457b

457b is a deferred compensation plan available to those working for governments or non-profit entities such as charities. The employer must be a state or local government or a tax-exempt 501c organization. Similar to a 401k, the 457b plans allow the employee to use pre-tax dollars to invest for their retirement. In addition, interest earned on the money in the plan is also tax deferred, meaning it's not taxed until you take the money out during your retirement. Due to dramatic price swings in your income, the taxes you do end up paying will be much less, too as you will presumably be in a lower tax bracket.

Contributions

The employer or the employee through payroll deductions can contribute up to the maximum the IRS allows as defined by section 402g. This changes year to year so it is important to talk to your financial planner about the maximum you can contribute. In 2012 the amount was $17,000. If you are over age fifty, you can make what are called catch up contributions that allow you to put in more than the base amount. That, too changes year to year and you need to discuss this with your financial adviser.

Tax Advantages

There are significant tax advantages to participating in a 457b plan if you work for a state or local government or a tax-exempt organization. You do not pay taxes on the money you put into the plan. Depending on your income level and tax bracket, this can be a considerable savings in building your principle. In addition, returns on the investments are not taxed at the time they are made. This means your investment grows faster and with the magic of compounding interest, grows bigger. You only pay taxes when you take the money out of the plan, presumably when you are retired and making less money and are therefore in a lower tax bracket.

Unlike a 401k, however, with a 457b plan, withdrawals are allowed after severance from employment where 401k plans have age restrictions. There are also no additional taxes for early withdrawals. But like 401k plans, you must start taking withdrawals by April 1 following the later of your retirement or turning the age seventy and a half. If you are a policeman or fireman, your retirement age can be as early as forty if your local jurisdiction defines it as such.

Rollovers to eligible plans are permitted if you work for a government. No rollovers are permitted for employees of a tax-exempt organization however you can combine 457b plans if you change employers. Again, your financial adviser can help you find an eligible plan to rollover into. There is no vesting, the money is 100% yours from the day you invest it. If your employer also contributes, there may be vesting on those funds. And 457b funds, including employer contributions, are not protected from creditors unless you work for a government.

457b plans are defined contribution plans. The amount of money you have at the end of your employment depends on many factors including how much you and your employer contribute and the return you get on your investments. That is why it is vitally important to have good financial advice on what investments are right for you for your age, salary, and risk tolerance. Defined contribution plans are replacing so-called defined benefit plans in many governments due to the high cost of the defined benefits plans. This requires you, as the investor, to make good, sound choices on investments and that is why a good financial adviser is vitally important.

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