Planning 457b withdrawals with a pension

[UNITED STATES] As retirees approach their post-employment years, effectively managing 457(b) plan withdrawals becomes crucial, especially when coupled with pension income. Unlike many retirement plans, 457(b) plans allow penalty-free withdrawals upon retirement, offering flexibility. However, understanding the tax implications and coordinating these withdrawals with other income sources, like pensions, is essential to optimize financial stability and minimize tax burdens.​

457(b) plans are tax-advantaged retirement savings accounts primarily offered to state and local government employees, as well as certain non-profit organizations. These plans allow participants to defer a portion of their salary into an investment account, where it grows tax-free until withdrawal. Upon retirement, withdrawals are taxed as ordinary income, but they are not subject to the 10% early withdrawal penalty, even if taken before age 59½. ​

Unlike 401(k) and 403(b) plans, which are governed by different sections of the Internal Revenue Code, 457(b) plans are unique in their withdrawal flexibility and catch-up contribution provisions. Employees nearing retirement may be eligible for a special catch-up contribution that allows them to double the normal annual limit in the three years before retirement, providing an opportunity to bolster retirement savings quickly. In 2025, the standard contribution limit for 457(b) plans is $23,000, with an additional $7,500 available for those aged 50 and older.

Tax Implications of 457(b) Withdrawals

While 457(b) withdrawals are not penalized for early distribution, they are subject to ordinary income tax. It's important to note that these withdrawals do not count as earned income and, therefore, do not affect Social Security benefits. ​

However, retirees must also consider state income taxes, which vary significantly across the country. While some states, such as Florida and Texas, do not tax retirement income at all, others may fully or partially tax 457(b) distributions. This geographic tax variability should play a key role in retirement planning, especially for those considering relocation. Understanding the local tax landscape can help maximize net income and extend the life of retirement savings.

Coordinating 457(b) Withdrawals with Pension Income

When planning withdrawals from a 457(b) plan alongside pension income, retirees should consider the following strategies:​

Assess Total Income: Calculate the combined income from both the 457(b) plan and the pension to determine your overall tax bracket.​

Strategic Withdrawals: Consider withdrawing from the 457(b) plan in years when other income sources are lower to minimize tax impact.​

Required Minimum Distributions (RMDs): Be aware that starting at age 73 (or 75, depending on birth year), retirees must begin taking RMDs from their 457(b) plans. Planning ahead can help manage these distributions effectively. ​

Another key strategy involves delaying Social Security benefits. By postponing Social Security until age 70, retirees can receive a higher monthly benefit—up to 8% more per year of delay beyond full retirement age. This tactic, when combined with withdrawals from a 457(b) plan and pension income, can create a more tax-efficient and sustainable income stream throughout retirement.

Additionally, retirees with both a defined benefit pension and a 457(b) account may consider structuring withdrawals to fill in income gaps or to manage health care premiums. For instance, keeping modified adjusted gross income (MAGI) below certain thresholds can reduce premiums for Medicare Part B and Part D under the Income-Related Monthly Adjustment Amount (IRMAA) rules. Planning around these thresholds can lead to significant cost savings.

Rollover Options and Considerations

Governmental 457(b) plans offer more flexibility in terms of rollovers. Retirees can roll over their 457(b) funds into an IRA, 401(k), or another qualified retirement plan, which may provide additional investment options and potential tax advantages. However, non-governmental 457(b) plans are more restrictive and may not allow rollovers into IRAs or other qualified plans. ​

Financial experts caution retirees to pay close attention to the type of 457(b) plan they hold. Non-governmental plans, often found in hospitals and certain non-profits, are technically the employer’s assets until distribution. This means they are exposed to the employer’s creditors and carry a higher risk profile. For retirees in this category, it’s especially important to begin the withdrawal planning process early and to seek legal or financial advice to mitigate potential risks.

Effectively planning 457(b) withdrawals in retirement, especially when combined with pension income, requires careful consideration of tax implications, required minimum distributions, and rollover options. By strategically coordinating these elements, retirees can enhance their financial stability and enjoy a more secure retirement. Consulting with a financial advisor can provide personalized guidance tailored to individual circumstances.​