457b vs Roth IRA: A Comprehensive Comparison Guide

Choosing between a 457b and a Roth IRA can be a daunting task, especially with so many options available. A 457b plan is typically offered by state and local governments, as well as certain non-profit organizations.

One key difference between the two is that contributions to a 457b plan are made on a pre-tax basis, reducing your taxable income for the year. Contributions to a Roth IRA, on the other hand, are made with after-tax dollars.

The tax benefits of a 457b plan are significant, with no taxes due on withdrawals in retirement. However, you'll pay taxes on withdrawals from a Roth IRA, but only if you withdraw earnings, not contributions.

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To be eligible for a 457 plan, you typically need to work for a government agency, a tax-exempt organization, or a certain type of 501(c)(3) organization.

Contributions to a 457 plan are made with pretax dollars, meaning you don't pay taxes on the money you put in until later in life.

Your employer can match your 457 contributions, which is a great way to get free money.

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A Roth 457(b) plan is a type of contribution option within a 457(b) plan, allowing you to make after-tax contributions that are not taxed when withdrawn.

In a traditional 457(b) plan, contributions are made pre-tax and taxed in retirement, but with a Roth 457(b) plan, you pay taxes on the contributions upfront.

You can make Roth contributions and associated earnings tax-free if certain criteria are met, which is known as a qualified distribution.

To be eligible for a qualified distribution, your Roth contributions and associated earnings must meet specific requirements.

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A 457 plan has some limitations to consider. You may have limited investment choices, which can restrict the potential growth of your savings.

One of the key disadvantages of a 457 plan is that you must start taking distributions at age 72, known as Required Minimum Distributions (RMDs). This can impact your financial planning and may not align with your retirement goals.

The RMD requirement can be a significant consideration when choosing a 457 plan. It's essential to factor this into your overall retirement strategy.

Here are some key disadvantages of a 457 plan to keep in mind:

No income limits apply to the Roth 457(b), making it accessible to faculty and staff at any income level.

The IRS income limit that applies to a Roth IRA does not apply to the Roth 457(b), so you can contribute regardless of your income level.

The Roth 457(b) has a much higher contribution limit than the Roth IRA, allowing you to save more after-tax dollars.

You can contribute your entire 457(b) contribution as after-tax Roth, which is not the case with the Roth IRA.

The Roth 457(b) may be particularly useful for individuals whose income is above the limit to qualify for a Roth IRA.

Curious to learn more? Check out: Rolling over Post Tax 401k to Roth Ira

The contribution limits for 457(b) plans are significantly higher than those for Roth IRAs. For 2024, the maximum annual contribution to a 457(b) plan is $23,000, with an extra $7,000 catch-up contribution for individuals over 50.

You can contribute to both a 457(b) plan and a Roth IRA, but the total contribution limit for all 457(b) plans combined applies, not a separate limit for each type of contribution. This means you can't contribute more than the total limit, even if it's split between tax-deferred and after-tax Roth amounts.

For your interest: Rrsp Contribution Limit 2024

To give you a better idea, here are the contribution limits for Roth IRAs and 457(b) plans:

If you're eligible for both a Roth IRA and a 457(b) plan, contributing to the 457(b) plan can make sense, especially if you're trying to maximize your retirement savings. The additional money invested in a pre-tax 457(b) plan could compound into a significant difference over time.

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With 457(b) plans and Traditional IRAs, you'll need to take Required Minimum Distributions (RMDs) at age 72. This means you'll have to withdraw a certain amount of money from these accounts each year.

The amount of your RMD is based on your age and the account balance from the previous year. This can be a bit of a challenge, especially if you're not used to taking withdrawals from your retirement accounts.

Roth IRAs, on the other hand, have no RMDs while the owner is alive, which is a big advantage.

Additional reading: Rules for Custodial Roth Iras

Taxation plays a significant role in retirement savings, and it's essential to understand the tax implications of different accounts.

Contributions to a Roth IRA are made with after-tax dollars, meaning you've already paid income tax on the money you contribute. However, this allows for tax-free growth and withdrawals in retirement.

If you take a distribution from a Roth IRA before age 59½ or within the first five years of opening the account, you may be subject to a 10% penalty tax.

On the other hand, contributions to a 457(b) plan are made with pre-tax dollars, reducing your taxable income in the year of contribution. This can be a significant tax benefit, especially for high-income earners.

Distributions from a 457(b) plan are taxable, but there is no penalty tax for withdrawals before age 59½.

Here's a comparison of Roth IRA and 457(b) plan contributions:

Required Minimum Distributions are a crucial aspect of retirement planning, and it's essential to understand how they work. RMDs apply to all employer-sponsored retirement plans, including 457s, once you hit age 72 (73 if you reached age 72 after Dec. 31, 2022).

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The amount of your RMD is based on your age and account balance from the previous year. If you have a 457 plan, you'll need to start taking withdrawals, or you risk having to pay a steep penalty.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 increased the age to 72 from the previous threshold of 70½. In 2023, the SECURE 2.0 Act raised the RMD age again to 73 and lowered the tax penalty to 25% of the amount not withdrawn.

Conversely, Roth IRAs have no RMDs during the account owner's lifetime. This feature allows the account to continue growing without the pressure of having to withdraw cash.

Here's a summary of the RMD ages and penalties:

If you're considering a 457 plan, be aware that some employers offer a designated Roth option, which allows you to make after-tax contributions that can be withdrawn later, tax-free. However, unlike a Roth IRA, your designated Roth account will be subject to RMDs.

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Tax rates can play a big role in choosing between a Roth IRA and a pre-tax 457(b). If you think you'll be in a higher tax bracket at retirement than you are now, a Roth IRA might be a good choice.

You pay tax on your contributions to a Roth IRA, but not on the distributions. This can be a good deal if you expect to be in a higher tax bracket at retirement.

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With a 457(b) plan, your contributions are made with pretax dollars, which means you won't pay taxes on the money until you withdraw it later in life.

You can invest up to the total annual contribution limit, and if your employer matches your contributions, you'll get free money every month. For example, if you invest $1,000 per month and your employer matches at 50%, you'll get $500 of free money every month.

The Roth contribution option in a 457(b) plan allows you to designate a portion or all of your contributions as Roth, which means the contributions and associated earnings can be withdrawn tax-free in retirement if the requirements for a "qualified distribution" are met.

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Investment options can be a crucial aspect of your investment and withdrawal strategy. A Roth IRA offers a wide range of investment alternatives, including equities, bonds, mutual funds, exchange-traded funds, and even real estate in some cases.

Having a diversified portfolio is essential, and a Roth IRA's flexibility allows you to create one based on your risk tolerance and investing objectives. This can help you make the most of your investment.

In contrast, 457(b) plans often have a more limited selection of investment options, which are typically chosen by the plan sponsor.

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You can withdraw money from your 457 plan before the age of 59½ without incurring a penalty.

This is a key difference from other employer-sponsored retirement plans, which often come with hefty penalties for early withdrawals.

The taxes on the withdrawal still apply, so keep that in mind when making your decision.

You'll need to pay taxes on the withdrawn amount, just like you would with any other income.

On a similar theme: Do You Pay Taxes on Roth Ira Capital Gains

If you're considering withdrawing from your 457 plan, make sure you understand the tax implications.

Here are some scenarios where you might be able to avoid taxes and penalties:

You can withdraw Roth assets from a 457(b) plan tax-free in retirement if the requirements for a "qualified distribution" are met.

To qualify, you must have had a Roth account in the plan for at least five years and be 59 1/2 or older. If you meet these requirements, you can withdraw your contributions and associated earnings tax-free.

If you don't meet the qualified distribution requirements, the earnings portion of any distribution will be taxable. This is why it's essential to understand the rules before making a withdrawal.

The good news is that Roth contributions can be withdrawn at any time tax-free and penalty-free. However, if you withdraw the earnings before meeting the qualified distribution requirements, you'll face taxes and potential penalties.

A Roth IRA is different from a Roth contribution option in a 457(b) plan, so it's essential to understand the specific rules for your plan.

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When deciding between a 457 plan and a Roth IRA, it's essential to consider the differences in contribution and withdrawal rules. Contributions to a 457 plan are made with pre-tax dollars, reducing your taxable income for the year, whereas contributions to a Roth IRA are made with after-tax dollars.

You can withdraw money from a 457 plan tax-free in retirement if you meet certain conditions, such as age 59 1/2 or separation from service. However, Roth IRA withdrawals are also tax-free if certain conditions are met, including a five-year holding period and age 59 1/2 or older.

If you have a designated Roth option for your 457 plan, you can make after-tax contributions that you can withdraw later tax-free, but your designated Roth account will be subject to Required Minimum Distributions (RMDs).

A 457 Plan and a Roth IRA are both popular retirement savings options, but they have some key differences.

You'll have to take required minimum distributions (RMDs) from a 457 Plan once you turn 72 (73 if you reached 72 after December 31, 2022), or face a steep tax penalty.

Roth IRAs, on the other hand, don't have RMDs during the account owner's lifetime.

Some employers offer a designated Roth option for their 457 Plan, allowing you to make after-tax contributions that can be withdrawn tax-free, but these accounts are still subject to RMDs.

If you're looking to transfer wealth to your beneficiaries, a Roth IRA might be a better choice, since it won't have RMDs during their lifetime.

Here's a comparison of the two options:

If you anticipate being in a higher tax bracket during retirement, a Roth IRA may be more beneficial.

A higher tax bracket during retirement means you'll pay less in taxes when you withdraw your money, which is a great perk.

If you expect to be in a lower tax bracket, a 457(b) plan may suit you better. This is because you'll pay taxes on the withdrawals, but you'll be in a lower tax bracket, so it's still a good deal.

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Government agencies and qualifying non-profits offer 457(b) plans, which is a unique benefit.

Roth IRAs, on the other hand, are available to anyone who meets the income requirements.

If you prefer a broad selection of investment options and want more control over your portfolio, a Roth IRA may be the way to go.

457(b) plans often have a more limited range of options, but if you're comfortable with that, it can work for you.

Consider the following: