Why I started investing money into 457(b) plan and maxed out Contribution limit

I’ve never taken retirement plans seriously. The way they work is – you set aside a portion of your hard-earned take-home pay and invest them into the retirement plans like 401(k), IRA or Roth versions and let it grow for a number of period until you reach retirement. The one big reason why I loathe them is because you can’t make any withdrawals before you are at the age of retirement else, you’ll have to 10% penalty and taxes.

The idea of not being able to access my own money was just mind boggling. Therefore, I never bothered to research any further on these types of (retirement) investment plan until I was required to pay huge tax on my earning this year. The tax benefit that comes with the 457(b) was the single enough reason for me to start investing my money into 457(b) plan and maxing out the contribution limit. I’ll explain below on other reasons why I considered 457(b) plan. Before I go into detail on how I started investing my money into 457(b) plan, let’s get some basics out of the way.

What is 457(b) tax- deferred Compensation Plan?

457(b) is a tax deferred employer sponsored retirement plan that is available for certain State, non-profit organizations and local government employees as discussed in IRC Section 457.

Under this retirement product, eligible employee can deduct elective amount from their pay check (referred to as deferral contribution) to contribute to the 457(b) account up to the contribution limit. This supplemental plan to other retirement plan is also termed as 457(b) deferred Compensation plan. This plan is called retirement saving plan since it helps to save, invest and grow before-tax or after-tax dollar through voluntary salary deferral. 457 (b), in so many ways, is similar to 401(k) with its own perks.

What are 457(b) Plan Contributions limits?

The maximum 457(b) plan contribution limit as of 2021 is $19,500 per year.

This is the standard contribution anyone can set aside from their income.

Employee over 50 years are also eligible to contribute additional $6,500 per year as a catch-up contribution which increase their limit to ($19,500+$6,500=) $26,000.

If you are within 3 calendar years of retirement, the contribution limit doubles to $39,000 as a special catch-up.

Why I started investing into 457(b) plan?

The main reason why I started investing in 457(b) plan is because you can’t grow your money if you don’t have them.

If you are an average guy like me; making decent income, and yet wondering where all your money disappears at the end of the years them what I’m sharing will make sense to you. As a W-2 employee, a big chunk of our money will be deducted in taxes. You don’t have control over this money because everyone earning money has to pay taxes. The more you make, higher the tax bracket you’ll end up with and uncle Sam will take a big share of it.

For an average person making decent income, if he/she can reduce taxable income, there is big savings. The big Gurus in personal finance calls it Tax avoidance. The basic concept is to reduce total taxable income by investing into tax advantage account, (like 457(b)).

You can’t completely skip paying taxes and will have to pay taxes when you withdraw but until your money is taken out of the account, you do not owe any money to the IRS. And the best part is it will grow tax free, if invested.

Another reason why I started investing into 457(b) plan is because, it does not have 10% early withdrawal penalty unlike traditional 401(k) and IRA. Saving my money for future (else it will be spent in my checking account), tax advantage and no early withdrawal penalty has made 457(b) plan lucrative investment.

I’ll show you below, how much I’m saving by parking my money in 457(b) tax deferral investment vehicle.

How much money am I saving on taxes by investing on 457(b) plan?

Let’s take a real example using my situation. I analyzed my two pay checks to compare the difference after I invested into 457(b). The analysis is based on the by-weekly pay stub and deductions include, taxes, insurances, Flexible spending account and 457(b) contribution.

Scenario 1: Before investing in 457(b):

Gross pay: $3,109.69

Deductions: $891.38 and

Take Home pay: $2,218.31

Scenario 2: After investing on 457(b):

Gross pay: $3,109.69

Deductions: $1,331.38 and

Take Home pay: $1,778.31

Generally speaking, my total deduction should go up by $500 on the Scenario 2 because that’s the amount that I’m deferring into 457(b) plan. But based on the figures above, my total deduction went up by only $440 ($1,331.38-$891.38).

Subsequently, you should have also notice this from the dip in my take home pay of $440 (from $2,218.31 to $1,778.31).

This shows that I’m saving $60 on my taxes in every pay check. That’s my $60 additional to keep. I would be spending $60 more every pay check had I not invested my money in 457(b).

I don’t know about you guys but (free) 60$ every paycheck sounds good to me. This one saving can pay off my full month worth of lawn mowing (I pay $30 for each lawn mowing for my house).

Can I withdraw money from my 457b plan to buy a house?

The short answer is No, withdrawal from 457b plan to buy a house is generally not allowed unlike in 401K plan. The plan can only make hardship distribution provided that the participant does not have any other source of income.

What are the differences between 457b and 401K plan?

Both 457b and 401K are defined contribution plans and are used for retirement.

The major difference between the two is, there is no early withdrawal penalty of 10% in 457b plan if the money is drawn out after the employee leaves the service.

Employer match is rare in 457b unlike 401K.

You can take short term loan against 401K for events like house down payment. This is not allowed under 457b.

how much tax do you pay on a 457 withdrawal?

A 457b plan will be taxed as a regular income when you leave the job also called “separation of service”. An early withdrawal penalty will be charge to you if you are withdrawing money after you left the job. At this time, you will not have any income, therefore it is the right time to withdrawal the money.

Withdrawing money from 457b plan is not complicated. It is fairly easy and straightforward. They money can be deducted as you may feel necessary. It can be one whole lump sum amount or certain amount distributed over certain time.

when can you withdraw money from a 457 without penalty?

The money can be withdrawn from the 457b plan penalty free once you leave the job. Otherwise, you’ll have to wait until 59 ½ to withdraw money penalty free.

The plan also gives you an option to take hardship withdrawal penalty free but this option is only available if all other avenues of getting money is exhausted.

Withdrawing money from 457b plan is not complicated. It is fairly easy and straightforward. They money can be deducted as you may feel necessary. It can be one whole lump sum amount or certain amount distributed over certain time.

Can I contribute to my 457b after I retire?

You can not contribute to your 457b plan after retirement or separation of service. You do not have to withdrawn money immediately as well. You can keep money into your 457b as long as you want until the required minimum distribution at the age of 72.

Can I close my 457b account?

You can close your 457b account based on the circumstances like unforeseen emergency. There is also a possibility of getting the penalty waived if submitted properly under unforeseen emergency packet.

457b plan is one of the best retirement investment plan that everyone should use it in their advantage if eligible. It is the one of the best place to park your money until retirement or leaving the job that grows tax deferred. It is popular early retirees before of its benefit of no early withdrawal penalty. Do you have 457b plan available to you and are you investing into 457b plan? Let us know in the comment. If not, what is keeping you from saving your money using 457b?