Though 457 plans and Roth individual retirement arrangements both offer tax-sheltered growth for the money in the plan, they offer significantly different tax benefits. But, you might not have to choose between the two. Since the contributions for the two plan types don't overlap, you can make full contributions to both plans -- if you qualify.
If you work for a state or local government, your employer can offer you the chance to contribute to a 457 plan. Roth IRA eligibility isn't dependent on your employer, but you do need to have compensation. Compensation includes only earned income and taxable alimony. Plus, your modified adjusted gross income has to fall below the annual limits for your filing status. For example, in 2013 you can't contribute at all if you're single and your MAGI exceeds $127,000 or if you're married filing jointly and your MAGI exceeds $188,000.
The limits for a Roth IRA are significantly lower than for a 457 plan. As of 2013, you can contribute up to $17,500 to your 457 plan -- $23,000 if you're 50 or older. Plus, your 457 plan contribution limit isn't cumulative with other retirement plans, so you could also max out your 401(k) or 403(b). Roth IRAs only allow contributions of up to $5,500 -- $6,500 if you're 50 or older. And, your Roth IRA contribution limit is reduced by any money you put into traditional IRA.
Contributions to a Roth IRA won't get you a tax deduction, but you will get your qualified withdrawals out tax-free. Qualified withdrawals require that you be at least 59 1/2, permanently disabled, taking out up to $10,000 for a first home, or withdrawing funds as a beneficiary from an inherited IRA. Plus, the Roth IRA must be at least five tax years old. Your 457 plan contributions reduce your taxable income in the year you make them. But, when you take distributions, you must include the withdrawals in your taxable income.
Early Withdrawal Penalties
When you have a 457 plan, you can withdraw your money any time without paying an early withdrawal penalty. Roth IRAs, on the other hand, impose a 10 percent additional tax on the taxable portion of nonqualified withdrawals. But, if you're taking a nonqualified Roth IRA withdrawal, you get all your contributions out tax-free first. Even when you take an early withdrawal of earnings, which count as taxable income, you can avoid the penalty if you qualify for an exception, like higher education expenses, health insurance when you're unemployed or medical expenses exceeding 7.5 percent of your adjusted gross income.