If you work in the private sector, you likely have access to a 401(k) plan that allows you to put aside a portion of your paycheck toward a tax-deferred retirement account. However, government and certain non-profit employees have alternative investment opportunities that are unavailable to the general public.
The alternatives for government employees are known as 457(b) plans for state and local government workers and Thrift Savings Plans (TSPs) for federal government workers. For highly compensated non-profit workers, the alternative is a 457(f) plan. Independent contractors are able to participate in either type of 457 plan.
In general, both 457 plans and TSPs are very similar to a 401(k). Both allow you to allocate a percentage of your wages to a tax-deferred investment program up to a specified limit. For tax year 2017, that limit is $18,000 plus another $6,000 in “catch-up” contributions if you are over age fifty.
Other plan similarities: All of the plans allow you to choose from a menu of various market investments. You must start taking out distributions from any of these retirement plans once you reach age 70-1/2. The plans can be either Roth plans using post tax-funds or traditional plans using pre-tax funds. Beyond these similarities lie some important differences.
401(k) plans are “qualified retirement plans” as defined by Section 401(a) of the tax code. 457 plans are non-qualified, and therefore not covered under the Employee Retirement Security Act (ERISA). This means that 457 plans do not have the 10% penalty for early withdrawal of funds that 401(k) plans do.
457 plans also have an extra catch-up provision that allows you to increase your catch-up contribution when you are within three years of your full retirement age, potentially up to $36,000 for 2016. In those years, you can set aside the lesser of twice the annual cap ($36,000) or the current year’s ceiling ($18,000) plus unused contributions from previous years.
TSP plans and 457(b) plans tend to have lower fees than 401(k) plans — around 0.03% for TSPs compared to approximately ten times that amount for a typical 401(k).
What is the downside of a 457 or a TSP plan — aside from working for the government? There are a few. The investment choices are generally limited for TSP plans, causing some workers to be tempted to roll their low-fee plans over into IRAs. However, there is no guarantee that any one of the IRA choices will do better than your existing plan.
With 457(b) plans, any matching contributions by your employer count against your overall contribution limit, reducing your potential total until the “catch-up years.” However, matching contributions are uncommon with these plans.
With 457(f) plans, there are additional restrictions. You must work for a specified time for the non-profit or forfeit the 457 funds. The assets are considered the property of the employer during your employment, thus the employer’s creditors can make claims against the 457 funds even though they are your contributions. 457(f)s cannot be rolled over into any other retirement plan.
These retirement plans are not always either/or choices. You can contribute to a TSP even if you draw a pension, and you can contribute to a 401(k) and a 457 plan at the same time if both options are available to you.
TSPs and 457s have enough advantages over a 401(k) that you should strongly consider contributing to them if you have the opportunity. If not, make sure you are contributing to a suitable retirement plan of some kind. Lottery tickets do not count.
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