Can I Max Out My 401k and 457?

If you just discovered you qualify for multiple retirement accounts, you might ask yourself, can I max out my 401k and 457?

Yes, you can max out both your 401k and 457 plan up to the maximum allowed by the IRS, which is $22,500 for each account.  Contributing the max to both accounts results in a total tax deferral of $45,000 per year, not including catch-up contributions.

This is a great way to maximize your tax advantages for those looking to bulk up their retirement accounts quickly.  If you decide to invest in both accounts your next question might be: 

 

Should I Max Out My 401k or 457 First?

Most of the time, it's better to max out your 401k first since your employer can contribute a company match.  Taking advantage of the company match is equivalent to a 100% return!

Unfortunately, your employer cannot match your contributions to the 457 plan.  Therefore, you should only contribute to the 457 plan after taking advantage of the entire company match in your 401k.

Here is a helpful flowchart I made on How To Prioritize Your Investments:

Maxing out 401k and 457 accounts in the correct order allows you to put the most money to work for you.  The money won't be going to Uncle Sam as an interest-free loan.

Instead, it gets invested and flourishes through the magic of compound interest.

Let me show you an example of the difference that maxing out your 401k and 457 can have on your retirement plans.

Scenario A:

A married couple making a combined $120,000 a year decides not to max out their 401k or 457 and invest in a taxable account.

To make things simple, I am not including other taxes and deductions.  As a result, they pay $12,837 in taxes and are left with $107,163.

Their expenses are $38,000/year.  Therefore, they are left with ($107,163 – $38,000 = $69,163).

With the $69,163, they invest it all into a taxable account where they make a return of 7% a year.

Using my Financial Independence Spreadsheet, we can calculate that after 20 years, their account has grown to 2.8 million.

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Scenario B:

In this scenario, the married couple making $120,000 a year combined decides to max out their 401k and 457. 

They pay only $1,800 in taxes and are left with $40,200.  Their expenses are $38,000/year, the same as before.

Therefore, they are left with ($40,200 – $38,000 = $2,200).

Since they contributed the max to both accounts, they already have $78,000 cost averaged into the market, so they decided to throw the remaining $2,200 into a taxable account.

Now they have a total of $80,200 invested, and each year they make a return of 7%.

Now my Financial Independence Spreadsheet calculates that after 20 years, their account has grown to 3.2 million!

A difference of $400,000!

This doesn't include other benefits, such as tax deductions from a lowered adjusted gross income (AGI) in scenario B.  There are taxes on the dividends in scenario A, while the money grows tax-free in scenario B.

Another way to look at it is; scenario B had an extra $11,037 each year to invest.  This extra money grew tax-free for 20 years into over $400,000.

To be fair, the family in scenario B will have to pay taxes on this extra money.

However, the tax liability should be much lower in retirement since you aren't earning any income in the form of a W-2 anymore.

You don't have to fit into one of these scenarios; these are just examples of the two extremes.  The takeaway is that investing through a tax-advantaged account helps you reach your retirement goals much faster.

The more tax advantages, the better!

 

The IRS allows you to max out your 401k and 457, so that is fantastic if you can do both!

What if you can only contribute to one or the other?

 

Which Is Better, 401k or 457?

For most, the answer is your 401k.  Employers usually do not match funds contributed to a 457 plan.  Also, most people plan to retire after the age of 60.

Therefore, the is no penalty for withdrawals from their 401k.

With 457 plans, you may have limited investment options, which might also carry higher fees than your 401k choices.

However, 457 plans have a unique option to take early withdrawals, penalty-free.

For us in the FIRE community, this means having access to your money much sooner.  We don't plan to work until we are 60 or older, so the 457 plan benefits may outweigh the benefits of a 401k.

This is also highly dependent on the investment options available in both accounts.

I would suggest carefully considering both accounts' investment options and fees, then making a decision that makes sense for you and your family.

Lastly, look at how the IRS explains it if you want to go directly to the source!

If you qualify for both a 401k and 457, you can now create your scenario, but first, I highly recommend reading Using a 457b Plan: Advantages & Disadvantages.

In that article, I detail exactly how to take full advantage of a 457 plan and avoid some pitfalls.

Planning for retirement using these accounts is not a one-size-fits-all.  Instead, your chosen path will depend highly on your options and financial goals.

However, now that you are equipped with the knowledge you've gained from this article, you can create a scenario that works best for your family.

If you are still unsure, it might be time to reach out to a fee-only advisor for professional advice. 

The peace of mind of knowing you have a professional on your side helping you can significantly outweigh the costs.