403(b) vs 457(b) Retirement Plans: Which Is Better for You?
As a medical worker, you may wonder which retirement plan you should choose. After all, you want to effectively plan for your future and ensure you’re putting money away using the most effective method possible. It’s a good idea to compare retirement plan options so you make the right choice for your situation.
We’ll look at the difference between a 403(b) and a 457(b) and discuss whether or not you can have both plans. By the time you finish reading this article, you may have a better idea of whether or not you should opt for a 403(b) or a 457(b) — or both!
403(b) plans, explained
A 403(b) plan is a retirement savings tool for the following types of employees:
- Public school employees
- Clergy and other individuals who work at a place of worship
- 501(c)(3) tax-exempt organization workers
- Public school and private school employees
- Hospital employee
- Home health agency worker
- Health and welfare service agency worker
A 403(b) plan allows employees to contribute some of their salary to the plan. 403(b) accounts allow your investments to grow, either tax-deferred or tax-free. They are much like retirement plans for private sector employees, particularly the 401(k).
How does it work?
When you contribute to a 403(b) plan, contributions generally come out of your paycheck before income taxes (on a pre-tax basis), lowering your tax liability. Your money grows tax-deferred — you do not have to pay income taxes on the money you contribute until you withdraw it in retirement.
Your employer may contribute to the plan on your behalf through matching or nonelective contributions. You must reach age 59½ before withdrawing funds or pay a withdrawal penalty and income tax, depending on when you made contributions on a pre or post-tax basis. Some exceptions exist, such as hardship distributions, severance from employment, disability, financial hardship, or death.
As an employee, you can decide how you invest your contributions. You typically select from mutual funds or other types of investment options.
A tax-advantaged, employer-sponsored Roth 403(b) combines elements of a Roth IRA and a traditional 403(b). Money goes into the account after you pay taxes. You can take tax-free withdrawals in retirement and pay no taxes on the money you earn.
Many employers offer contribution matching programs, just like in a pre-tax or traditional 403(b). Employees can contribute to a Roth version of a 403(b) account, but employers cannot — they can only fund traditional 403(b) plans. Any contributions from your employer will go into a separate traditional 403(b) account.
You can withdraw money from a Roth 403(b) when you reach age 59½, when employment ends, or if you face financial hardship, disability or death.
Limits of 403(b)
You can contribute up to $22,500 in 2023 through an elective salary deferral. Employees 50 or over can add a larger catch-up deferral — $7,500 in 2023.
Employer and employee elective salary contributions also have a limit, generally the lesser of $66,000 of the combination of all employer contributions and employee elective salary deferrals to all 403(b) accounts or 100% of includible compensation for the employee’s most recent year of service.
Employees who have at least 15 years of service with the same eligible 403(b) employer has a 403(b) elective deferral limit increased by the lesser of: $3,000, $15,000, reduced by the additional elective deferrals made in prior years due to this rule, or $5,000 times the number of the employee’s years of service for the organization, minus the total elective deferrals made for earlier years.
457(b) plans, explained
A 457(b) plan offered by state and local government agencies and certain nonprofits (including health care agencies) allows you to save money in a savings account. Contributions are deducted from your paycheck and grow tax-free while held in the account. Your employer can add money through a contribution matching program, but it’s important to note that most choose not to.
You cannot withdraw funds from a 457(b) account while working for the plan sponsor. Once you’ve left your job, you can take out funds free of the 10% early withdrawal penalty common to other retirement plans but will generally have to pay taxes on any money that hasn’t been taxed before.
The contribution limit for a 457(b) is $22,500 for 2023 for workers under age 50. You can also contribute an additional $7,500 in 2023 if you’re 50 or older.
Workers can save extra money starting three years before the “normal retirement age.” They can contribute as much as twice the limit, or $45,000, for 2023. The amount can vary depending on the organization you work for.
A Roth 457(b) works similarly to a Roth 403(b) in that it allows you to save after-tax dollars for retirement.
Differences between 403(b) and 457(b) plans
Let’s look at some differences between a 403(b) and a 457(b), including employer contributions, catch-up contributions and withdrawals.
- Employer contributions: Employers may contribute to both a 403(b) or 457(b) account but the 403(b) has a much higher limit than the 457(b) in 2023.
- Catch-up contributions: You can contribute an additional $15,000 over five years to a 403(b) if you’ve worked for the same employer for at least 15 years. You may also double your annual contribution limits for a 457(b) during three years leading up to the “normal” retirement age, assuming you didn’t max out your 457(b) contributions before.
- Withdrawals: You can start taking penalty-free withdrawals at any age from a 457(b) when you leave your employer but must wait until you turn 59 ½ with a 403(b).
Can you have both retirement plans?
Some employers offer both plans. Both types of plans may allow you to save more money for retirement on a tax-deferred basis.
You may want to consider contributing to both a 457(b) and a 403(b) plan because contribution limits aren’t tied together. You can contribute to both but are bound by the individual total contribution limits set by the IRS for each type. Maxing out your contributions to both accounts means you could contribute up to $45,000 in both plans, and even more if you’re 50 or older.
Consider making an appointment to talk to a financial planning professional to determine whether it makes sense to contribute to both plan types.
Which plan retirement plan is best for you?
No one “right” plan fits every single person. Each individual has different goals and preferences as they navigate choosing the right retirement plan. Therefore, it’s a great idea to consider your goals, investment horizon, and other factors, such as additional savings goals you may have before you land on the right plan that fits your needs.
Find out which plan works best for you by talking to a financial advisor about making the puzzle pieces fit your particular situation.