A South Texas Insurance / Investment broker has gained new school district clients using competitive investment options through 457 plans. In the past several months three large South Texas school districts have expanded their retirement options to include a 457 plan along side their traditional 403b plan. Fees are a competitive 35 basis points. These districts include Brownsville ISD, Donna ISD and the San Benito ISD, totaling over 12,000 employee lives.
The differences between a 403(b) and 457 plan offer valuable options to plan participants with varying needs.
How does a 403(b) work?
Public schools, colleges, universities, charities, state governments, local governments and other tax-exempt entities under section 501(c)(3) of the IRS code are able to offer 403(b) plans. Many of these entities have a separate, primary retirement plan – often a Defined Benefit pension plan – and the 403(b) plan is an additional vehicle for retirement savings. Sometimes the 403(b) plan is the primary retirement plan.
The 403(b) is a strictly voluntary program wherein employees can contribute money to a retirement savings account that functions almost exactly like a 401(k): an employee makes a pre-tax contribution in the form of a payroll deduction, and that money grows tax-deferred until retirement. Though there is no legal or tax restriction preventing employers from matching employee contributions, it is rare.As with 401(k) plans, there are penalties for distributions taken prior to age 59½; investment growth is tax-deferred; and approved distributions incur regular income taxes.
Unlike standard 401(k) plans, 403(b) plan documents allow multiple providers to administer, or manage, 403(b) plans – including insurance companies and investment companies – so an employee can choose which provider they prefer. Each provider will offer a different set of investment options. Most 403(b)-eligible employers have begun hiring third-party administrators to manage their provider list so that, for example, a school district does not have 30 companies that can manage district employees’ 403(b) plans. **See the note below for additional information about 403(b) plans compared with 457 plans.
How does a 457 work?
Public schools, colleges, universities, charities, state governments, local governments and other tax-exempt entities under section 501(c)(3) of the IRS code are able to offer 457 plans. The 457 is a strictly voluntary program wherein employees can contribute money to a retirement savings account. Employees make pre-tax contributions in the form of payroll deductions, and that money grows tax-deferred until retirement.
As with 403(b) plans, many of these employers have a separate, primary retirement plan – often a Defined Benefit pension. Employers can legally engage in matching contributions, and this is more common with a 457 than a 403(b) – but not as common as with 401(k) plans. As with 403(b) plans, 457 plan documents allow multiple providers to administer the plans. The 457 plan is often called a “Top Hat” plan because it offers double-deferral when coupled with a 403(b). For example, an employee can reach the contribution limit for a 403(b) and still contribute the entire contribution limit to a 457 – or vice versa. Further, as previously noted, many of these employees also have a Defined Benefit pension plan from which they will receive retirement income. In this manner, employees who can afford to make extremely large annual contributions could choose to accumulate far more employer-sponsored retirement wealth than most people employed by corporations.
As with all of the aforementioned Defined Contribution Plans, growth is tax-deferred. Upon taking approved distributions, people pay regular income taxes on 457 distributions. The significant difference between 403(b) plans and 457 plans involves the distribution rules. Anyone still working at the employer that sponsors their 457 plan cannot take distributions until age 70½ without penalty. However, if the employee leaves that employer, the employee can take distributions at any age without penalty.**See note below for additional information about 403(b) plans compared with 457 plans.
**A note about 403(b) and 457 plans: Where applicable, people can contribute to both plans, to one plan or to neither. Often employees choose to contribute more money to a 403(b) than a 457 because of the stricter age-related 457 distribution limitations. Someone nearing retirement might not want to change jobs, fearing a lower salary elsewhere. Job change and retirement are the main options available to an employee who wants to take 457 distributions. For that reason, many people treat the 403(b) as a primary plan and the 457 as a supplemental plan. However, some people – particularly younger employees – do choose to make a 457 their primary plan because they can take distributions at any age when they stop working for the employer who sponsors the plan.
