Would you like a better version of a 401(k) or 403(b) to invest in for retirement?
How about something with the same tax-deferred benefits of those plans, but with more flexible rules that eliminate penalties? Would you like it if were almost guaranteed to have low fees? Or if a government overseer ensured that the plan was administered fairly? If you haven’t already, please nod your head.
If you’re a state employee, you most likely have access to the plan I just described. It’s called a 457. Unfortunately, there’s a good chance you’ve never heard of it. My wife, a public school teacher in Massachusetts, has had access to a great 457 plan for seven years but had heard not one word about it from her superiors. Only through my research and writing about retirement did we uncover the details (in her case it’s called the SMARTplan), and we are in the process of signing up now.
First, some explanation. The name “457” relates to the tax code change that put the plan into existence. It provides a way for public employees to save money for retirement by removing money right from their paychecks before taxes are paid on it. As of 2016, the limit is $18,000 per year, the same as a 401(k) or 403(b). To break that down: for every $1,000 set aside, a person will save $150-$280 on their taxes each year, depending on their tax bracket. When the money is withdrawn in retirement, it is taxed as ordinary income.
It sounds ho-hum on the surface, but there are a few key differences that make 457s worth looking into. Because each state has one centrally-managed 457, its fees are in general cheaper than similar 403(b) plans. They also contain simpler investments on the whole, with less chance of a salesman pressuring participants into complex, high-fee insurance products. But most importantly, after a 457 investor leaves their place of employment, they are allowed to remove money from the plan without incurring a penalty.
This allows early retirees, or those needing money, to avoid the 10% penalty attached to 401(k) and 403(b) withdrawals that take place before the age of 59 ½. This added flexibility makes the plan a no brainer, as it passes a common sense test over other plans: better in some ways, worse in none. And for those who already have 403(b)s that they like, it’s not an either/or proposition: a person can invest up to $17,500 per year in each plan for a grand total of $35,000 in potential tax sheltering each year. I didn’t believe this at first, but as of right now it’s true.
But if a 457 is such a slam-dunk (and in my opinion it is, though each state is different, so do your research), then why didn’t anyone tell my wife? I can’t be sure, but I have a theory. When she started teaching, she got a sheet of paper with a dozen 403(b) providers. Many, but not all, were insurance companies. Each company listed the name of a local salesperson with their desk number. Some of these salespeople came to her school to provide information on investing. These salespeople stood to make money from these teachers, and though their intentions were largely good, their very existence virtually ensured that their products would be expensive. Otherwise how would their salaries be paid? When we inquired about a 457 plan, her school actually didn’t know who to contact, because no one had ever asked about it. We ended up using the website to sign up. It appears that the 457, unlike the 403(b), has few beneficiaries and therefore few cheerleaders.
So for today, I will be that cheerleader. If you work for a state, ask your employer about 457 plans. And if they have one, but you’ve never heard of it before, ask ‘why not?’