457s and Roth IRAs are both savings plan options that can help you reach your future retirement goals. However, which savings plan option fits your needs best as a medical professional?
It’s worth considering a wide range of retirement plan options before you choose the right one for you. In this article, we’ll take a look at the definition of a 457 plan and the benefits and drawbacks of a 457. We’ll also take a comparative look at Roth IRAs, looking at the pros and cons of this retirement savings vehicle as well.
When you finish comparing the two, you may have a better idea of which option may fit your goals and investment timeline. Let’s get started.
How 457 plans work
A 457 plan is a savings plan offered to civil servants, executives at hospitals, municipal employees, law enforcement officers, and other nonprofit employees. Participants can make pre-tax contributions, enabling tax-efficient growth for retirement savings. You don’t pay capital gains on the investments in your account that you buy and sell.
You can invest in two different types of 457s, 457(b) plans, and 457(f) plans. Employees who work for the state or government can tap into 457(b) plans, while highly compensated government (and nongovernment) employees can take advantage of 457(f) plans. You can also take advantage of traditional and Roth 457s:
Traditional 457: You indicate how much in contributions you want to be taken out of your paycheck before taxes, lowering your overall tax bill. You pay income taxes on the withdrawals when you take out money in retirement.
Roth 457: With a Roth 457, you fund your account with already-taxed money in exchange for tax-free withdrawals in retirement, including any earnings you make while your money sits in the Roth 457 prior to retirement.
You cannot withdraw funds from a 457 account while working for your employer. Once you leave your job, you can take funds out without penalty. However, you will pay taxes on any money that hasn’t been taxed before.
You can contribute $22,500 for 2023 if you are 50 or younger. If you’re 50 or older, you can contribute an additional $7,500 in 2023.
457 plan pros
What are the benefits of putting your money into a 457 plan? Let’s take a look:
Double plan contributions: A 457 allows participants to double their retirement plan contributions as early as three years before the “normal” retirement age. In other words, you can contribute as much as twice the limit, or $45,000, for 2023. The amount can vary depending on the organization you work for.
Can put more in: You can contribute an extra $7,500 per year if you’re at least 50 years old for a total of $45,000 in 2023.
Can withdraw without penalties: Unlike other retirement plans, you can take out 457 money without penalties when you no longer work for the employer, even if you are not yet 59½ years old.
Rollover options: When you leave your job, you can rollover your account into an IRA, 401(k) or IRA annuity with the 457(b) plan but not the 457(f) plan.
457 plan cons
What are the downsides to a 457 plan? Let’s take a quick look at the cons because they can help you decide whether you might want to contribute to a 457 or not.
Employer contributions count: Employer contributions count as part of your annual maximum contribution, reducing the risk you may contribute as an individual.
Matching program limitations: Not all employers with 457s match employee contributions. Employees must work to save enough to meet their own needs.
May not qualify right away: The 457(f) plan rules require you to work two years for your employer before becoming eligible for the plan. If you leave the company prior to that time period, you forfeit any rights to the 457(f) plan.
How Roth IRA plans work
A Roth individual retirement account (IRA) allows you to invest without paying taxes (and penalty-free) when you withdraw your funds in retirement as long as you’re 59½ or older and have met the minimum account holding period of five years.
In 2023, the contribution limit is $6,500 a year. People 50 and older can contribute an additional $1,000. If you make more than $153,000 a year as an individual or are married and make more than $218,000 a year together, you cannot contribute to a Roth IRA.
Unlike traditional IRAs, where you must begin taking required minimum distributions (RMDs) by April 1 of the year after you turn 72, you do not need to take RMDs for Roth IRAs.
You may want to consider a Roth IRA as a good savings option for those who expect to be in a higher tax bracket in the future. Tax-free withdrawals are even more advantageous in that situation.
Take a look at Roth IRAs and 457s side by side:
Nonprofit and government employees
When do you pay taxes on 457s and Roth IRAs?
You contribute to 457 plans with pretax earnings, which means you pay your taxes when you make the contribution, and earnings are tax-free. All contributions to 457 plans grow tax-deferred until you retire when they are rolled over or withdrawn. All withdrawals are taxable, no matter what.
You make contributions to a Roth IRA “after tax,” which means you pay taxes on the income prior to putting it in your Roth account. You get a tax break when you withdraw your money in retirement. You must reach age 59 ½ and have your account open for at least five years in order to avoid paying penalties.
You can withdraw money from your 457 plan before the age of 59½ without incurring a withdrawal penalty. However, note that regular income taxes on the withdrawal still apply.
You can withdraw your contributions (but not the earnings) at any time and for any reason without any tax or penalties with a Roth IRA. Earnings withdrawals are only free from taxes and penalties if your account is at least five years old and you are 59½ or older.
Withdrawals on the earnings in the account work differently, however. They are subject to income taxes and a 10% penalty, depending on age and length of time you’ve had the account.
What about 457 Roth plans?
Some employers offer a Roth option for your 457 plan. Similar to a Roth IRA, you can make after-tax contributions to your 457 plan that you can withdraw tax-free later. Unlike a Roth IRA, your designated Roth account will be subject to required minimum distributions (RMDs), so you may want to consider a Roth IRA as well or in place of a Roth 457.
As long as they qualify as a “qualified withdrawal,” Roth contributions and associated earnings can be withdrawn tax-free in retirement. Contributions and associated earnings are qualified if five years have passed since January 1 of the year in which the first contribution was made to your account or you are at least 59 ½ years old. If the qualified distribution requirements are not met, the earnings portion of any distribution will be taxable.
As a medical professional, you may want to consider opting for both the 457 and Roth IRA, but you may want to talk with a local, reputable financial advisor before you make a final decision about your investments.