Thursday, August 19, 2021

Retirement Savings: 401(k) vs. 457

Within the last few years, a number of people in my life have retired.  While one of them likes to joke about the glamorous life she leads tending to her yard and scooping dog poop, the truth is that they're all living their best lives.  I am absolutely inspired as I watch them all make their individual choices to do things like snowbird, create a garden oasis, move to another state, build their dream homes.  They're all making different choices, but the fact remains that they have all positioned themselves to allow their money to support them in living their best lives.  I think we could all learn something from that wisdom.

What do you want to do when you retire? Have you spent much time thinking about that?  I'm in the middle of a real estate transaction right now; buying a piece of real estate in which to live.  I can tell you that my partner and I were considering retirement goals and dreams when making this choice.  We wanted a serene atmosphere and the appropriate amount of space for our situation.  It was important that we could have it fully paid off by our desired retirement date, and that we could still save considerably for our retirement.  We are fairly adventurous and will likely want to travel, or at least have the option to travel.  Maybe we'll want to take a big RV trip or have a cottage by the lake.  The truth is that we aren't sure yet, but what we are sure of is the fact that we want choices, and that's something money can afford us.

I talk so much about inspired action as a part of my process of using Law of Attraction in conjunction with my finances.  Imagining myself having all of these choices in front of me feels really inspiring and makes me really, truly want to save money. In part, I believe that I can have any of these things that I want, and beyond that belief lies a collection of actions I'm inspired to take.  Sometimes people get inspired to take an action, but then they get a little hung up on the technicalities of some financial tool or strategy because they don't fully understand them. This is where a little knowledge goes a long way! I get really excited about the idea of saving for my retirement, but I can see where people get a little confused.  I mean, I have SO MANY choices of retirement accounts that I can use?  My employer offers me a TDA, 401(k), and 457.  There are Roth options on both the 401(k) and 457, plus, I could use my IRA to save!  How are we supposed to decide which will serve us best?  In this mini-series, I am taking the time to compare some of the various retirement savings vehicles in order to help people with that very thing!  This week, I am comparing the 457 with the 401(k).  When I compare these two accounts, I am looking at the traditional versions of them.  It's important to realize that there might be Roth options available (there certainly are for me), and I do like to use them!  But, in comparing the traditional versions, we can gather a bit of data about some key differences in order to inform our choices.


Let's start with a quick overview.  A 401(k) is a retirement savings vehicle that many employers offer as a benefit to their employees.  A 457 is very similar, except that a 457 is generally only offered to state and local government employees (and certain nonprofits).  So, oftentimes police officers, teachers, and other civil servants will have a 457 as an option.  Interestingly, the 401(k) is covered by the Employee Retirement Income Security Act of 1974, also knowns as ERISA, whereas a 457 is not.  This makes a 457 a nonqualified retirement plan.  Why does this matter?  If your employer has given you both options, you can literally contribute the max to both of them!

Contribution Limits:

I want to start by reminding you that contribution limits are subject to change and tend to be updated annually.  In 2021, a person using a 401(k) can contribute up to $19,500.  This limit is the same for the 457.  If you have access to a 457 and a 401(k), you should be getting ridiculously excited right now.  If you aren't, let me reiterate a point so you too can get excited.  If you have access to both a 401(k) and a 457, you could contribute a full $19,500 to the 401(k) and then turn around and contribute another $19,500 to your 457!  Again, this is because of what I said above about ERISA.  Now, if you're in the 50+ age category, this deal gets even better.  People in the 50+ category get what's called a "catch-up contribution," which basically means that you can contribute an extra $6500 per year to a 401(k) or a 457.  The catch-up contribution is the same for both!

There's also a very strange little rule that applies to a 457 that could really work to your benefit if you know about it.  It's called the "Double Limit."  In the last three years of your working career, you are allowed to contribute double the annual contribution limit to your 457 if there were years in which you were eligible but not contributing.  To clarify further, you can take advantage of the double limit in the last three years prior to retirement or use the catch-up contribution, but not both.  This means for those three years, you could contribute up to $39,000 into your 457 if there were years that you hadn't been contributing (but were eligible).  That's a huge advantage!

Employer Match:

People like to talk about being sure to contribute enough to the 401(k) to get the full employer match. Quite frankly, I couldn't agree more!  Why on earth leave free money at the table!  Now, matches are really common with a 401(k), although they aren't required to do so.

A company match is extremely rare with a 457. Oftentimes, people working for government entities receive a pension, therefore they don't typically get a match on top of that.  Now, in the rare event that you actually have a 457 with a match, there's an additional oddity you might want to be familiar with.  If a 457 has a match, the match counts toward the overall limit.  For example, if the annual limit is $19,500 and your employer puts in $10,000, you only have $9,500 left that you can contribute because both their contributions and yours in combination will have hit the limit.  It doesn't work that way with a 401(k).  With a 401(k), the match doesn't impact your contribution limit.

Early Withdrawals:

If you want to take money out of your 401(k) before you hit age 59 1/2, you will not only have to pay taxes on the funds, but you will also incur a 10% penalty!  Ouch!  No one wants that! Interestingly, that penalty doesn't exist with a 457!  Now, you'll still have to pay the taxes, but you won't have to pay a penalty for an early withdrawal.  If you're considering early retirement, that's a big deal!


I hope reading this has given you a sliver of inspiration as you design your way forward, creating for yourself the financial life of your dreams.  Sometimes we get paralyzed by what we don't understand, and I get it, but just a little knowledge goes such a long way! As you wade through these comparisons, I hope some little nuggets of information jump out at you and inspire you to want to take advantage of something that is presenting you with the opportunity to live the life of your dreams. Don't you owe that to yourself?

Further Reading:

My 3 Bucket Approach to Retirement Savings

Retirement Savings: Roth IRA vs. Roth 401(k)

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