FDNY 457 vs 401(k) – What are the Differences?

Two types of Internal Revenue Service-sanctioned, tax-advantaged employee retirement savings plans are the 401(k) plan and the 457 plan, both are available to FDNY members. As tax-advantaged plans, participants are allowed to deposit pretax money that then compounds without being taxed until it is withdrawn. These retirement savings accounts were designed to serve as one leg of the famous three-legged stool of retirement: workplace pension, Social Security, and personal retirement savings.

457 Plans

457 plans are IRS-sanctioned, tax-advantaged employee retirement plans offered by state and local public employers and some nonprofit employers. They are among the least common forms of defined-contribution retirement plans. As defined-contribution plans, both 457 and 401(k) plans are funded by employees contributions through payroll deductions.

These funds are funneled to the respective retirement account without being taxed, unless the participant opens a Roth account, and any subsequent growth in the accounts is not taxed. The annual maximum contribution limit for 457 plans is $20,500 for 2022. For employees over the age of 50, both plans contain a catch-up provision that allows up to $6,500 in additional contributions. It is possible to take loans from both 401(k) and 457 plans. One benefit of 457 plans compared to 401(k) plans is the IRS does not assess an early withdrawal penalty to 457 participants who take money out before age 59½, though the amount taken is still subject to normal income taxes. The participant would have to separate from their employer before taking withdrawals from their 457.

While both plans allow for early withdrawals, the qualifying circumstances for early withdrawal eligibility are different. With 457 accounts, hardship distributions are allowed after an “unforeseeable emergency,” which must be specifically laid out in the plan’s language.

401(k) Plans

Generally, 401(k) plans are offered by private, for-profit employers, and some nonprofit employers and are the most common type of defined-contribution retirement plans. 401(k) plans have an annual maximum contribution limit of $20,500 for 2022. For employees over the age of 50, a catch-up provision allows up to $6,500 in additional contributions per year.

Earnings in a 401(k) plan accrue on a tax-deferred basis. At the same time, 401(k) plans offer a menu of investment options that are prescreened by the sponsor, and participants choose how to invest their money in one or a combination of these investment options. The biggest drawback for a 401(k) is restrictions on withdrawals. The IRS will impose a 10% penalty for 401(k) withdrawals before the age of 59½, with only a few exceptions. This ensures that 401(k) savings go toward an employee’s retirement.

Which Is Better For You?

As 457 plans are nonqualified retirement plans, it is possible to contribute to both a 401(k) and a 457 plan at the same time. Many large government employers offer both plans, as is the case of the Fire Department of New York. In such cases, the joint participant is able to contribute maximum amounts to both. This could be a huge asset for those who can afford to take advantage of this to get more access to tax deferred growth compared to what is normally allowed by the IRS.

457s are savings plans primarily offered to government employees, including state and local government officials, public school teachers, county and city employees, and first responders. By contrast, 401(k) retirement plans are usually offered by private enterprises. But some big government employees might offer both. Here’s how to decide which is the best choice for you.

• There are more similarities than differences between a 401(k) and a 457.
• They both offer the same tax advantages. Employees can deduct their contributions from their taxes in the current year. Investments grow tax-free and when funds are withdrawn retirees pay regular income tax on those withdrawals.
• They can both offer Roth options, which allow people to pay income tax now in exchange for tax-free withdrawals in retirement.
• They have the same standard contribution limits of $19,500 in 2021 and $20,500 in 2022 with an additional $6,500 catch-up contribution limit for those 50 and older.
• They both allow for loan provisions if you need to temporarily access funds early.
• They both typically offer a selection of funds to invest in, and they charge fees for managing the plans.
• The big differences are the penalty on early withdrawals:
  • Once you leave your employer you can access your 457 penalty free
  • You have at wait until 59½ to access your 401(k) penalty free.

All else being equal, investors should consider the investment options and fees for each plan. If one plan offers the investment options you like or it has considerably lower fees, opt for that one. But maybe you don’t have to make a choice at all — there’s nothing that says you can’t contribute to both!

Moreover, since a 457 isn’t a qualified retirement plan, the contribution limits for a 457 and qualified retirement plans like a 401(k) don’t overlap. That means you can contribute the maximum amount to both plans, and that’s totally fine with the IRS. That’s a potential $39,000 in tax-advantaged savings if your employer offers both a 401(k) and a 457. If you can swing it, that’s probably the best option of all.

One last piece of information to note for FDNY members, the Trade Priorities and Accountability Act of 2015 included a provision that will allow more public safety officials to take early distributions without penalty from more of their government-sponsored retirement plans.  Furthermore, those public safety officials who separate from service at age 50 or older are no longer subject to a 10% penalty to access the retirement funds that are held are held in government sponsored retirement plans.