United States
Hong Kong403(b) and 457 plans: the public and non-profit routes
A 403(b) is a defined contribution plan for schools and non-profits, working much like a 401(k). A governmental 457(b) has its own separate contribution limit and no 10 per cent early-withdrawal penalty on separation from service.
Two plans that look like a 401(k) and differ in ways that matter to the clients who have them.
The 403(b)
For public schools, universities, hospitals and other tax-exempt organizations. Same elective deferral limit as a 401(k), shared with it if someone participates in both. Same limit, shared.
Historically invested in annuities, which is why they were called tax-sheltered annuities and why the fee structures in many legacy 403(b) arrangements are poor. Reviewing the investment options in a client's 403(b) is frequently the highest-value thing a planner does for a teacher.
A special catch-up is available for employees with 15 years of service with the same employer, in addition to the age-50 catch-up.
The 457(b)
A deferred compensation plan for state and local government and certain tax-exempt employers. Two features make it genuinely different.
- A separate limit. A governmental 457(b) has its own elective deferral limit, not shared with a 401(k) or 403(b). Someone with both can defer the limit twice.
- No early-withdrawal penalty. Distributions after separation from service avoid the 10 per cent penalty regardless of age.
The first is why a teacher with both a 403(b) and a 457(b) can save far more than the headline limit suggests, and it is a favorite exam point.
A governmental 457(b) holds assets in trust for participants. A non-governmental one does not - the assets remain subject to the employer's creditors. That is a substantial risk difference and the exam tests it.
The special catch-up
A 457(b) offers a final three-year catch-up allowing up to twice the normal limit in the three years before normal retirement age, to the extent of previously unused deferral capacity. Whichever is larger.
In a governmental plan it cannot be combined with the age-50 catch-up in the same year - the participant uses whichever is larger.
Rollovers
Governmental 457(b) balances can generally be rolled to an IRA or another eligible plan. Non-governmental ones can generally only move to another non-governmental 457(b).
And rolling a governmental 457(b) into an IRA loses the penalty exemption, which is a real planning consideration for someone retiring before 59½.
Who this matters to
Teachers, professors, nurses, municipal employees, and non-profit staff. Between them a large share of the population, and a group whose plans are frequently poorly explained to them.
A planner who understands the 457 penalty exemption and the double limit can add more value to a public sector client in one conversation than in most portfolio reviews.
Contribution and benefit limits are indexed annually and several were changed by recent legislation. Confirm the current figure against the IRS before relying on it.
Common questions
What is a 403(b) plan?
A defined contribution plan for public schools, universities, hospitals and other tax-exempt organizations, working much like a 401(k) and sharing the same elective deferral limit.
What makes a 457(b) different?
A governmental 457(b) has its own separate contribution limit, not shared with a 401(k) or 403(b), and distributions after separation from service avoid the 10 per cent early-withdrawal penalty regardless of age.
What is the risk with a non-governmental 457?
Assets remain subject to the employer's creditors rather than being held in trust for participants, which is a substantial difference from the governmental version.
Can you use both catch-ups in a 457?
Not in the same year in a governmental plan. The participant uses whichever is larger - the age-50 catch-up or the final three-year catch-up.
Should you roll a 457 into an IRA?
Not without considering the penalty exemption. Rolling a governmental 457(b) into an IRA loses the exemption from the 10 per cent penalty, which matters for anyone retiring before 59½.