A 547(b) plan is likely your main retirement savings option if you work for the state or local government, or certain non-profits such as a church. With a 547(b) things can be a little confusing because plans such as the 547(b) (and also 403(b) plans), typically get less attention. That’s a shame because 457(b)s are just as important and in many cases just as useful at 401(k)s, they just happen to be less common. However, 547(b) plans are hardly obscure, since millions of Americans have access to them. Fortunately, the differences to a 401(k) are not that great and 457(b) plans have some benefits over 401(k)s.
Just like a 401(k) a 547(b) plan is a workplace scheme to help you save for retirement. You can put aside money from your paycheck to build up a retirement nest-egg. That can be a nice setup because many people don’t save enough for retirement. Saving automatically can help you stick to a saving plan. As a nice bonus, since you’re saving for retirement pre-tax it can reduce the tax you pay now. However, remember it’s only tax-deferral, so you will pay the tax in retirement.
547(b) are tax-deferred plans. This means that you don’t pay when the money goes in, or should it grow or pay dividends. Typically, you end up paying the tax when you take the money out to spend it, normally in retirement. This means that by using a 547(b) you may save on taxes for your retirement savings. This is especially true if you expect to be in a lower tax-bracket in retirement, as many retirees are. If you elect to use a Roth 457(b), then that changes the tax angle. There are still tax benefits with a Roth, but they occur when the money comes out, not when it goes in. So like 401(k) plans 547(b) plans can offer both traditional and Roth versions. A Roth version may make sense if you are younger and expect to see your tax bracket increase in retirement. However, not all 457(b) plans have a Roth option.
As its fundamentally a retirement scheme, you do, typically, have to use the money in retirement. Generally this means you have to start making withdrawals from your 401(k) or 457(b) by the time you are 70.5, though 457(b) plans are more flexible on potential earlier withdrawals (see below).
In both, cases your employer may make contributions into the 401(k) or 457(b) plan as well if they choose to.
For most people, the annual contribution limits are the same too. For 2019, that’s $19,000 or $25,000 if you’re 50 or over. Remember too, that your contribution amount can never exceed your pay. Also, if you’re very close to retirement, contribution limits may differ (see below).
547(b) plans more flexible on withdrawal than 401(k)s. If you have left your employer, then you can normally take out money from your 457(b) without the 10% penalty that a 401(k) plan may incur for early withdrawal. That extra flexibility for 457(b) plans is helpful, but remember these plans are intended for retirement, so if you are that anxious to get at your money, then perhaps a retirement plan is not right for you, though the tax-deferral element may still be advantageous.
547(b) plans also have an accelerated way to contribute when you’re close to retirement. 401(k) plans do not have this feature. You must be within 3 years of normal retirement age to use it. If you haven’t used your contribution limit in prior years, then you can contribute up to $36,000 a year if you qualify, so it gives you a way to build your tax-deferred savings rapidly if you can afford to. Of course, you cannot save more than your salary.
So in fundamental ways 401(k) plans and 457(b) plans are quite similar, as a tax-advantaged way to save for retirement from your paycheck. However, 457(b) offer potential benefits if you’re close to retirement and want to make additional contributions based on under-contributing in past years. Plus 457(b) plans can give you easier access to your retirement funds after you leave your employer. That said, here we are dealing with the plans at a high level in terms of rules and tax consequences. The specifics of any employer-matching and investment options can ultimately make a big difference to your savings outcomes regardless of the specific type of retirement account they are in.