Should Teachers Use a 403(b) or 457(b) for Retirement?

A pension is often a public teacher’s primary method of funding retirement. However, given the unstable state of pensions in today’s world, it’s wise to save for retirement through an additional plan. Typically, whether you’re teaching in a public or a private school, you’ll have two plan options:

• A 403(b)
• A 457(b)

I’m often asked,  “Which of these accounts is “best” to fund?” Unfortunately, there is no cut and dry answer. The truth is, like most things in personal finance, deciding which of these options is best for you will be based solely on your unique goals and financial situation.

Know the Difference

The first step in deciding which account is right for you is to understand the key differences between the two. Let’s explore your 403(b) first.

403(b)

A 403(b) is typically offered to non-profit employees, like teachers. This defined-contribution plan acts much like a 401(k) in a few ways:

• Employees contribute to their 403(b) with pre-tax money taken directly from their income
• Employers can offer a “match” program to contribute to the account
• People must start taking required minimum distributions (RMDs) at age 70, but can withdraw from the account as early as 59½.
• Taxes are deferred and will be applied when the account holder starts taking distributions
• Your 403(b) can be rolled over to an Individual Retirement Account (IRA)
• You can contribute $18,500 to your 403(b) in 2018
• 403(b) programs offer a “catch up” contribution allowance for plan participants over age 50 of $6,000 (in addition to your baseline contribution limit)

457(b)

A 457(b) may look similar, but there are a few notable differences. Here is a high-level overview of how this account type works:

• Employees contribute to their 457(b) with pre-tax money taken directly from their income
• Employers may choose to contribute funds to your 457(b), though any funds they contribute count toward the annual limit
• Taxes are deferred and will be applied when the account holder starts taking distributions
• Withdrawals can be taken before 59½ without penalty, but you must be retired.
• Your 403(b) can be rolled over to an Individual Retirement Account (IRA)
• You can contribute up to $18,500 in 2018
• If you are older than 50, you are allowed an additional contribution of $6,000/year
• If you are within three years of normal retirement age (according to your plan) you may be able to contribute up to $37,000 in 2018

Benefits to Consider

Given these facts, it’s clear that each account type has their own unique benefits. 403(b)s doesn’t have the same contribution requirements for your employer. This means that any “match” they provide doesn’t count toward your contribution limit. Potentially, this could mean you’re able to take advantage of the “free money” phenomenon that’s often discussed when talking about employer contributions to your workplace retirement plan—definitely not a bad thing.

On the other hand, the 457(b) plan offers a sneak-attack savings option: the ability to contribute almost double to your retirement savings if you’re close to retirement. The ability to take distributions before age 59 ½ if you’re already retired without penalty is also a huge benefit.

Red Flags to Watch

One aspect of retirement accounts that isn’t discussed enough is the fact that many 403(b) plans are largely funded by annuities. Unfortunately, the annuities that comprise many 403(b) plans are often relatively predatory. They come with high fees, and the fund managers make significant profit by selling them to you. These annuities often come with contracts that lock teachers into the plan for 5-12 years, and breaking the contract can come with fees sometimes up to 6% of your total account balance. Watch out for insurance-based 403(b) plans—there are almost always cheaper options that still do the same job.

Which Is Best?

When you’re trying to decide whether a 403(b) or 457(b) is right for you, it’s best to weigh the pros and cons based on what your financial goals are. For example, if your 403(b) doesn’t appear to be insurance-based, and you’re not close to retirement, it could be a great option (so long as the investment choices will put you on track to reach retirement savings goals while still keeping fees low). However, if you’re nearing retirement and need to double down on savings, a 457(b) may be the way to go. Talking through your choices with a financial planner can help you to clarify what you’re looking for, and what option is right for you.

What are your thoughts on the 403(b) versus 457(b)? Come and share in our WeAreTeachers HELPLINE group on Facebook.

Plus, why most new teachers should not be using a 403(b).