Just like 401(k)s and 403bs, many 457 plans are now offered in both the traditional and Roth varieties. With a traditional 457, your contribution is deducted from your taxable income, reducing your taxes in the contribution year. So if you earn $60,000 and contribute $10,000 to your 457, your taxable income drops to $50,000 and you defer paying taxes on the $10,000 -- saving, for example, $2,500 if you're in the 25% tax bracket. You do get hit with taxes upon withdrawal later, though, when you're taxed at your ordinary income tax rate.
Meanwhile, the Roth 457 works differently. Your contribution doesn't have any effect on your taxes in the contribution year. It's made with post-tax, not pre-tax, money. That may not seem particularly attractive, but hang on: If you follow the rules, when you withdraw your money in retirement, you do so tax-free ! That can be a very big deal.
The money in your 457 account can't be invested in just anything. Typically, your employer's plan will offer a range of choices, such as a few managed stock and bond funds and some index funds.
It's worth noting that whereas matching funds from employers are a key feature of 401(k) and many 403(b) plans, 457 plans rarely offer an employer match. That's not as tragic as it may seem, though, because most 457 plan participants work for the government and are eligible for pensions. Thus, the 457 plan is more of a supplemental retirement plan than a critical primary one.
The power of the 457
Still, a 457 plan is a powerful savings tool. To understand how powerful, imagine that you contribute $8,000 per year to your account for 25 years. Imagine, too, that your money grows at an annual average rate of 8%. If so, you'll end up with... $613,000! That can go a long way in retirement. If you invest mostly or completely in stocks and average a 10% annual growth rate, then you'll end up with more than $865,000!
You can amass even more than that if you contribute more each year to your account -- especially in your early years, as early dollars have the longest time to grow. Remember, the contribution limit is at least $18,000, and it is increased over time to keep up with inflation.
Here's another way that a 457 plan is powerful: it can be used and funded in addition to a 401(k) plan. The contribution limits for 401(k)s and 403(b)s are meant to be a single total for each year for all such plans, combined. But the 457 is a separate beast, with separate contribution limits.
If one of your workplace's benefits is a 457 plan, making significant contributions to it is probably a very good idea.
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The article What's a 457 Plan? originally appeared on Fool.com.
Longtime Fool specialistSelena Maranjian,whom you canfollow on Twitter , has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
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