There are about 10 million or more employees in the United States that work for state or local governmental agencies. Those government agencies will often offer a pension plan and/or a traditional retirement plan like a 401(a) (note I didn’t say 401k there is a slight difference) or 403b. A lot of times these employers will mandate a contribution like 5% or 10% of your salary. However, that 10% contribution is lower than the recommended 15% put forward by many financial planners.
So what can you do to increase your savings?
Well, you could enroll in an IRA (Traditional or Roth) where you could save $5,500 per year ($6500 if you are over 50). But that is small potatoes when compared to another savings vehicle/retirement vehicle that doesn’t get discussed a lot and that is the 457b plan.
What is a 457b?
Before I go further I have to give credit to Ed Mills over at Millionaire Educator for providing a lot of groundwork on this subject. Ed has a brilliant post on 457 plans and did a great podcast on the subject over at ChooseFI (a podcast I think everyone who wants financial independence should listen too).
A 457b plan is another retirement vehicle that is often offered to public employees (e.g. school teachers, police, etc) and some non-profit organizations. 457b plans are sometimes called deferred compensation plans. Here is why I love them (and I am repeating things others have said, but these are my reasons to love them).
First, you can max a 457b plan up to $18,000 AND you can also max out a 403b plan if it is available to you. In other words, if you don’t take the pension at your place of employment and you have a 403b you can max the 403b AND the 457. At most private work places you only get a 401k or a 403b and then you have to find different retirement vehicles to max. You could save up to $36,000 with your employer that is tax-deferred. You can SUPERCHARGE your savings.
Second, the rules on 457b plans are pretty sweet. 457b plans are considered deferred compensation, which means that the rules about withdrawing that money are a little different than other retirement plans. In a normal retirement plan (e.g. 401k or 403b) you would pay a 10% penalty on your money if you took it out before 59 1/2. With the 457b plan, when you leave your employer and not before, you can actually role that money to an IRA OR leave the money with your former employer and take the money out little by little WITHOUT penalty. There is NO 10% penalty for taking out the money before 59 1/2. Now you will still have to pay taxes on this compensation, but if you follow some smart planning rules you could actually max out some retirement accounts and use your 457b plans to fund your retirement almost tax free (another post for another time), letting the money grow in those other accounts.
Third, 457b plans often give you the same investment options as a normal retirement plan. When you put money in a 457b plan that money isn’t just a savings account. You have the ability to make that money grow through normal investments such as mutual funds and the like. A 457b acts just like a normal retirement plan, but without the withdrawal penalty. If I look back on it now I think I should’ve done the 457b instead of the 403b. C’est la vie.
Finally, there are some places where you have THREE employer-based retirement accounts that are tax-deferred. And I am one of the lucky ones. For example, when I began working at my employer I had a choice of a pension plan or what we called the Optional Retirement Plan, which was classified as a 401a (not 401k). I chose to do the Optional Retirement Plan for a number of reasons, which you can check out in the highlighted post in the previous sentence.
However, because of my job I am mandated to put 10% of my income into that account. So that is retirement account #1.
In addition to my 401a I can open up a 403b (Retirement Account #2). So a couple of years later I opened up a 403b account, which I have been maxing for the past couple of years. I didn’t realize it at the time, but I could have also opened up a 457b (Retirement Account #3), which I am going to start at the beginning of the new year. In other words, I can have a 401a, 403b, AND 457b plan. That means I can be saving about 45k a year that is TAX deferred. WAHOOO!
Now I don’t think I will be able to max out the 457 right away, but I am going to start with a small amount and slowly build from there.
The Bottom Line: If you are a local or state government employee or work for a non-profit that allows it consider a 457b plan. They can be especially helpful if you are behind on retirement savings, want a bit more diversification than your pension plan, and/or want to supercharge your savings. I am lucky that I have 3 options available AND I can also put money into an IRA if I want. The 457b is one of the best kept secrets for a lot of us. Use it to your advantage!