You cannot rely on your pension alone to take care of you during retirement. This is why retirement savings plans are a great way for you to put money aside so you can enjoy your retirement.
But with so many plans out there, how can one make an informed decision on which to choose?
In today’s post, we will talk about the difference between two popular retirement savings plans: the 403(b) plan and the 457(b) plan.
What is the difference between the two? Who is eligible to participate in these plans? What are the contribution limits for each? How about pros and cons?
By the end of this post, you will know the difference between a 403(b) and a 457(b) plan and which one may be best-suited for you.
The 403(b) Plan
A 403(b) plan is also called a tax-sheltered annuity (TSA) plan.
It is a retirement plan for:
- Public school employees
- 501(c)(3) organizations (private non-profit organizations)
- Cooperative hospital service organizations
- Civilian faculty or staff of the Uniformed Services University of the Health Sciences
- Certain ministers
The contribution limit for a 403(b) plan in 2019 is $19,000. If the person is over 50 years old, they can contribute up to $6,000 more if they want to catch up with their retirement savings.
Individual accounts in a 403(b) plan can be set up in the following ways:
- An annuity contract: This is a contract provided through an insurance company.
- A custodial account: This is an account invested in mutual funds.
- A retirement income account: This one is set up for church employees. Generally, retirement income accounts can invest in either annuities or mutual funds.
What Are the Benefits of a 403(b) Plan?
The advantages of contributing to a 403(b) plan include:
- You don’t have to pay income tax on your allowable contributions until you start making withdrawals; typically, after retirement. Employees will still pay Social Security and Medicare tax on contributions, however.
- The earnings and gains on your 403(b) plan are not taxed until you withdraw them.
- The third benefit is that you could be eligible to take a credit for elective deferrals contributed to your 403(b) account. This means if you and your employer make eligible contributions, you may be able to take a credit of up to $1,000 if you are filing single or $2,000 if you are filing jointly. This credit could reduce the federal income tax you pay. You are eligible for this third benefit if:
- You are over 18 years old.
- You are not a full-time student.
- Nobody else, such as your parents, is claiming you as an exemption on their tax returns.
- Your adjusted gross income is no more than:
- $63,000 for 2018 ($64,000 for 2019) if your filing status is married filing jointly;
- $47,250 for 2018 ($48,000 for 2019) if your filing status is head of household (with qualifying person); or
- $31,500 for 2018 ($32,000 for 2019) if your filing status is single, married filing separately, or qualifying widow(er) with dependent child.
The 457(b) Plan
People who work with state and local governments can participate in the 457(b) plan.
Employees working at certain tax-exempt organizations under the Internal Revenue Code 501 are also eligible to contribute to a 457(b) plan.
In 2019, employees with a 457(b) plan can contribute up to $19,000 to their plan. If you are within 3 years of the normal retirement age, under this plan, you can contribute up to $38,000 extra in 2019. If you are over 50 years old, you can also put in an extra $6,000.
From this provision alone, you can see that compared to the 403(b) plan, you can contribute more money to a 457(b) plan.
There are significant advantages available to people who contribute to a 457(b) plan. Those advantages include the facts that both contributions and earnings made on retirement money are tax-deferred.
If it is allowed, a participant in a 457(b) plan can make Roth contributions to his or her retirement. This way, the participant pays taxes before contribution and thus they will not have to pay taxes on interest and earning during retirement.
The thing to note here is that because this plan is offered to state and local government employees, the chances of employer matching are usually low.
When employers do match, however, it is in addition to whatever the allowable employee contribution is.
So for instance, if an employer contributes $5,000 to the plan, the participant/employee can only contribute $15,000 in 2019.
How They Are Similar
The 403(b) and 457(b) plans are similar in the fact that they can be offered to employees who work in the public sector such as governmental organizations and tax-exempt organizations/non-profit organizations.
Another similarity is that contributions and earnings in both plans are tax-deferred until the contributor starts making withdrawals.
They also both have catch-up plans based on certain stipulations.
How They Are Different
From a pure which-one-of-these-will-make-me-the-most-money standpoint, a 457(b) plan is a better option than a 403(b) plan simply because you can contribute more money to it.
Here’s how they differ:
- The 457(b) plan provides more catch-up options. As I mentioned above, an employee who is within 3 years of retirement can contribute up to $38,000 extra in 2019 under the 457(b) plan. The 403(b) plan, on the other hand, only allows a $6,000 catch-up under the same circumstances.
- The number of investment options under a 457(b) plan are fewer than the 403(b) plan. Thus, if you wanted access to a wider array of investment options, the 403(b) plan would be a better choice. This is where a 403(b) participant could beat a 457(b) participant in overall earnings with strategic investing.
If you work in any of the areas already mentioned, chances are your employer can offer you a 403(b) and/or a 457(b) plan.
In this post, my goal was to lay out the differences between the plans because it does get confusing.
Are you currently participating in either plan? Let us know in the comments below.
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.