457 vs Roth IRA: Key Differences to Consider for Retirement Planning

Retirement planning is a critical step toward financial security, and choosing the right savings vehicle can significantly shape your future. Among the available options, 457 plans and Roth IRAs stand out for their distinct benefits, catering to different financial needs.

Eligibility Criteria

457 plans are designed for employees of state and local governments and certain non-profit organizations. For instance, a city worker or a non-profit hospital employee can use these plans to boost their retirement savings in a tax-advantaged manner.

Roth IRAs, on the other hand, are available to a wider audience, with income limits determining eligibility. In 2024, individuals can contribute if their modified adjusted gross income (MAGI) is below $153,000 for single filers or $228,000 for married couples filing jointly. This broader accessibility makes Roth IRAs a versatile option for private sector workers and self-employed individuals seeking tax-free growth and withdrawals in retirement.

Contribution Limits

For 2024, the IRS sets the 457 plan contribution limit at $23,000, with an additional $7,500 allowed for participants aged 50 and older, bringing the total to $30,500. These limits help participants build substantial retirement savings.

Roth IRAs have smaller limits. In 2024, individuals can contribute up to $7,000, with an extra $1,000 catch-up contribution for those aged 50 and older, making the maximum $8,000. These caps apply to total IRA contributions, not just Roth IRAs, and eligibility to contribute the full amount depends on income levels.

Tax Considerations

457 plans allow pre-tax contributions, reducing taxable income for the year. Investment growth within the plan is tax-deferred, with taxes applied upon withdrawal, often during retirement when participants may be in a lower tax bracket.

Roth IRAs take a different approach. Contributions are made with after-tax dollars, but qualified withdrawals are entirely tax-free. This can benefit those expecting to be in a higher tax bracket during retirement. Additionally, Roth IRAs are not subject to required minimum distributions (RMDs) during the account holder’s lifetime, offering greater flexibility in managing retirement income.

Early Withdrawal Rules

457 plans do not impose a 10% early withdrawal penalty for distributions taken before age 59½, though withdrawals are subject to regular income tax. This flexibility is advantageous for those needing early access to their funds.

Roth IRAs allow penalty-free and tax-free withdrawals of contributions at any time. However, to withdraw earnings tax-free, the account must be at least five years old, and the distribution must meet qualifying conditions, such as reaching age 59½, becoming disabled, or buying a first home.

Required Minimum Distributions

457 plans require participants to begin taking RMDs at age 73, as mandated by the SECURE 2.0 Act of 2022. The annual withdrawal amount is based on the account balance and IRS guidelines. Failure to take RMDs can result in penalties.

Roth IRAs are exempt from RMDs during the account holder’s lifetime, allowing funds to grow tax-free indefinitely. This feature is particularly useful for estate planning, as Roth IRA assets can be passed to heirs without mandatory withdrawals during the account holder’s life.

Investment Flexibility

Investment options in 457 plans are typically curated by the plan sponsor, such as a government agency or non-profit. These options often include mutual funds, target-date funds, and stable value funds, though they may lack the customization available in other accounts.

Roth IRAs offer broader investment choices, including individual stocks, bonds, mutual funds, ETFs, and even alternative assets like REITs or precious metals. This flexibility allows investors to tailor their portfolios to their financial goals and risk tolerance.