Understanding the Benefits of a 457(b) Plan for Firefighters

As a firefighter, securing the retirement you deserve involves exploring every available option. If your state or local government offers a 457(b) Deferred Compensation plan, consider yourself lucky. This plan provides an excellent opportunity to potentially increase your retirement savings, a benefit not all firefighters have access to.

The 457(b) Deferred Compensation Plan

The 457(b) plan is less of a plan and more of an investment account that you can opt into via automated payroll deductions. Within that account, you can choose from a selection of investments, such as mutual funds and annuities. Depending on what’s available to you, you may have the option to contribute either pre-tax (traditional) funds or post-tax (Roth) funds. Unfortunately, not every 457(b) plan provides a Roth component.  

Pre-tax contributions allow you to deduct that contribution from your taxable income, reducing your tax burden for the year and possibly dropping you a tax bracket. In retirement, you’ll owe ordinary income tax on your withdrawals. Post-tax contributions don’t give you a tax break for the year, but you’ll enjoy tax-free growth and tax-free withdrawals.

457(b) Deferred Compensation Plan
Feature Description
Plan Type 457(b) Deferred Compensation Plan
Contributions Automated payroll deductions
Investment Options Curated selection of investments such as mutual funds and annuities
Pre-Tax (Traditional) Contributions Deducted from taxable income, reduces tax burden for the year, ordinary income tax owed on withdrawals
Post-Tax (Roth) Contributions No tax break for the year, but offers tax-free growth and tax-free withdrawals
Early Withdrawal Penalty No penalty after separation from service

You may have noticed something, though – doesn’t this look similar to a 401(k)? If you thought that, you’re absolutely right. However, there are some critical differences between the two.

Firstly, the 457(b) is typically not your primary retirement account as a firefighter; that would be your pension. Instead, it’s a supplemental retirement account designed to give you more power over your retirement savings and, with the power of investing, potentially accelerate them for a better retirement. 

Secondly, unlike a 401(k), governmental 457(b) plans do not have an early withdrawal penalty if you separate from service before the age of 59½, a boon for firefighters who are often forced into early retirement due to injury or illness.

Thirdly, the contribution limits for 457(b) plans can be unique. For instance, in the three years leading up to your normal retirement age, you may be able to contribute more than the standard annual limit, allowing you to catch up on your retirement savings if you started late.

457(b) Plan Contribution Limits
Contribution Type Details
General Annual Contribution Lesser of 100% of participant's compensation or the elective deferral limit:
  • $23,000 in 2024
  • $22,500 in 2023
  • $20,500 in 2022
  • $19,500 in 2020 and 2021
Catch-Up Contributions (Age 50+) Allowed for state and local government 457(b) plans
Special 457(b) Catch-Up Contributions For 3 years prior to the normal retirement age, participants can contribute the lesser of:
  • The elective deferral limit (listed above)
  • The basic annual limit plus the amount of the basic limit not used in prior years (only if not using age 50+ catch-up contributions)

Finally, while both 457(b) and 401(k) plans can offer traditional (pre-tax) and Roth (post-tax) options, the investment choices and plan specifics can differ significantly. For example, 457(b) plans often include annuities as an investment option alongside mutual funds. In contrast, 401(k) plans may offer a broader range of investment options, including a more extensive selection of bonds.

Is the 457(b) Plan Right for You?

If your local or state government offers a 457(b) plan, we highly recommend looking into the plan’s offerings before beginning contributions. Why? Its offerings may come with high fees, so it’s important to compare these with alternative investment accounts like an IRA. However, if the fees are low, then it begins to make more sense to contribute to it for its tax benefits. 

Before you begin contributing, make sure that the investment options align with your risk tolerance and investment timeline. For example, if you only have a few years until retirement, it might not make sense to purchase long-term mutual funds. 

The Power of Compounding Gains

If you do determine that investing within your 457 is the optimal path for your savings, try to start as young as possible. If you can’t afford to maximize your contributions right away, start with what you can, even if it’s $20. Just an insignificant amount could begin to make a difference decades later. 

Even if you contributed only $20 a week and never increased that amount, you’d still end up with over a million dollars after 35 years, assuming a 5% growth rate.

For Visual and Educational Purposes Only – Your Results Will Vary

If you’re not sure how much you can afford, sit down with a financial professional to craft a budget and plan to help you get your money working for you as much as possible. Whenever you get a COLA increase or promotion, consider stashing more into your savings rather than improving your lifestyle immediately. 

Retirement Withdrawals

Traditional, Pre-Tax Funds

When you make it to retirement, you can withdraw as much or as little as you want – but that doesn’t mean there won’t be negative consequences, especially for your sizeable withdrawals. You’ll owe income tax on your withdrawals, and if you take out too much, you might go up a tax bracket. Once you turn 73, the IRS requires you to take a minimum distribution each year, known as the Required Minimum Distribution (RMD). This RMD should be factored into your overall retirement plan, and you may want to begin winding down your 457 before this happens to minimize the tax impact. However, making that call is complex – a consultation with a financial professional would be highly advised. 

Roth, Post-Tax Funds

Roth funds don’t come with RMDs and don’t count towards your taxable income, giving you a very flexible savings tool. However, not all 457 plans come with a Roth component. If you have the option to contribute to both, a careful mix of traditional and Roth funds could help you keep your taxes low in your accumulation years and again in your retirement years. 

Risk Management

Your 457(b) plan is an investment account, and you should treat it as such. To minimize the impact of a market crash, it’s important to diversify your investments and as you approach retirement, consider shifting away from growth-oriented, aggressive investments toward safer options, such as annuities.

You should also rebalance your portfolio quarterly to ensure that your investments remain in proportion to one another and stay within your risk tolerance levels. Regular rebalancing helps maintain a balanced portfolio and reduces the risk of any single investment dominating your overall strategy.

Lastly, reviewing your portfolio regularly with a financial professional is crucial. They can help you readjust your strategy as your financial and life situation changes, ensuring that your investment approach remains aligned with your retirement goals.

In Conclusion

A 457(b) Deferred Compensation plan offers an incredible opportunity to boost your retirement savings, providing flexibility and powerful growth potential through strategic investments and an excellent opportunity to increase your retirement readiness in a world where, as a firefighter, nothing is guaranteed. 

However, choosing to invest in a 457(b) isn’t as simple as it might seem right away, so don’t navigate this journey alone. Partner with a Protection Red financial professional to craft a personalized strategy that aligns with your goals and adapts to life’s changes. Your dedication to saving now can lead to a comfortable, financially secure retirement.

Invest wisely, stay informed, and enjoy the peace of mind that comes with knowing you’re on the right path. Your future self will thank you. Click the button below!

The information contained in this article is for educational purposes only, this is not intended as tax, legal, or financial advice. One should always consult with the tax, legal, and financial professionals of their choosing regarding their specific situation.

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