Making the right choice between a Roth IRA and a 457 Retirement Plan can be complicated, but understanding the benefits and features of each account before you invest can help ensure that your retirement savings are on track.

We'll explain what makes these two options unique including how contributions work, taxation rules, eligibility requirements, etc. With this information, you'll be better equipped to decide which retirement plan best meets your financial goals. Get ready to compare these popular investment accounts today.

Roth IRA, and how does it differ from a 457 retirement plan

A Roth IRA is an individual retirement account that allows you to contribute up to $6,000 per year (as of 2021) of after-tax income into an investment account. Contributions are not tax deductible, but withdrawals during retirement can be taken without additional taxation. If you invest your money in a Roth IRA and it grows over time, you won’t have to pay taxes on the gains when you withdraw them later in life.

In contrast, a 457 retirement plan is an employer-sponsored deferred compensation plan. Participants can defer up to 100% of their salary into the plan, and contributions are usually tax-deductible. Withdrawals from 457 plans are generally subject to taxation, but some withdrawals before retirement may qualify for special tax treatment. It's important to note that a 457 plan is only available if your employer offers one, so not everyone will be eligible for this type of retirement plan.

Both Roth IRA and 457 plans are great options for retirement savings, but the key difference comes down to taxes. With a Roth IRA, you’ll pay taxes up front on contributions but not when you withdraw during retirement, while with a 457 plan, you’ll get an upfront tax deduction on contributions but pay taxes when you withdraw later in life. Depending on your financial situation and goals, either option could be the right choice.

Pros and cons of a Roth IRA

Pros

• Flexibility: With Roth IRAs, you can withdraw contributions anytime without penalty or taxes, allowing you to access your money if needed.
• Tax-free growth: Any gains on investments in a Roth IRA are not subject to taxation during retirement, meaning you can keep more of the money you’ve earned over time.
• Unlike regular IRAs and 401(k)s, Roth IRAs don't mandate that members begin receiving required minimum distributions (RMDs) at age 70 1/2, providing them more flexibility over when they remove money from their account.
• Long-term savings for children and grandchildren: Roth IRAs are a great way to set up long-term savings for your kids or grandkids. Because you’ve already paid taxes on the money, it can benefit from tax-free compounding over time and be passed to a child without taxation when they reach adulthood.
• Contribute after retirement: You can still contribute to a Roth IRA as long as you have earned income, so if you’re still working (or even if you have other sources of income) after retirement age, you can continue saving with this type of account.

Cons

• Low contribution limits: The maximum annual contribution amounts are limited to $6,000 per year (as of 2021).
• Age restrictions: Roth IRA contributions are only available for individuals under 70 1/2.
• Income restrictions: Due to income restrictions, which phase out at specific thresholds in most states, high incomes may not be able to contribute to a Roth IRA.
• Early withdrawal penalties: Withdrawals before age 59 1/2 may result in a 10% penalty plus additional taxes and fees if applicable.
• Low contribution limit carryover: Any unused annual contributions cannot be rolled over into the following year if they exceed the annual limit of 6,000 dollars per person (not per household). This means you must ensure your total contributions don’t exceed the limit for any given year.

Pros and cons of a 457 retirement plan

Pros

• Tax-deferred contributions: Contributions to a 457 plan are made with pre-tax dollars and are therefore exempt from taxation until you begin withdrawals in retirement.
• Employer match: Many employers will offer matching contributions to their employee’s 457 plan, which can be a great way to maximize your savings and get the most out of your employer’s retirement benefits.
• High contribution limits: Unlike Roth IRAs, the contribution limit for 457 plans is much higher at $19,500 per year (as of 2021). If you have the income to do so, you can save more money in this type of account than with a Roth IRA.
• Ability to borrow against funds: You can borrow up to 50% of your 457 plan’s balance (up to $50,000) for various purposes, such as purchasing a home or paying for an education.
• No RMD: As with Roth IRAs, 457 plans don’t require participants to start taking RMDs at age 70 1/2, which gives them more control over when they take withdrawals from their account.

Cons

• Early withdrawal penalties: Withdrawals before age 59 1/2 may result in a 10% penalty plus additional taxes and fees if applicable.
• Low contribution limit carryover: Any unused annual contributions cannot be rolled over into the following year if they exceed the annual limit of 19,500 dollars per person (not per household). This means you must ensure your total contributions don’t exceed the limit for any given year.
• Lack of estate planning: Unlike Roth IRAs, there is no estate planning benefit with a 457 plan, as withdrawals are taxed upon death and cannot be passed to heirs without taxation.
• Limited investment options: Depending on your employer’s 457 plan provider, you may be limited in the investments available in your account.
• No tax-free gains: Any gains on investments held inside a 457 plan are subject to taxation when withdrawn during retirement.

How to decide between the two plans?

When deciding between a Roth IRA and a 457 retirement plan, several factors must be considered. First, look at your current income and compare it to the contribution limits of each plan. If you’re in a higher tax bracket or have more income than allowed for contributions to a Roth IRA, you may want to opt for a 457 retirement plan.

If you have an employer who offers matching contributions or other incentives for their employees’ 401k plans, these should also be considered when making the decision. Another factor to remember is how long you plan on investing in each type of account.

FAQS

What is the downside of a Roth IRA?

The primary downside of a Roth IRA is the income limits, which phase out at certain thresholds in most states. Withdrawals before age 59 1/2 may result in a 10% penalty plus additional taxes and fees if applicable.

At what age does a Roth IRA not make sense?

A Roth IRA may not make sense for someone over 70 1/2, as Roth IRAs require RMDs (required minimum distributions) to be taken from the account at that time. Alternatively, a 457 plan has no RMD requirement and can provide more flexibility for older investors.

Should I do IRA Roth or 457?

The best choice depends on age, income level, and investment goals. If you are under the income limit for a Roth IRA and have long-term investing goals, opting for a Roth IRA may be more beneficial.

Conclusion

A 457 Retirement Plan and a Roth IRA are great retirement savings options. The two plans differ in important ways when managing financial security and tax benefits. The 457 Plan provides certain advantages over the Roth IRA, like higher contribution limits and lending opportunities, while Roth IRA provides a chance to save post-tax money.