Financial Planning for Doctors

Should I invest in my 457 plan? It seems like there should be an easy answer to that question.  Unfortuntaely, that’s not the case.  While a 457 plan has some great features (like being able to use a 457 in early retirement without the 10% fine a 401K experiences), whether you should use it or not is complicated. It’s just as easy as whether or not you should invest in your 403(b) or 401K. If you are asking if you should use your 457, this is the post for you.

What is a 457 plan?

Just like any other retirement plan with numbers, this comes from the part of the IRS tax code (section 457) for deferred compensation plans.  A “deferred compensation plan” allows you to make pre-tax contributions and will allow your earnings to grow tax-free while in place.

There is an important distinction, though, and I am going to make it easy.  There are two ways you can qualify for a 457.

The first is that you work for the government and are provided a governmental 457.  The other way you can have access to a 457 is through a non-governmental employer, which grants you access to a non-governmental 457.

While the governmental and non-governmental 457’s have some similarities, there are also some very important differences.  This post will help you sort it all out and give you a clear answer on whether you should use your 457 plan or not.

The following are some details that are similar to both a governmental and non-governmental 457 (NG-457) to help you determine if you should invest in your 457.

Applies to All 457 Plans

Contribution limits for 457 plans are $19,000 for most.  For some over the age of 50, you may be able to contribute more (possibly as much as $37,000 if within three years of retirement age for your plan).

All 457’s may be transferred from one 457 to another (governmental to governmental; non-governmental to non-governmental).  However, the receiving plan must accept transfers.

You must take payments by April 1st following year of retirement or age 70.5 years old (whichever happens later).

Governmental 457s versus non-governmental 457s (Reference IRS publication)

  • Governmental 457’s may be rolled over to eligible retirement plans (i.e. IRA’s).  NG-457’s cannot be rolled into an IRA.
  • Age > 50 catch-up contributions are only available for governmental 457s.
  • NG-457’s are “Top-Hat” plans and must limit the number of people who can participate to “groups of highly compensated employees or groups of executives, managers, directors or officers.”
  • Governmental 457’s often allow Roth contributions. NG-457’s do not allow Roth contributions…otherwise this would be a great way to avoid the possible tax consequences of bad distribution options, which are discussed more below.
  • This is the most important difference: Governmental 457s are backed by the US government (NG-457s are backed by individual institutions and are available to creditor’s upon legal action or bankruptcy). This is the exact wording from the IRS on non-governmental 457s:

[Non-governmental] Plan assets are not held in trust for employees, but remain the property of the employer (available to its general creditors in the event of litigation or bankruptcy)….Employees are lower in priority than general creditors in the event of legal claims against the employer.”

What this last bullet point means is that if your institution goes bankrupt or into major litigation, your hard-earned retirement money is available to creditors.

This is very different from your typical 401K or 403B which is not only protected from employer litigation, but often protected even in most personal litigation (i.e. medical malpractice cases).

Should I Invest in My 457 plan?

There are certainly tax benefits associated with participating in a 457.  This includes being able to contribute pre-tax money to decrease your overall tax burden.  The gains also grow tax-free.  Your only taxation occurs when you take it out.  This all sounds exactly like your standard (pre-tax) contributions to a 401K and 457.

If you have a governmental-457, this is backed by the government.  If the government defaults, we are all in trouble. The market would likely crash.

This provides some comfort for those with a governmental 457.  In fact, I would argue that you could view a governmental 457 as a second 401K or 403B.  It’s just as safe and provides many of the same benefits. Congrats, if you have one!  Don’t think twice, go use it.

For example, my wife works full-time as an early learning childhood coach (i.e. coach for kindergarten and 1st grade teachers).  So, while she has access to a 401K (which we also use), we preferentially prefer her governmental 457, which can be used in early retirement unlike a 401K.

So, first, we fill up her governmental 457 with $19,000 and put any remaining money left from her salary towards her 401K.  While we focus much more on financial independence than early retirement, the 457 will be accessible to us in early retirement if we went that route.

Non-governmental 457’s are not the same: What you should consider

The differences between a governmental and a NG-457s may seem small, but nothing could be less true.  If you have a governmental 457, go contribute if it has good options.

If you have a NG-457, you need to make sure your specific plan doesn’t have the following three problems before participating.  Going through this will help you answer whether you should invest in your 457 or not.

Remember, you are comparing investing in a NG-457 to a taxable/brokerage account where you’ll be paying taxes on the gains.  So, if any of the following look problematic, I’d prefer a taxable account.

Reason to Pause #1: Poor Financial Situation

Remember, your NG-457 money is available to creditors.

Combine this with the fact that most of us do not have inside information on our employer’s financial situation.  That makes for an uncomfortable and sleepless situation.  If you don’t think your employer can close up shop, ask physician on fire.

So, before you contribute to your NG-457, you should be intimately familiar with your employer’s financial situation.  What’s their bond rating?  How much cash on hand do they have?  Have there been any recent changes that would lead you to believe there are financial troubles?

Reason to Pause #2: Bad distribution options

The distribution options are sometimes terrible.  You cannot contribute via Roth to non-governmental 457s. Therefore, you are likely to foot a huge tax bill if you leave your employer unless your new employer accepts transfers (not always the case).

Many 457 distribution plans require you to take the lump sum upon leaving. That’s a huge loss to taxes. Who wants to pay taxes on an additional $250,000-500,000 when you retire or leave your employer?  That’s what happens if you are forced to take the lump sum.

So, if the lump sum is the only option, consider using a taxable account instead.

In order to know the specific options your 457 offers, request the plan documents and read them thoroughly.  Ask questions.  Make sure you understand exactly what is being offered.

Reason to Pause #3: Poor Investment Options

Some 457 plans have high-expense ratio funds, and nothing else.  If this is the situation, don’t feel forced to take advantage of the tax savings just to invest in bad funds.

Instead, pay the taxes, know that your money is yours, and cut your ties.

However, if your plan has low-cost index fund options, and the first two reasons to pause haven’t tripped you up, it’s definitely worth considering the use of your NG-457 plan.

Take Home: Should I Invest in my 457 plan?

If you have a governmental 457

The answer is easy.  If you have the income, then you should participate.  It’s essentially an extra 401K/403B.

After you fill up your 401K/403B, the governmental 457 should be the next retirement space you fill up.  If you have room after that, then a stealth (HSA) IRA and backdoor Roth IRA are your next bets.  Then a taxable account.  Governmental 457’s make life easy.

If you have a non-governmental 457

All of the following assumes that your 457 has good options in which to invest (i.e. low expense-ratio passively managed index funds).  

The answer becomes more complicated.  The one thing that I can tell you that no one would disagree with is that you should be intimately familiar with your employer’s 457 plan.  Ask for it.  They are required to give it to you by law.

Also, in my opinion, you should contribute to your 401K/403B, stealth (HSA) IRA, and backdoor Roth before you consider a non-governmental 457.  Those offer better features with less risk.

I would not participate in a non-governmental 457 unless I was satisfied with number 1 and number 2 above in the section above on what should give you “pause.”  You must be very confident of your employer’s financial situation and stability.  If you have any concerns, then don’t participate in your 457.  A taxable account is a better option in this situation.

If you are okay with your institution’s financial situation and stability, then check the distribution options.  If they don’t let you a) keep the money in or b) take the money over a period of years… then, again, I would hesitate to participate in that 457.  The up-front tax-benefit will likely be a wash if you have to take it all out quickly at the end. For those who plan to leave their current employer or plan to FIRE (retire early), the 457 is not a great option unless your distribution options are solid.

That said, if you are happy with your employer’s financial situation, the NG-457 offers good investment options, AND the distribution options are reasonable… then this may be a good way to fill the gap before age 59.5 when you can access your 401K/403B.

The 20% You Need to Know

I’d consider this part of the 20% of personal finance that you need to know to get 80% of the results.

If you want to know more about what doctors (and other high-income professionals) need to know about personal finance, check out my book – The Physician Philosopher’s Guide to Personal Finance.  It maintains a 5-star review on Amazon.

I realize this is a contentious topic. What are your thoughts?  I’d love to hear them, particularly if you disagree with my assessment.  Do you contribute to your non-governmental 457?  If so, does it meet my criteria?


29 thoughts on “Should I invest in my 457 plan?”

  1. Hi TPP! This is a great review of 457’s and the distinction between the governmental and non-governmental variety.

    I would also like to note the potential advantage of withdrawing from your 457 account penalty free (unlike 401k or 403b) if a person separates from their employer early. This could be useful for early retirees who want to access their money before 59 1/2.

    And I totally agree with you… if you have a governmental 457 available, it’s a no brainer… do it! Just like you, my wife contributes to her governmental 457 (she’s a state prosecutor). Between maxing out this account and her 401k, it’s allowed us to save a lot for retirement (and shelter a lot from taxes). In fact, her entire paycheck earlier this year (pre-maternity leave) was used to fund both accounts so we will be minimally taxed on her income :).

  2. I went back and forth, literally, in the past 5 years. Some years I did and some I didn’t contribute to my non-govt 457. I am privy to the financials and we are super solvent so I’m not worried. However, I’m leaving this year and will need to take a distribution, leave it or take it over 5-10 years. My new employer has non-govt 457 but doesn’t accept transfers.

    It’s got about 36K so I’m just gonna take the lump sum next year. Taking over 10 years makes more sense financially but I don’t want to keep track of it over 10 years. I’ll take the tax hit 2018. I’m going down a bracket with the new code and new job so it’s not terrible.

    In retrospect I would not have contributed. They plans are not transparent and the rollover options are unknown until new employment is secured. However, if I retire early the 456 is the first money to take. As I might RE, I will be doing another 457 next job. Tax tail wagging? Maybe… but my bracket is soooo high I can’t help myself.

    • Yeah, that’s exactly what I plan to do with my 457. Use it to bridge the gap to 59.5 when I can use my 403B. Have a post coming up on bridging this gap.

      It is tough to decide because no one knows what the future holds. Will you change employers? Will your employer’s financial situation change?

      Like poker (and life) you just have to make the best decision you can with the information you have at the time. You can’t judge your result based on the result.

  3. I’m now maxing out my governmental 457, as a State govt employee. The tax benefits have been great, and it allows me to painlessly saved 30%+ of my income straight off the top. The biggest benefit is the ability to access the money penalty-free before 59.5, since many government employees are retired from service long before that age (police and fire, especially). I wish I could roll it over to Vanguard but I don’t see where they host 457 plans, so I’ll keep it with Voya.

    • It’s great that you can roll it over at all since it’s a governmental. My non-governmental 457 is not allowed to do that.

      Have you looked to see if other big companies outside of Vanguard (Fidelity, Schwab, etc) allow 457 roll overs?

      I, too, love the fact that you can access it in early retirement without getting hit with the 10% penalty.

      • Well I haven’t researched it much at all because my plan does not allow in-service withdrawals or rollovers, but I am separating from service to take a new job soon (within a few weeks!) so I will be looking into it more very soon. I literally just got the offer between posting the earlier message and your reply 5 minutes later 🙂

  4. I would also add pausing if the investment options are just terrible. Its been a while since I’ve looked at a 457, but sometimes they are provided to governmental entities by insurance companies, causing some high all-in fees that can eat away at what were your up front tax savings. Its not always a good idea to invest in every tax free plan available.

  5. A couple of questions I’ve had a hard time finding answers to:
    1) What if your company is bought out by another company and the acquiring company doesn’t have a 457 or decides not to continue it?
    2) I’ve asked our HR person about timing of distributions if I leave the company and she replied that I can choose the distributions to start at any date, not necessarily the date I leave the company. But this seems to run counter to this article. What’s the right answer? Is it plan-dependent?

    • 1) not sure about this one, but given that your 457 was being run by a company of some kind (TIAA, Transamerica, etc) I imagine you’d have similar options to when you left the employer. Otherwise it might be plan dependent.

      2)I think it is plan dependent. I do know that some employer’s will let you keep your money in the 457. This would not be appealing to me as I would be pretty far away from what is happening there after I leave. I would want to take the money a
      s soon as possible while minimizing my tax burden. The entire time it is there it is available to creditors.

  6. Nice post! It was interesting to see the comparison as well as what to watch out for with non-governmental 457 plans.

    I have a government 457 plan, and I’m currently in year 2 of maxing it out. I’m in the over 50 group that didn’t contribute enough in the past. Being able to now put in $37,000 per year is fantastic!

  7. Seems like the best reason for ng-457 is early retirement. But I was surprised to read about rule 72(t). That rule seems to make the ng-457 less valuable, but I do hold one of these 457 and just cannot help using it as a tax deduction. I paid 21% in effective tax this year. I see that as a 21% instant ROI. My company is very large though, so that helps me sleep a little. And for those that will talk about my taxes in retirement…I would direct you to WCI. Because I expect to be very judicious in my withdrawal method and pay very little, see his article.

  8. Thanks for the post. Got super excited when I found out my first job would have a 457, but WCI’s article and yours kinda deflated the balloon. I don’t know what the funds are yet, but non-governmental and lump sum as the only distribution option seems to make it a non-starter for my personal situation. Too bad.

  9. I put in max ng-457 contribution for several years and have 200k in there. I stopped contributing about 2 years ago. Plan to retire at 65 in two years and was going to take out as lump sum the year after just because of the creditor exposure. From a tax standpoint I should probably withdraw over 5 years, but not comfortable with 10 years which is also available. Also cognizant of current tax structure that will probably change after 2024. So I go back and forth between lump sum and 5 years. Since I plan to delay Social Security until 70, the 5 year plan sounds more rational to bridge 65-70 along with some taxable accounts. I will have to assess the financial health of the company when time comes. I didn’t contribute for several years because of risk but then I was hit with AMT and just wanted to reduce my taxable income.

  10. Thanks for the info! Helpful!

    FYI, the three year catch up is double the annual max contribution, so $38k for 2019. My husband is doing this in his government 457 plan.

  11. Great post. When I got my first job, I called HR to ask about the ng-457. The person literally told me not to invest. 2 years later the hospital was millions in debt, laying off physicians, and looking for a buyer. It was a stressful enough time without having to worry my money would go to their creditors. And hospital closure seems to keep happening across the US, so I don’t even consider them an option!

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