A Deep Dive into 403(b)s, 457(b)s, and cash balance plans

When you hear the phrase “retirement savings account,” what comes to mind? Most people associate retirement savings with traditional 401(k) and IRAs—but those are just the tip of the iceberg. For some employees, retirement savings opportunities come in 403(b)s, 457s, cash balance plans, and other accounts. 

While some retirement plans share similar characteristics, plan participants should understand the unique nuances of each—contribution limits, tax treatment, required distributions, withdrawal restrictions, etc.

Below, we’re exploring some important yet less talked-about retirement savings opportunities for employees.

403(b) Plans

Non-profit organizations and tax-exempt employers most commonly use 403(b) plans. If you’re a healthcare professional at a not-for-profit hospital, an educator, a clergy member, or a government worker, your employer may offer you a 403(b).

It may help to think of it this way: a 403(b) is the public or not-for-profit sector’s equivalent of the private and for-profit sector’s 401(k). However, there are some key differences.

How a 403(b) Works

Eligible employees can contribute to their 403(b) plan using payroll deductions (just like a 401(k)). They can determine a dollar amount or percentage of their paycheck to be automatically deducted before taxes each pay period. This amount would then be deducted from their taxable income for the year, with the funds in the plan growing tax-deferred until retirement.

Some employers also offer a Roth 403(b) option, which enables employees to contribute after-tax dollars to the account. While this won’t lower your taxable income, it creates tax-free retirement income.

Your employer may offer an employer match as an incentive to use the plan—meaning that for every dollar or percentage you contribute, your employer will match it (up to a certain limit).

Other elements of a 403(b) include:

• Loans: You can borrow against your 403(b) if your plan allows it. The IRS limits loans up to 50% of your vested balance or $50,000 (whichever is smaller). You may borrow the full balance for accounts with less than $10,000. Again, your plan may have different limitations, but these are what’s been mandated by the IRS.¹ 
• Hardship withdrawals: If you or your spouse or child have an “immediate and heavy” financial hardship, the IRS does allow you to take a hardship withdrawal without incurring early withdrawal penalties (though you’ll still be responsible for the ordinary income tax liability). 
• Catch-up contributions: Plan participants over 50 may make additional contributions beyond the annual contribution limits. For 2024, the catch-up contribution limit is $7,500.
• Required minimum distributions: Starting at age 73, you must take a minimum amount of distributions from your 403(b) each year (unless you are still employed with the organization sponsoring the plan). 

Pros and Cons of 403(b) Plans

403(b) plans have relatively high contribution limits compared to IRAs. For 2024, the limit is $23,000 (or $30,500 for those over 50).²  

However, these plans tend to come with limited investment options, which some employees may find frustrating (particularly those who like to DIY or customize their investments).

457(b) Plans

Again, a 457(b) is in the same family as 401(k)s and 403(b)s, but this particular plan is geared toward state and local government employees.

Like the 403(b) described above, employees can fund their plan using pre-tax payroll deductions and enjoy tax-deferred growth until retirement. The employee contribution limit is the same ($23,000, or $30,500 for those over 50), and employers may offer a Roth 457(b) plan option.

457(b) plans may also offer loan options and hardship withdrawals, with similar stipulations as 403(b)s. These offerings will vary by employer.

How 457(b) Plans Differ

Some 457(b) plans offer participants a three-year catch-up period, which they can leverage for the three years leading up to retirement. For those three years, the participant may contribute up to twice their standard contribution limit or their contribution limit plus unused portions from previous years (whichever is less).

For example, if you were using the three-year catch-up period in 2024, you could contribute up to $46,000 (two times the annual $23,000 limit) or $23,000 plus what you didn’t contribute in previous years (as long as you’re not using catch-up contributions). 

This three-year catch-up option can need clarification, so talk to your plan provider for additional information.

Employer Matching

While employer matching is standard for 401(k) and 403(b) plan sponsors, it’s rare for those participating in a 457(b) plan to receive employer matching. If they do, the matched amount goes toward their annual contribution limit. Matching is uncommon because most government employees are already offered a pension, and the 457(b) is considered a supplemental savings plan.

Early Withdrawals

Generally speaking, plan participants won’t get hit with the same 10% early withdrawal penalty if they tap into their 457(b) plan before the typical retirement age of 59.5. This is primarily because government workers, like firefighters and police officers, retire earlier than the traditional retirement age (often on disability). 

Cash Balance Plans

While a cash balance plan is technically considered a defined benefit plan (meaning it pays a guaranteed rate of return on employer contributions), it has some characteristics mirroring those of a defined contribution plan (like a 401(k) or 403(b)).

This option is especially popular among small businesses with 10 or fewer full-time employees, particularly those with owners who are also employees. Cash balance plans can be set up so that the owner/employee receives larger benefits than other employees (as long as certain nondiscrimination rules are met).

The benefits paid out in a cash balance plan are based on the plan participant’s account balance—as opposed to other determining factors, like years of service. 

How a Cash Balance Plan Works

As an employee, you do not contribute to your cash balance plan. Instead, your employer commits to contributing a certain percentage of your salary plus interest to your plan each year. If you earn $200,000 and they contribute 5% of your salary, that would equal a $10,000 contribution (plus whatever additional interest is promised).

Once you retire, you can opt to take your benefits as a lump sum or as monthly annuity payments—just keep in mind these benefits will count towards your taxable income.

When leaving your employer who sponsors the cash balance plan, your options are to:

• Roll the balance into an IRA
• Take a lump sum payment (which would be taxable)
• Convert the balance into an annuity

Cash balance plans are commonly combined with other employer-sponsored plans, like 401(k)s. When combined, these plans can help employees and business owners set aside substantial savings for retirement.

Need Help Optimizing Your Employer Benefits?

Depending on your employer, you may not have a choice in retirement plan options—but it’s still important to understand what’s being offered and how you can make the most of it between now and retirement.

If you have questions about your current plan or you’re considering the benefits package of a new employer, we encourage you to speak to an advisor. Our team can help you determine how your retirement contributions will fit into the rest of your financial picture while keeping a close eye on your long-term goals. 

Reach out now to schedule a complimentary consultation.

^Sources:

^{1 Retirement plans FAQs regarding loans}

^{2 Retirement topics – 403(b) contribution limits}