Are Withdrawals From a 457(b) Private Subject to Early Withdrawal Penalty?

Everyone needs a retirement nest egg. It can be exciting to watch the balances in your retirement accounts grow year after year, but it also can be frustrating if you need that money before you reach retirement age. Generally, there are penalties imposed for withdrawing money early from tax-deferred retirement accounts; however, those penalties don't apply to 457(b) plans. It's important to understand the 457b withdrawal rules before you take action, though.

A 457(b) plan is a deferred compensation plan established by a state government or other tax-exempt employer. If you work for a state agency, or if you're considered a manager or highly compensated employee of an eligible tax-exempt organization, you may be able to defer part of your income from tax by depositing it in a 457(b) account. You can invest your deferred income in stocks, bonds and other securities. If you participate in the plan, your 457(b) account contributions and earnings are excluded from your taxable income until you withdraw them. Although you won't pay a 10 percent penalty on early withdrawals, you will find that 457(b) withdrawal rules require that you pay taxes on the amount at the time you withdraw it.

Federal law places 457(b) withdrawal restrictions on accountholders. In general, you can withdraw money when you reach age 70 1/2 or when you leave your job, no matter how old you are. However, there is an exception to the general rule. You may also be allowed to withdraw money from your 457(b) account to pay expenses related to an unforeseeable emergency. The circumstances that qualify as an "unforeseeable emergency" for the purpose of a 457(b) plan withdrawal are narrowly defined and fact-specific. You may also withdraw money from your 457(b) plan without leaving your job if you have an unforeseeable emergency. For example, if a sudden accident or illness involving you or one of your dependents causes you a severe financial hardship, or if you lose your property through casualty or because of an extraordinary, unforeseeable event, you may make an emergency withdrawal. If your loss is covered by insurance or if you can cover the loss yourself by cutting off your 457(b) income deferrals or liquidating some of your assets, you can't make an emergency withdrawal. Sending your kid to college, buying a home and paying off credit card debt aren't considered emergencies, but, for example, repairing uninsured water damage to your primary residence is.

The one major change with the 2018 tax law is an increase in the limits on deferred compensation for certain employees. Previously, certain emergency service providers such as firefighers and paramedics could receive special length of service awards and not have it seen as deferred compensation for 457(b) plans. Previously the limit on that exemption was $3,000 per year. In 2018, that limit doubles to $6,000.

In 2017, withdrawals from a 457(b) plan were not subject to the 10 percent penalty seen with other plans. However, the income was subject to taxation as soon as it was withdrawn. This has not changed with the 2018 tax laws.