IRC 457 Early Withdrawal Guidelines

If you work for a government agency, your retirement plan may be classified as a 457 plan. As with a 401(k), you can deposit pretax money into your retirement plan to build up savings for later in life. Under the Internal Revenue Code, you can take money from a 457 early without paying the 10-percent early withdrawal penalty, but you’ll still have to pay taxes on the money.

What Is a 457 Plan?

A 457 plan is a type of retirement plan, similar to a 401(k) or 403(b). You may hear it referred to as a deferred compensation plan. It is limited to a small pool of employees within the greater employment market – namely state and local government employees and a few select nonprofit organizations.

There’s a reason the pool is limited. The only employers that can offer a 457 plan are those that have tax-exempt status on their federal income taxes. With a 457 plan, you can put pretax money into the account, where it will grow untaxed until retirement, when you’re taxed on each distribution. There are a couple of ways a 457 plan differs from other retirement plans, however, including early withdrawal penalties and contribution limits.

IRC 457 Early Withdrawal

There’s some good news for those participating in a 457 plan. Unlike other retirement plans, under the IRC, 457 participants can withdraw funds before the age of 59½ as long as you either leave your employer or have a qualifying hardship. You can take money out of your 457 plan without penalty at any age, although you will have to pay income taxes on any money you withdraw.

If you roll your 457 over into an IRA, as many plan holders do, you lose the ability to access the money penalty-free. This means if you have a 457, you’re better off leaving the money in place in case you ever need to make an early withdrawal. As with other plans, you’ll need to begin taking distributions by the time you’re 70½.

Requirements for Early Withdrawal

Although you won’t pay any 457 early withdrawal penalties, it isn’t easy to take money out of your plan if you’re still with your employer. The only way you’ll be able to is if you have a hardship withdrawal, and you’re only allowed to claim a hardship if you have a qualifying unforeseeable emergency.

Your plan will lay out exactly what qualifies as an unforeseeable emergency, but generally speaking, it is defined as a severe financial hardship that happens as a result of one of the following:

• Pending foreclosure/eviction from a primary residence
• Medical expenses
• Funeral expenses

Even when an employee qualifies for a 457 early withdrawal, all other avenues must be exhausted first. That means if reimbursement from insurance or liquidating assets is an option, the employee will be asked to do that first. Only the amount necessary to resolve the current emergency will be allowed to be withdrawn from the plan. If you do take an early distribution due to hardship, you’ll also be required to abstain from making deferrals into the plan for a certain period of time.

457 Distributions for Disasters

In recent years, the IRS has temporarily relaxed its 457 withdrawal rules to allow victims of natural disasters to qualify for a hardship withdrawal. These rules are modified in response to very specific disasters within a tax year and expire at a certain point. Plan holders must take action to withdraw funds to pay for these natural disasters within that timeframe.

Most recently, these exceptions were made for those living in areas impacted by Hurricane Michael and Hurricane Florence. You have to live in one of the designated localities, which the IRS provides in list form when the exception is announced. These same exceptions are extended to those with 401(k) and 403(b) plans.

457 Distributions Postemployment

If you’re no longer with your employer, taking distributions isn’t quite as complicated. You can withdraw funds from your 457 account as you need them, or set it up to automatically make payments to you. You’ll pay taxes on every distribution, though. If you take too much in one year, it could shift you into a higher tax bracket, leading to more coming out from your entire income.

Being able to take the money out doesn’t mean you should, though. Leaving the money in the plan, undisturbed, means that it will continue to earn, which means more money to take care of you in your golden years. It may be enough to know that the money is there if you ever need it.

Exceptions for Public Safety Workers

Some retirement plan holders work in positions that require them to put their lives at risk on a daily basis. A portion of these public safety workers often have 457 plans since they’re employed by local government agencies. When these employees have other retirement plans that qualify for a 10-percent withdrawal penalty, they may be able to access their funds without the penalty once they reach the age of 50.

Although public safety workers with 457 plans won’t have that concern, there is another benefit that may interest them. Qualifying public safety workers can now use up to $3,000 from their retirement plans to pay for health insurance premiums. To get this benefit, retired employees must elect to have the money deducted from their distributions and sent directly to the health insurance company.

457 Plan Contribution Limits

Another area where 457 differs from some other plans is with contribution limits. These vary from one year to the next, but for 2019, you’re limited to $19,000 if you’re under the age of 50. At 50, that limit increases to $25,000. The 457 and 401(k) have this in common.

If your employer offers multiple plans, you can contribute to more than one and beat the contribution limit. So, if you have the option of a 401(k) and a 457 and you’re under the age of 50, you can contribute up to $38,000 a year between the two plans. However, if you withdraw from your 401(k) plan before the age of 59½, you’ll pay a 10 percent penalty in addition to the taxes you’ll owe on the amount.

Rollovers and Transfers

The IRS’s 457 withdrawal rules change a little when you move money into your account from other places. If you move the funds from a 457 into another 457, this will be a nonissue. However, if you roll money over into the account from another type of retirement plan, you won’t enjoy early distributions on that amount without penalty.

When assets are moved into a 457 from an IRA or other type of retirement account, the plan must separate that money due to the different treatment of those funds. Any earnings on that money must also be in that separate account. Whatever rules applied to those funds under the previous plan would still apply once they’re in the 457 plan, including a 10-percent penalty. However, the money that was contributed directly into the 457 and not rolled over would continue to enjoy penalty-free early distributions.

The Three-Year Rule

If you’re less than three years from retirement, IRC 457 allows you to contribute extra to your plan, known as either the three-year rule or the last-three-year catchup. Under these rules, you’ll generally be allowed to contribute double the limit for that year, or any allowed amounts you didn’t take advantage of in previous years. These rules can vary from one year to the next and depend on what your particular plan allows.

For those whose 457 plan allows both double the limit and unused limits from previous years, you’ll have to choose. You can either take double the year’s limit or the limit plus unused limits, but not both. Chances are, you’ll pick the one with the largest deferral. However, your employer may require you to gather documentation to prove you didn’t contribute up to the limit in certain years.

Employer Matches and 457 Plans

Although the better 457 withdrawal rules do make 457s a viable option, they have a downside. Unlike 401(k)s, you rarely see employer matches with 457s. This is because employees who have access to a 457 plan often also have a pension as part of their employee benefits. In those instances, a 457 serves as a supplemental plan, with the employer already contributing to another plan.

Another downside is that employer matches with 457s count toward the IRC 457 contribution limits for the year. In other words, if you’re only allowed to contribute $19,000 and your employer kicks in $10,000, you can only add another $9,000 before you’ve reached your limit. With 401(k) and 403(b) plans, the employee can still contribute up to the limit regardless of how much the employer contributes.

Setting Up a 457 Plan

Your human resources department will likely guide you through the process of setting up your plan. If it isn’t mentioned, though, you may want to ask about it, especially if you know 457 plans are among the benefits your employer offers. You’ll agree to have a set amount withheld from your paycheck and deposited into your retirement plan, so once it’s set up, there will likely be nothing further you need to do.

As part of signup, you’ll be given options for directing your money. There will likely be at least a little risk with anything you choose, but if you leave it alone, over time it will come back from any declines. You should receive a statement at least once a year that lets you know how your 457 plan is doing.

Taxes on 457 Plans

The best thing about a 457 plan is that you put the money in pretax. There it stays, earning interest, with no taxes owed. Unfortunately, when you reach retirement and take your first distribution – or if you take an early distribution – you’ll immediately owe taxes on every amount you take out of the plan.

As with other retirement accounts, 457 distributions are taxed as ordinary income. That means your distributions will be combined with any other income you have for the year, with all of it putting you into the applicable tax bracket for that year.

Rolling Over a 457

If you leave your employer or retire, you have the option to roll your 457 over to another plan. Moving it to another pretax plan is fairly straightforward. It will just require working with both plan administrators to make sure the transfer happens. You’ll pay taxes on the new plan just as you would have if you’d left the money in your 457.

There are limits to where you can move your 457, though. You can roll your plan over to a traditional IRA, 401(k), 403(b) or a qualifying 457 plan. If your 457 plan is a governmental plan, you cannot move the funds to a nongovernmental 457 plan.