Named after the bit of Internal Revenue Code that created them, 457(b) plans let employees save up to $15,000 a year in 2008, or, if they are over 50, up to $20,500. In 2009, employees can save up to $16,500 a year, or, for those over 50, up to $22,000. Contributions are tax-free and can grow tax-free until the money is withdrawn.
There are two types of 457(b) plans. One is for government employees, including state and local workers, police officers, firefighters and some teachers. The other covers only highly compensated employees of non-profit corporations, such as hospitals, charitable groups and unions.
Advantages of 457(b) Plans
All 457(b) plans share advantages over other types of employer-provided retirement plans, such as 401(k) and 403(b) plans. Chief among them is that there is no 10% penalty for taking money out of 457(b)s before workers turn 59 1/2, as long as they are retiring or ending their employment. Income taxes are owed but can be avoided if the money is rolled into another retirement plan. Non-profit workers can only roll the money over into another 457(b), but government plans can be rolled into a personal IRA or any employer-sponsored plan.
In addition, employees who have both 457(b) plans and 401(k)s or 403(b)s can contribute the maximum allowable amount to both. In 2008, the combined contribution caps are $31,000 a year, or $41,000 for those over 50. In 2009, they are $33,000 a year, or $44,000 a year for those over 50. Employees can contribute up to their entire salary.
The advantages don't stop there. In addition to the "catch-up" contributions offered to employees over 50 in most plans, many 457(b) plans allow employees who are within three years of their plan's normal retirement age to contribute up to 200% of the maximum allowable contribution. In 2008, that is $31,000. In 2009, it is $33,000. The clause helps workers, such as police officers or firefighters, who may reach normal retirement age before they are 50. Workers over 50, however, have to choose between the normal catch-up or the three-year cap.
Drawbacks to 457(b) Plans
Employers don't have to offer 457(b) plans to all of their employees, as they do with 403(b)s. But independent contractors who do business with employers can be included.
Also, 457(b) plans can give participants the option of borrowing from their accounts, which can inhibit the plan's growth. Participants must start taking required minimum withdrawals plans in the year in which they turn 70 1/2.
Because of the major differences between 457(b)s and most other retirement plans, they are considered "non-qualified" by the government. That means that 457(b)s are not governed by the same laws that created 401(k), 403(b) and most other workplace retirement programs. However, the money saved in a 457(b) account must be held in trust for the employee, or inside a custodial account or an annuity, which means it can only be used for the employee's benefit.