457(b) vs. 401(k): How These Retirement Plans Compare

Understanding the Basics: What Sets These Plans Apart

The 401(k) Plan Foundation

The 401(k) plan serves as America's most recognizable employer-sponsored retirement account. Established under Section 401(k) of the Internal Revenue Code and governed by both the Internal Revenue Code and the Employee Retirement Income Security Act (ERISA), 401(k) plans allow employees to contribute pre-tax earnings directly from their paychecks - potentially lowering their current taxable income while helping build long-term retirement savings.

Private sector employees typically encounter 401(k) plans, though some governmental and non-profit organizations also offer them. The Internal Revenue Service sets strict annual contribution limits, and early withdrawals before age 59½ generally trigger a 10% penalty plus regular income taxes.

The 457(b) Plan Distinction

A 457(b) plan operates exclusively for employees of state and local governments, certain non-profit organizations, and tax-exempt entities. Unlike 401(k) plans, governmental 457(b) plans exist outside ERISA protection, creating advantages and considerations.

The most striking difference? No early withdrawal penalties. While you'll still owe income taxes on distributions, the 10% penalty that haunts early 401(k) withdrawals doesn't apply to 457(b) plans.

Contribution Limits

Standard Annual Contribution Limits

For 2025, both 457(b) and 401(k) plans share identical employee contribution limits, which have increased slightly due to cost-of-living adjustments:

• Standard limit: $23,500.
• Catch-up contributions (age 50-59 and 64+): The standard age 50+ catch-up is $7,500, but for the specific years you are 60, 61, 62, or 63, that limit is replaced by a higher $11,250 limit.
•  Total potential catch-up contributions: Ages 50-59, 64+ is $31,000 annually, ages 60-63 is $34,750 annually.

But here's where it gets exciting for eligible employees: you can potentially contribute to both plans simultaneously. The IRS treats 457(b) and 401(k) contribution limits separately, meaning qualifying individuals could theoretically contribute up to $62,000 annually ($47,000 if under 50).

The 457(b) Special Catch-Up Rule

457(b) plans offer a "special catch-up" provision unavailable in 401(k) plans. During the three years preceding normal retirement age, participants can contribute up to twice the annual limit or the basic annual limit plus the amount of the basic limit not used in prior years (whichever is less). A participant cannot use the special catch-up and the age-based catch-up in the same year.

• Example scenario: Sarah, age 62, plans to retire at 65. Under the special catch-up rule, she can contribute up to $47,000 in 2025 (2 x $23,500), assuming she has unused contribution capacity from previous years. This is significantly more than the $34,750 she could contribute using the standard and age 60-63 catch-up.

Tax Implications

Pre-Tax Contributions Strategy

Both plans primarily operate on a pre-tax basis, reducing your current tax burden while deferring taxes until retirement. This approach works particularly well for individuals currently in higher tax brackets who expect to be in lower tax rates during retirement.

Tax savings calculation:

• $20,000 contribution × 24% tax bracket = $4,800 current-year tax reduction.
• Future withdrawal taxed at potentially lower retirement tax rate.

Roth Contributions: Building Tax-Free Wealth

Many modern 401(k) plans offer Roth contribution options, allowing after-tax contributions that grow tax-free. Some governmental 457(b) plans also provide Roth features, though availability varies by employer.

The Roth strategy particularly benefits younger employees or those expecting higher tax rates in retirement. Social Security taxation, along with RMDs, may affect retirees’ tax brackets. Clients should consult with the Social Security Administration or a tax advisor to understand their specific situation.

The SECURE 2.0 Act included a provision that employees earning over $145,000 in the prior year would be required to make all catch-up contributions on a Roth (after-tax) basis. This was originally set to begin in 2024.

The IRS has delayed the implementation of this rule. For the 2025 tax year, this mandate is not in effect. All employees, regardless of income, can still make their catch-up contributions on a pre-tax basis if their plan allows.

Early Access: The Critical Difference

401(k) Early Withdrawal Restrictions

401(k) plans impose strict early withdrawal penalties:

• 10% penalty on distributions before age 59½.
• Limited hardship exceptions for specific emergencies.
• Loan options up to 50% of vested balance (maximum $50,000).

457(b) Flexibility Advantage

Governmental 457(b) plans allow penalty-free withdrawals immediately upon separation from service, regardless of age. This flexibility creates powerful early retirement strategies unavailable with 401(k) plans.

Non-governmental 457(b) plans carry more restrictions, including potential forfeiture risks if the sponsoring organization faces financial difficulties.

Investment Options & Fees

401(k) Investment Landscape

Established 401(k) plans typically offer robust investment menus including:

• Target-date funds for hands-off investing. The principal value of the funds is not guaranteed at any time, including at or after the target date.
• Index fund options with low expense ratios.
• Actively managed mutual funds across asset classes.
• Sometimes individual stock purchasing.

Large employers often negotiate competitive fees, though smaller companies may face higher administrative costs passed to participants.

457(b) Investment Considerations

Governmental 457(b) plans usually provide similar investment options to 401(k) plans, often managed by the same financial institutions. However, some key differences emerge:

• Fewer provider options due to specialized market.
• Potentially higher fees in smaller plans.
• Limited self-directed options compared to some 401(k) plans.

Non-governmental 457(b) plans may offer more restricted investment menus and carry additional fiduciary risks.

Employer Contributions: Matching & Beyond

401(k) Matching Programs

Most 401(k) plans include employer matching contributions, essentially free money for participating employees. Common structures include:

• Dollar-for-dollar match up to 3-6% of salary.
• Partial matching (50 cents per dollar contributed).
• Profit-sharing contributions based on company performance.

457(b) Employer Contribution Reality

Governmental 457(b) plans less commonly offer employer matching, though some state and local governments provide matching or non-elective contributions. When available, these contributions don't count against your annual contribution limit.

Key consideration: If your employer offers 401(k) matching but no 457(b) matching, prioritize capturing the full 401(k) match before maximizing 457(b) contributions.

Who Should Choose Which Plan?

457(b) Plan Advantages

401(k) Plan Advantages

Common Pitfalls to Avoid

Over-Contributing Mistakes

The IRS doesn't forgive over-contributions. Exceed annual limits and you'll face:

• 6% excise tax on excess contributions.
• Double taxation if not corrected promptly.
• Administrative headaches correcting the error.

Ignoring Required Minimum Distributions

Both plans require distributions beginning at age 73. Failing to take required minimum distributions triggers a 25% penalty on the amount you should have withdrawn.

Underestimating Investment Fees

High fees can devastate long-term returns. Please keep in mind that all investments come with risk, including the potential for loss of principal.  Before investing it is important for you to consider your specific objectives, risk tolerance and time horizon.

Let's run an example:

• Initial Balance: $300,000
• Time: 20 years
• Assumed Annual Return (before fees): 7% (a common historical average)

Scenario 1: Lower Fee (e.g., 6.5% net return after a 0.5% fee)

• After 20 years, your balance would be approximately $1,084,800.

Scenario 2: Higher Fee (e.g., 5.5% net return after a 1.5% fee)

• After 20 years, your balance would be approximately $878,600.

Conclusion

Choosing between a 457(b) and a 401(k) comes down to your job type, retirement goals, and available options. It’s not about which one is better, but it it’s about what works best for your situation. The contributions you make now can shape your future. Take time to review your choices and plan with intention. Make them count.

   Explore how these plans can help secure your retirement. Start Your Free Plan  

Sources

1. 457(b) Deferred Compensation Plans – Internal Revenue Service. https://www.irs.gov/retirement-plans/non-governmental-457b-deferred-compensation-plans
2. Retirement Plan Contribution Limits – Internal Revenue Service. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-contributions
3. Early Withdrawal Penalties and Exceptions – Internal Revenue Service. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions
4. 401(k) limit increases to $23,500 for 2025, IRA limit remains 7,000. https://www.irs.gov/newsroom/401k-limit-increases-to-23500-for-2025-ira-limit-remains-7000
5. Roth Comparison Chart - Internal Revenue Service (IRS). https://www.irs.gov/retirement-plans/roth-comparison-chart