How much do you know about your retirement plan or retirement plans in general?
Very few know as much as they think they do. In fact, I’ve found that a majority of retirement plan investors simply make an allocation selection at the beginning of their career and never monitor the status or make any changes.
This can be an absolute disaster as not only do things change over time, but so do you and your goals.
Here are some common questions I receive regarding employer retirement plans.
Q: Can I max out my 401k, 403b, and 457b? Or am I limited to the $18,000 annual maximum (for 2016) collectively among all three type accounts?
A: While you cannot max out all three, you can max out the 401k or 403b at $18,000/yr AND the 457b at $18,000/yr for a total of $36,000 (2016 maximum) PLUS any catch-up contributions.
The IRS rules used to limit you to a total maximum per individual of $18,000/yr which is the reason there’s often confusion, however, those rules changed in the early 2000’s.
Before going into more debt, let’s take a look at each of these accounts.
Q: “What is a 401k?”
A: A 401k is a retirement savings plan sponsored by an employer.
This plan allows employees to elect to have a portion of their income withheld from their paycheck (before taxes are taken out) to be deposited into their 401k account. The contribution is then invested at the direction of the employee and, many times, employers will offer a match. The maximum 401k contribution for 2015 is $18,000, plus any applicable catch-up contributions.
As long as the employee allows the funds to remain in the account, the employee does not have to pay taxes on the balance. However, any withdrawals made prior to age 59 ½ may be subject to a 10% early-withdrawal penalty.Upon reaching age 59 ½, employees are able to make withdrawals penalty free and the dollars are taxed at ordinary income levels.
Upon reaching age 59 ½, employees are able to make withdrawals penalty free and the dollars are taxed at ordinary income levels.
Why 59 1/2? I don’t know either.
Q: What is a 403b?
A: A 403b is very similar to a 401k plan, but they are designed for tax-exempt and nonprofit organizations (schools, hospitals, religious groups, etc).
They have the same tax advantages, contribution limits, and early-withdrawal penalties as the 401k plan. The 403b has the same maximum as the 401k except the total employee contributions between the two must not exceed the employee maximum for either plan. So for 2016, the $18,000 employee maximum counts for both 401k and 403b contributions combined.
Q: What is a 457b?
A: The 457 plan is a type retirement plan offered to state and local governmental employees, as well as certain non-profit organizations.
It is similar to the 401k and the 403b in that you can make pre-tax contributions from your paycheck, but the plan differs when it comes to contribution limits and early-withdrawal penalties. You should pay close attention to whether your 457b plan is a governmental or non-governmental plan.
Often times non-governmental plans are far less flexible in terms of distribution options. For example, it’s not uncommon to see non-governmental 457b plans require full distribution if your employment terminates (at any age). Although you would avoid the 10% penalty with 457b early distributions, this would be fully taxed at ordinary income and could ramp you into the highest tax bracket. Something you want to avoid at all costs if possible.
Question: Should I consider the Roth version of each plan?
A: All three types of retirement plans may also allow for Roth contributions. You must check with your specific plan document to determine if your plan allows for this. The Roth contribution will be after-tax however the balance will grow tax-free and qualified withdrawals will also be tax-free.
You need to check with your specific plan document to determine if your plan allows for this. The Roth contribution will be after-tax however the balance will grow tax-free and qualified withdrawals will also be tax-free.
I would also suggest you looking into whether the Roth option is similar or quite a bit different from a Roth IRA. For example, the Roth TSP and Roth IRA’s are completely different even though they share a similar name.
Question: What if you’re not able to maximize your contributions and need to prioritize between the 401k, 403b, and 457b?
A: This can be tricky – there is no one size fits all answer.
– Cooper Mitchell
About Dane Financial, LLC
Dane Financial, LLC is a Registered Investment Advisory firm based in Springfield, Missouri that specializes in Financial Planning and Investment Management for Pre-Retirees, Federal Employee’s, and Millennials.
We offer the following products and services: retirement income strategies, wealth accumulation strategies, asset protection, tax minimization strategies, long-term care planning, and IRA, TSP, and 401(k) rollovers.
We are located on the third floor of the Bradford Place Building.