By now, many people are familiar with the basic concepts of a 401k retirement savings plan. But, did you know there are different kinds of 401k plans? Do you know what a 457 plan is, or what its variation, the Roth 457 plan is? If you already have a good understanding of regular 401k plans, or traditional 401k plans, then it’s pretty easy to see the difference. If not, don’t worry, we’ll walk you through it step by step.
Standard Features 401k and 457 Plans
The regular parts of a 401k plan are relatively well known. An employer must start and run the 401k plan. Contributions made to the 401k plan are traditionally made with pre-tax dollars. That means that you pay no taxes on the amounts you contribute to a 401k plan. Also, no capital gains taxes or taxes on dividends are due while the money grows inside of the 401k savings plan. In exchange, you cannot withdraw money from a 401k plan prior to age 59 1/2 except in very specific circumstances without penalty. In addition, you will have to pay taxes on the money as you withdraw it from the account. And, finally, once you turn 70 1/2 years old, you will have to start taking requirement minimum distributions (withdrawals), or RMDs from your 401k retirement plan account.
For more information about 401k rules and basics, see the 401k primer. A 457 plan works very much the same way, except they are generally only allowed for government entities, and they have some differences about withdrawing money.
Roth 401k Features
A Roth 401k is to a 401k plan, what a Roth IRA is to a traditional IRA. (Likewise, the Roth 457 retirement plan.) The main difference is between a regular 401k and a Roth 401k is that with a Roth 401k retirement plan, you do NOT make contributions with pre-tax dollars. In other words, you do get taxed on the contributions you make to a Roth 401k. However, unlike a traditional, or regular 401k plan, you do not have to pay taxes on that money, or any of its earnings, when you withdraw it, as long as the account is at least five years old.
Two other very big differences between a Roth 401k and a Roth IRA are that Roth IRA contributions are limited by income, and the maximum contribution is $17,500 per year for a Roth 401k or Roth 457, and a maximum contribution of $5,500 for a Roth IRA. (Plus catch-up contributions, if you are old enough.) You can however, contribute the maximum to BOTH a 401k and an IRA, including Roth 401k and Roth IRA plans. Furthermore, if the plan allows it, participants can also contribute to BOTH a Roth 401k plan and a Roth 457 plan.
There is one very big difference between Roth 401k plans and Roth IRAs. Required Minimum Distributions, or RMDs do not apply to Roth IRA plans. However, RMDs do apply to all employer sponsored retirement plans, including Roth 401k and Roth 457 plans.
Company Specific 401k Plan Rules
One thing that is less well-known, is that while the basics, and the tax rules of a 401k plan are defined by law and the IRS tax code, there are many parts and features of 401k plans, and 457 plans, that are left to the discretion of the employer in how they want the plan to be set up. For example, individual 401k plans may, or may not, offer in-service withdrawals for employees who still work for the company.
The State of Colorado recently decided to offer Roth 401k plans and Roth 457 plans to state employees who are PERA members. Plans are supposed to be ready by the end of the 2014 year.