Can You Contribute to Both a 403(b) and 457 Plan

Many universities and colleges offer access to both a 403(b) plan and a 457 plan. A question I get often is, “Can I contribute to both a 403(b) and 457 plan?” The answer is yes. If your employer offers both, you can contribute to (and max out) both. Let’s take a closer look at the retirement picture in higher education and how you can maximize your retirement plan contributions.

Higher education faculty members are postponing retirement…

There are many reasons that employees choose to continue working well into their 60’s, 70’s, or beyond. Many really enjoy their work and continue to be engaged with their teaching and research. For others, the thought of leaving what they’ve known for 30+ years is a scary idea, so they remain employed for the sense of purpose. Unfortunately though, many continue working because they don’t feel like they are financially secure enough.

Faculty Retirement Statistics

  • Between 2000 and 2010, the number of professors age 65 or older nearly doubled
  • 60% of faculty plan to work to age 70 or beyond
  • Another 15% plan to work until age 80+
  • Of those age 60 and older, 77% listed personal finances as the reason for delayed retirement

SEVENTY-SEVEN percent! This is an astoundingly high percentage, especially given the generous retirement plan benefits from most colleges and universities. My goal in working with faculty at higher ed institutions is to help them to retire when they desire, on their own terms.

When it comes to securing your financial future, it’s important to control what you can control. Markets are unpredictable. In fact, 22 of Wall Street’s brightest analysts can’t even get close to predicting the future of the market. There’s no sense in trying to do so. Instead, you should do your best to control what you can control: your risk exposure and your savings rate. This article is all about the latter. As a higher ed employee, you have unique opportunities to build a sizable nest egg. They key is to be disciplined and consistent.  

In the higher education world, saving and investing for retirement begins with 403(b) plans. For some, they have the availability to utilize a 457 plan as well. It’s important to understand the ins and outs of these plans and understand how you can take full advantage of them.

403(b) Plans

What is a 403(b)?

Simply put, a 403(b) is a retirement plan that is offered by public schools, many tax-exempt organizations, and churches. In the past, they were commonly referred to as a “tax-sheltered annuity” or TSA. Universities and colleges are generally 501(c)(3) organizations, which means they use 403(b)s as their main retirement plan. 403(b) plans are very similar to the more common 401(k) plans. They are named 403(b) plans because that is their section of the tax code.

The Basics of a 403(b)

Contributions are made to your plan in a few different ways. One, you can make employee contributions through a salary reduction agreement. Two, your employer can contribute to your plan, on your behalf. They often do this through a match. Example, they will match 100% of your contribution amount up until yours reaches 6% of your annual pay. Another way employers contribute is through a flat percentage. I’ve seen schools that offer anywhere from 7-15% of your pay into your 403(b), regardless of whether you make employee contributions or not.

Your employee contributions are made pre-tax. You contribute through salary deferral and the amount you contribute lowers your taxable income dollar for dollar for that year. This can help you by staying or lowering you into a lesser tax bracket. For higher ed professionals, this can also help you to qualify for lower student loan payments, among other benefits. (Have student loans? Look into PSLF)

Your 403(b) account grows tax-deferred. Not only do your contributions lower your taxable income, but the growth within your account is not taxed until you withdraw the funds. This can help you to build wealth quicker because you are reinvesting all growth in your account rather than paying a chunk each year to Uncle Sam.

Withdrawals are taxed at your ordinary income tax rate once you reach age 59 ½. If you take money out prior to age 59 ½, you are subject to income tax and also a 10% early withdrawal penalty. There are a few exceptions to avoid the penalty. These include separation of service after age 55 and hardship provisions. Once you reach age 70 ½, Uncle Sam makes you take required minimum distributions, whether you need the money or not. The government wants their tax dollars that you’ve deferred for years.

403(b) Contribution Limits

If you are under age 50, the maximum pre-tax employee contribution is $18,000.

If you are over age 50, the IRS allows for employees to use “catch-up” contributions.  In 2017, the catch-up amount allowable is $6,000.  This makes your maximum employee contribution limit $24,000.

Your employee and employer contributions combined cannot exceed $54,000.  It is rare for this limit to come into play but it is still important to know.

Another item to be aware of is the 15-Year Rule.  Employees with 15 years of service with their current employer and an annual average contribution of less than $5,000 per year are eligible for an additional $3,000 contribution per year.  These extra contributions are limited to $15,000 over your lifetime.   Employers are not required to make the 15-Year Rule available. In fact, many have done away with it.

457 Plans

What is a 457?

457 plans are retirement plans available to employees of state and local governmental agencies, and certain tax-exempt organizations. Some employers offer only a 457 plan. For higher education, you normally only see 457 plans made available alongside 403(b) plans. When both are available, you can contribute to both. Not only can you contribute to both, you can max out both plans. I find that many employees are unaware that they can max out the two plans concurrently. This is a great way to supercharge your retirement savings.

The Basics of a 457 Plan

Contributions are made pre-tax and are tax-deferred, much like 403(b)s. The contributions are made by you, the employee, via a salary reduction agreement. It is less common for employers to make any contributions into the 457 plan, but it does happen on occasion. When both plans are offered, the 403(b) is typically the primary retirement plan for the institution.

Withdrawals are taxed as ordinary income. A huge advantage to 457 plans is that following separation of service, THERE IS NO EARLY WITHDRAWAL PENALTY.  This is immensely underutilized. If you plan on retiring before 59 ½, 457 plan contributions can be the bridge that gets you to the point when your 403(b) assets are no longer subject to early withdrawal penalties. This is also a great option for a family in which spouses have a significant age gap. If you wish to retire at the same time, but the younger spouse won’t be 59 ½, it won’t be an issue if you have assets in a 457.

457 Contribution Limits

The elective deferral limit for 457 plans in 2017 is also $18,000.

If you are over age 50, the IRS allows for employees to use “catch-up” contributions.  In 2017, the catch-up amount allowable is $6,000.  This makes your maximum employee contribution limit $24,000.

Special 457(b) catch-up contributionsif permitted by the plan, allows a participant for 3 years prior to the normal retirement age (as specified in the plan) to contribute the lesser of:

  • Twice the annual limit ($36k in 2017), or
  • The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions)

Normal Retirement Age is the age specified in your employer’s 457 plan and is typically the age you choose for the purpose of initiating your Special 457 Catch-Up election. You must:

  • Be age 65, or
  • Have the right to retire to receive full retirement benefits under your employer’s pension plan with no reduction for age or service
  • No later than age 70½

Maximize Contributions in 403(b) & 457

Want to maximize your retirement savings within your work retirement plans? Consider these examples from the IRS:

You’re in a 457 and a 403(b) plan, and each plan allows the maximum deferrals for 2017. You may be able to defer:

  • When you’re under age 50: $18,000 to each plan in 2017
  • If you’re age 50 or older in a 457 plan: $24,000 to each plan if both plans allow age-50 catch-ups
  • When you’re age 50 or over and your 457 plan has a 3-year catch up: $24,000 to the 403(b) plan and $36,000 to the 457 plan  ($18,000 x 2)
  • If you’ve worked for a qualified organization at least 15 years: you may be eligible to contribute up to an additional $3,000 to the 403(b) plan account

Other Items to Consider

  • Everyone’s situation is different. There is no one-size-fits all formula.
  • Most plans also offer the ability to make Roth contributions. Roth contributions are made with after-tax money. These contributions do not lower your taxable income in that year. However, they grow tax-deferred and withdrawals are tax-free when you make a qualified distribution.
  • If you aren’t phased-out, you can also max out a Roth IRA at $5,500 (if under 50, $6,500 if over 50).

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