403(b) vs 457(b): The Retirement Accounts Teachers Should Be Maxing Out
If you’re a teacher or work for a nonprofit, you’ve got some unique retirement savings options: the 403(b) and the 457(b). Both accounts have their perks and quirks, but fully understanding them could set you on the path to a financially secure retirement.
Understanding 403(b) Accounts
The 403(b) plan is tailored for employees of public schools and certain tax-exempt organizations. Think of it as the equivalent of the 401(k) in the private sector. You can contribute a maximum of $22,500 for 2023, which increases to $30,000 if you're age 50 or older, thanks to the catch-up provision.
The money you contribute is pre-tax, reducing your taxable income for the year. For example, if you earn $60,000 and contribute the max of $22,500, you only pay taxes on $37,500. This can significantly lower your tax burden, especially when you're in a higher tax bracket.
Investments within the 403(b) can grow tax-deferred until retirement, and many plans offer a selection of mutual funds or annuities. It’s crucial to compare these options since fees can vary widely. Keep an eye out for expense ratios; ideally, you want funds that charge under 0.5%.
Peeking into 457(b) Accounts
The 457(b) is another solid option for those in state and local government, as well as some nonprofit organizations. It has its distinct advantages. First off, like the 403(b), you can also contribute $22,500 for 2023, with the same catch-up contribution if you’re 50 or older.
A key feature of the 457(b) is its flexibility when it comes to withdrawals. Unlike the 403(b), which typically penalizes you for withdrawals before age 59½, the 457(b) allows you to take out funds without a penalty if you separate from service, regardless of age. This can be particularly beneficial for teachers who may transition to different careers or retire early.
For instance, if you decide to retire at 55 after a long career in teaching, you can access your 457(b) funds without paying the usual 10% early withdrawal penalty.
Comparing the Benefits and Drawbacks
Both accounts provide unique benefits and some drawbacks. The 403(b) allows for more investment options, especially if you're in a plan that offers mutual funds and annuities. However, the limitations on withdrawals can be a downside if you’re uncertain about your post-retirement plans.
On the flip side, the 457(b) offers more flexibility but may have fewer investment options, depending on the plan. Additionally, with both plans, you’ll want to be wary of fees. If you’re in a high-fee plan, it could eat into your savings over the years.
For example, consider if you contributed $22,500 annually for 30 years to either plan. Assuming a 7% average annual return, you’d have around $2.2 million at retirement in a low-fee scenario. But if your plan charges a 1% annual fee, that amount could shrink to about $1.9 million. Those fees matter!
Maxing Out Your Retirement Accounts
Given the differences between these plans, many teachers choose to max out both accounts if possible. This is known as 'stacking' your contributions, and it’s a savvy way to maximize your tax-advantaged savings. For 2023, if you’re 50 or older, you could contribute up to $60,000 between both plans!
Here’s a quick strategy: if you can afford it, consider putting as much as you can into your 403(b) first to take advantage of the investment options, then max out your 457(b) contributions to benefit from the withdrawal flexibility.
Remember, you can also consider a Roth IRA with after-tax dollars, which could provide tax-free growth and withdrawals in retirement. Just make sure you stay within the income limits set by the IRS, which are $138,000 for single filers and $218,000 for married couples filing jointly in 2023.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Please consult a fee-only CFP or SEC-registered investment advisor before making investment decisions.