There are several types of retirement savings accounts. Among the most popular are 401(k) plans and IRAs, including Roth IRAs. For employees of state and local governments or certain tax-exempt organizations, a 457 plan is another option. Understanding the features of each kind of retirement plan is the key to choosing the right combination of retirement accounts for you.
A Roth IRA is an Individual Retirement Arrangement. A Roth IRA account is opened and fully managed by a single individual regardless of their employer or employment status. A 457 plan is a deferred compensation plan setup and managed by a state or local government or certain tax-exempt organizations. Only employees of entities with an established 457 plan may contribute money to a 457.
Funds invested in a Roth IRA grow tax-deferred while within the account. When withdrawn in retirement, all monies taken out of a Roth IRA are tax-free. Likewise, funds within a 457 plan grow without taxes on gains or interest. However, money withdrawn during retirement is subject to ordinary income taxes.
One of the major advantages of a 457 plan is that all contributions and earnings may be withdrawn from the plan without penalty upon separation of service from the employer. Regular income taxes are still due on withdrawn funds. Withdrawals of gains or income from a Roth IRA before age 59 1/2 are subject to ordinary income taxes and a 10 percent penalty. However, all contributions may be withdrawn at any time tax and penalty free.
Contributions made to a Roth IRA account provide no tax deduction. However, contributions to a 457 plan are made with pre-tax dollars. That means that contributions are not taxed and reduce the overall income of the taxpayer.
Roth Designated Accounts in 457 Plans
The Small Business Jobs Act of 2010 permits the use of designated Roth accounts. Such accounts offer the same tax benefits of the Roth IRA within the 457 plan. Contributions made into Roth designated accounts are made with post-tax dollars and do not reduce taxable income or provide any deduction.