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Are you one of the lucky few who have access to both a 403b and a 457b? Many public educators do! These options provide you significant tax advantages and enable you to save large amounts pre-tax. When starting out, you’ll likely need to choose one over the other. It’s important to understand the benefits of each. Let’s compare the 403b vs 457b and review a decision-making process to help you choose between the two.
What Are 403b or 457b plans?
403(b) and 457(b) are tax-advantaged savings vehicles for employees of certain organizations. People are often familiar with the 401k. It is similar, but not identical. The names are derived from the relevant IRS tax code and are often written 403b and 457b or even 403 and 457.
Both 403b and 457b are available to public educators if your employers offer the plan. The two are similar but do have distinct differences that are important to understand.
For an in-depth look at each, check out my previous posts:
One important note: In this article, I’m referring to governmental 457b plans. If you work for a public education agency this is almost certainly what you have.
How Are They Similar?
As I mentioned, the two share several features. Both must be offered through your employer. You contribute in pre-tax dollars through payroll deductions.
The standard allowable contribution for each is the same: $19,000 in 2019.
Additionally, they each have an over-50 catch-up contribution of $6000. Each also has an additional catch-up option that will be detailed in differences.
Both can generally be rolled over into other retirement accounts if you leave an employer. You may, or may not, want to do this. (See this helpful rollover chart for more detail.)
Contributions to both, and growth of investments are tax-deferred. Regular withdrawals will be taxed as income for both. Both are subject to required minimum distributions at age 70.5.
Sadly, for educators many of the offerings are fee loaded products. This is a similarity I hate to list, but you need to be aware.
What Are The Differences?
There are a few differences between the two that may factor into your decision to contribute.
Accessing Your Funds
You can access your 403b under normal circumstances at 59 ½. If you withdraw funds earlier, you will pay a 10% penalty. There are ways to avoid this, but they add complexity.
This is a big advantage for the 457b. You can make withdrawals without incurring penalty upon separation from service at any age. This is a huge advantage for someone considering early retirement.
Both funds have emergency withdrawal options. For 403b, the language is “financial hardship” and for 457b it is “unforeseen emergency.” The 403b emergency withdrawal covers more situations.
In addition to the already mentioned 50+ catch-up option, the 403 and 457 each have a second catch-up option. They’re different, however.
The 457b has a significant advantage for those approaching normal retirement age. Within three years of the plan-defined normal retirement age, an employee can contribute double the standard amount to a 457. This catch-up provision allows for late starters or aggressive savers to contribute up to $38,000 per year just to your 457b!
The 403b also has a second catch-up option offered by some employers. If you’ve been with an employee for more than 15 years, you may have the option to contribute an additional amount up to $3000 per year. Your employer has to choose to offer this as an option. Not all do.
403(b) is a retirement plan, while 457(b) is a deferred compensation plan. This doesn’t matter much to you. However, if your employer contributes to a 403b, the contribution isn’t subject to FICA taxation. Contributions to 457(b) are subject to FICA.
403b vs 457b Comparison
Which Should I Invest In First?
Now that we have all that information – the big question: If you have both how do you decide which to invest in? The decision-making in the 403b vs. 457b can seem complex. I’ll break down my process for deciding which, if either, to choose.
Let me start by making clear that I am not a financial advisor. I am a career educator and financial enthusiast, but do not know your financial situation and preference. The following is how I approach making my own personal decisions in relation to these accounts. As always, when in doubt consult your financial planner.
To make the best decision between a 403b and 457b, you need to gather some information.
Both 403b and 457b have to be offered through your employer. Before going any further, confirm that your employer does offer each. Almost all public employers provide access to a 403b, but a 457b isn’t always available.
If only one is available, you can use the following process to decide if you should use it.
If both, or either, are available to you, the next step is to list all of the available providers. Unfortunately, in most cases you will be presented with far too many options.
This complexity is disguised as “choice” and supposedly empowering. In reality, it’s designed to confuse and potentially put you in a bad investment. Fortunately, you aren’t going to fall for it!
Make a list of all the providers available. Ideally, you will see Vanguard, Fidelity, or some other reputable option mixed in with the typical insurance companies. If you choose, you can eliminate some providers at this step.
I typically remove insurance companies automatically.
Record Investment Choices
Make a list of the available investment options. The number of options can be daunting.
Remember, this is designed to overwhelm and confuse you. Don’t let it! We are going to narrow this down in a moment.
Next to each option, record the fee you will pay. Fees can be complex but the first step is knowing what they are.
I simply ignore annuity products because the fees can be stacked and hidden throughout.
Include both the fund fee and any administrative fee for your options. For example, my 457b has a .15 administrative fee on top of any fund fee. For the fund that is .1% that means a total fee of .25%
Fees can be a major drag on your investments. I prefer fees to be as low as possible. Hopefully, you have options with total fees of .5% or lower.
I would consider investing in 403b or 457b for fees up to 1% due to the tax advantages. Over that, and I’d seek out other investment options. You may have different thresholds.
Sadly, many educators don’t have 403 or 457 options below 1%. Some are 3% or higher. This is criminal.
Your Investment Plan
Finally, you need to know your own investment plan and goals. This can be a complex topic, and that complexity is outside the scope of this post. If you are just starting out, don’t get paralyzed at this point.
One popular, relatively simple option for your consideration is the Three Fund Portfolio.
In my 403b and 457b I look for index funds. Target date retirement funds are also acceptable due to relatively lower fees and good diversification. Personally, I consider these good options and wouldn’t hesitate to contribute to either, barring excessive fees.
If you are not comfortable managing your own portfolio and do not have a broad market index fund or target date retirement fund available for a reasonable fee, you may want to consult a fee only financial adviser (Post coming soon on this!)
Now that you’ve gathered the information you need, you are ready to make a choice between the two! The following chart summarizes the decision-making process I follow.
You can download a printable version here.
I’ve briefly described each decision step after the chart.
Don’t worry – while there are a lot of boxes and lines on the chart, you’ve already done the hard work by identifying your options and investment plan. The chart is a way to quickly walk through to a decision!
The Flow Chart 403b vs 457b : Which Do I Choose
Step 1: List your options and fees
Select your preferred (or best) option in each fund. Record it, and the related fee for quick reference.
Step 2: Decide which options are acceptable.
Which options fit your needs? 403b, 457b, or both.
If no options are acceptable, then move on to IRA or brokerage options.
Step 3: Consider fees
If you have investment options that fit your needs, review the fees. Are the fees acceptable for your preferred product? If yes, continue.
Step 4: Decide Between the Two
If not, I’m sorry. Move on to other options while we work to ensure that all educators have access to good 403b and 457b products.
By this point, you may have already decided between your 403b and 457b, or decided that neither is acceptable.
If the options and fees for both are acceptable, you are in a rare position!
Can You Afford to Fund Both?
Yes – then do that! Your wealth will grow quickly.
If you can only afford to start investing in one (which is true for most of us, particularly when starting out) you have a choice to make.
If you are considering early retirement, or prioritize the freedom of accessing your investment when leaving your current job, then I would choose the 457b.
If not, select the option with the lowest fee.
If both your 403b and 457b have good options with equivalent acceptable fees then you are in truly great shape! You have three options, all good:
- Pick the 403b because of the more flexible emergency withdrawal options
- Split your contributions between both
- Flip a coin (or other random selection method)
Congratulations, you’ve navigated the 403(b) vs. 457(b) choice! Easy, right?
Summary: 403b vs. 457b
Having access to two tax advantaged retirement savings plans is a huge benefit. You have the ability to invest large sums of money, and have those investments grow tax-deferred.
Don’t be paralyzed by the choices and options you have.
- Understand the similarities and differences between the two
- Review your investment options in each
- Know the fees
- Use a decision-making process
- Set-up your payroll contributions (consult your HR office)
- Watch your wealth grow!