The difference between 457 and 403 is not 54

Here in Des Moines we have a public hospital, Broadlawns Medical Center. The retirement opportunities for employees differ quite a bit from the corporate world.

Employees of the hospital are participants in IPERS (Iowa Public Employees' Retirement System). Contributions to IPERS are mandatory and set by the legislature. With the exception of Sheriffs, Deputies, and protection occupations, the current contribution rate is 3.9% from the employee and 6.05% from the employer for a total of 9.95%. By 2010 the contributions are rising to a total of 11.45% but that is the another topic. IPERS is a defined benefit plan. The participant's benefit is based on a formula of age, years of service, and income. While IPERS has a great track record and offers good benefits, many employees want to know what else they can do for retirement (especially if there is a tax advantage).

Broadlawns offers two additional retirement programs for employees. A 403(b) or Tax Sheltered Annuity (TSA) and/or a 457(b) deferred compensation plan. As a provider of both of these programs, I am often asked by Broadlawns employees to explain their choices.

What's the same?

There are plenty of similarities between a 457 and 403(b):

• The maximum contribution to each plan in 2008 is $15,500
• Both plans allow an additional $5000 contribution for participants at least 50 years old
• Contributions to both plans are tax deductable
• Growth within both plans is tax deferred
• Distributions from both plans are taxable

Most of the differences deal with distributions. Getting money out of a 403(b) is a lot easier than getting money out of a 457, but that access comes at a price. 403(b)'s can allow distributions for financial hardships. These hardships can include purchasing a house, or college tuition. If the participant is under age 59 ½ they can withdraw the funds, pay the income tax and a 10% penalty. In a 457 the definition of a financial hardship includes a standard of "unforeseeable emergency" so buying a home or paying tuition would not qualify. However, in return for the more restrictive definition, there is no penalty for premature distributions from a 457.

So which is best? It is hard to pick one over the other. Contributions to one plan do not affect eligibility for the other so try to fund both! If I was asked to choose only one, then I would probably choose the 457. Yes, distributions are a bit more restrictive but I'm fine with that. These funds are meant for retirement, not now. But there is one premature distribution scenario which tips the scales in favor of the 457.

Both plans allow for distributions on separation of service, but the 457 does not impose a penalty if you are under age 59 ½. If you are out of work and down on your luck you may be forced to take a withdrawal from you retirement plan. The TSA has the extra kick in the teeth of a 10% penalty. With the 457 you simply pay the income taxes on your withdrawal; no penalty. To me, that favors the 457.

References:

• IRS Publication 571 Tax Sheltered Annuity Plans
• IRS Publication 575 Pension and Annuity Income

54 by vanou

Comments

[Hal]

How very interesting...

I actually did not have a choice with my current employer--they contributed to a 403(b) on my behalf as part of my benefit package, and I had the option to elect a salary deferral in a 457(b) (which I'm doing).

I knew there were differences, but didn't really care what they were because I didn't plan on doing anything with this money until I retire, except roll it over if I change employers and my new plan and the law will allow it.

Anyway, thanks for the info!

[Janet]

Art, how to 401(k) and IRA products stack up in the "distribution for college tuition" category? ~ Janet

[Art Dinkin]

@Hal- You know I love reading your blog. Glad you like reading mine too.

@Janet- Good question. Too much for a comment so I will tackle that in an upcoming post.