as a traditional IRA, Roth IRA, 401(k), 403(b), or another 457(b) plan.
How 457(b) plans work
State and local governments as well as certain non-governmental organizations may provide 457(k) plans to allow employees to save for retirement. The contributions made to the 457(b) plans are held in trust, and they can be rolled over to other qualified retirement plans like traditional IRA, Roth IRA, and 401(k).
The contributions made to a 457(b) plan grow tax-deferred over time, and participants only pay taxes when they withdraw funds from the account. If you have a Roth 457(b) plan, you won’t get the benefit of an immediate tax reduction on your taxable income, but you will take tax-free distributions in retirement. Both traditional 457(b) and Roth 457(b) plans require employer sponsorship; you cannot open a 457(b) as an individual without your employer’s consent.
Withdrawals rules for 457(b) plans
Since 457(b) plans are not classified as qualified plans, they are not limited by the same distribution rules that apply to 401(k) and 403(b) plans.
If you have not left the employer, your 457(b) assets will be locked up, and it will be difficult to withdraw funds from the account unless you have an unforeseen hardship. Even then, your employer may not approve it unless it meets its hardship exemption requirements. Some 457(b) plans may also offer plan loans to participants, but the loan must be paid over the loan term at an interest.
If you have left the employer sponsoring your 457(b) plan, you will be allowed to withdraw some or all of your retirement savings regardless of your age. You won’t pay a 10% penalty on the distribution even if you are below 59 ½, but you will owe income tax on the amount withdrawn.
In comparison, withdrawals from other employer-sponsored plans like 401(k) and 403(b) are subject to income taxes and an additional 10% penalty if you are below 59 ½. Depending on your tax bracket, you could lose a significant portion of your withdrawals to taxes. You can avoid paying the early withdrawal penalty tax by delaying distributions until you reach retirement age.
Early distributions from 457(b) plans
Once you leave your job, you can make an early withdrawal from your 457(b) plan, and you won’t be subject to the 10% penalty tax that other employer-sponsored plans have.
Typically, the penalty exemption for early 457(b) withdrawals was designed to help state and local government employees such as firefighters and police officers who retired early due to a disability or injury. The penalty exemption allowed these workers to access their retirement savings early without penalties. You may be eligible for a hardship withdrawal if the hardship is caused by an illness, accident, eviction or foreclosure, funeral expenses, property losses, or other unforeseen emergencies.
However, just because you can access your 457(b) money penalty-free does not mean you should tap into your retirement money. Withdrawing money from your retirement savings before you are retired means that you are spending money that ought to finance your retirement, and this could jeopardize your retirement goals.
457(b) Required Minimum Distributions
457(b) are subject to the required minimum distributions (RMDs) rule. Once you reach age 72, you must start taking RMDs from your 457(b) account. If you have a traditional 457(b) plan, you will pay income taxes on the distributions you take. However, if you have a Roth 457(b), you won’t pay income taxes on the RMDs.
457(b) rollovers
Once you leave your employer, you can decide to roll over your 457(b) balance to another retirement account. If you have a government 457(b) plan, you can roll over your funds to a traditional IRA, Roth IRA, 403(b) plan, SEP IRA, or government 457(b) plan. Here is an IRS chart that shows the retirement accounts you can roll into.
If you have a 457(b) plan with a private tax-exempt employer, your rollover options will be limited. You can only roll over your 457(b) balance to another private 457(b) plan. If you have retired, and you don't have another qualified 457(b) plan to roll into, the retirement savings will be distributed to you in a lump sum. This could push you to a higher tax bracket, and you will be hit with a giant tax bill.
Comparing 457(b) vs. 403(b) Withdrawal Rules
One of the benefits that 457(b) participants have over 403(b) participants is the ability to make early withdrawals penalty-free. As long as you have left your job or retired, you can take penalty-free withdrawals from your 457(b) plan at any age. In comparison, early withdrawals from a 403(b) plan attract a 10% penalty if you are below 59 ½.
Once you retire, withdrawal rules for 457(b) and 403(b) are similar. You can take penalty-free withdrawals from both retirement plans after 59 ½, but you will still pay income taxes on the distributions. Additionally, once you reach age 72, you must take RMDs from both retirement plans to avoid incurring a 50% penalty tax.
