457 Plans for Physicians: What Most People Get Wrong About Deferred Compensation

Speaker 1 – 00:00
We’ve actually gotten a couple comments on a few of our YouTube videos about this. Should I be funding my 457?
Is your plan a governmental or non governmental plan? A governmental 457 works very similar to a 401k. The big
difference between non governmental 457s and governmental is that non governmental are technically assets that
are still on the employer’s balance sheet. That money is not technically yours. When would it make sense?
Because these plans exist for a reason. Why would someone fund a non governmental 457? It’s not automatically
good or bad, but it’s entirely dependent on how it’s structured.
Speaker 2 – 00:36
There are some strategic ways that you can use your 457 as long as.
Speaker 1 – 00:41
You’re following those order of operations and you’re really analyzing the plan documents for the 457. That would
be our framework. But there are a lot of situations where 457 would make sense. So Tyler, one of our clients just
asked us recently, should I be funding my 457? We’ve actually gotten a couple comments on a few of our YouTube
videos about this. So we figured making a full podcast, breaking down what a 457 is, the different types of 457
plans, why they exist, and does it make sense for you? We’re going to kind of deep dive into all this. But Tyler, let’s
just give a quick background. So what is a, a 457 plan? And, and what, what companies or systems would be
supporting a plan like this?
Speaker 2 – 01:28
Yeah, 457 plan. I know it can kind of get confusing with all these different 4 57, 4 1, 4 3. Like what do they all
mean? A 457 is just another type of tax deferred retirement plan.
Speaker 1 – 01:39
Right.
Speaker 2 – 01:40
It’s usually available to government employees. That’s state and local. There’s actually another version that’s a non
governmental plan. You would see these in like hospitals, surgery centers, if it’s a nonprofit, universities, churches,
stuff like that. Similar to a 401k limit is still $24,500 for 2026. But what’s interesting is it’s kind of separate from the
403B plan. I think sometimes they call it a top hat plan. So you actually can contribute another $24,500 on top of
the 403 that you’d have with your employer.
Speaker 1 – 02:22
Yeah, that’s really important. So a 457, I would almost think of it like a deferred compensation plan. So it’s a
separate retirement plan under a different section inside the Internal Revenue Code. And so like you just said, you
can contribute 24,500 into your 401k and then also on the side contribute another 24,500 into your 457. That’s the
maximum you can defer assuming you’re under the age of 50. So really important limit because those limits are
totally separate. So you can do both, which is a big pro to funding a 457. So a quick clarifier, a 457, it’s not
automatically good or bad, but it’s entirely dependent on how it’s structured. And so like you said, there’s two
different types. There’s governmental 457s and then there’s non governmental.
Speaker 1 – 03:11
So we’re going to talk through the differences between those because they’re really important for a
recommendation is you know, should you be funding this or is this something you should potentially pass on? So
similarity to the 457 and the 401k is that the deferral limits are the same. So if you’re looking at a governmental
457 for example, you can contribute 24,500. Typically that can be pre tax or Roth. So a lot of governmental 457
have a Roth option inside of them. And so that’s super helpful if you have that Roth option. Generally we like that’s
all tax free growth and the tax free distributions down the road. So we really like the Roth option there.
Governmental 457s allow for rollovers. So after you separate from service, you can roll out your governmental 457
plan into like a traditional IRA or a Roth IRA.
Speaker 1 – 04:07
So there’s easy access to those funds. If and when you leave your job, you’re able to move that into an individually
held account. Governmental 457s also have catch up contributions. So if you’re over the age of 50, there’s
additional catch up contributions you can make. And then with the Secure Act 2.0 that was passed in 2023, there’s
also additional catch ups if you’re age 60 to 63. So a governmental 457 works very similar to a 401K. A lot of the
same provisions, a lot of the same parameters, a lot of the same features. So for that we really like the, the big
difference between non governmental 457 and governmental is that nongovernmental are technically Assets that
are still on the employer’s balance sheet.
Speaker 1 – 04:56
And what I mean by that is I would almost think of non governmental 457 funds like wages that have not yet been
paid to you. And so what I mean by that is that money is not technically yours. So if you’re contributing to a 401k or
a governmental 457, that money is held in trust, it’s protected. So if the, if you’re contributing to a 401k and your
employer goes under, well, the money that you contributed on your end, that’s protected. If you’re vested in any
employer contributions, that’s protected as well. Similar structure with a governmental 457, a non governmental,
that’s still just wages that hasn’t been paid to you. So that’s really that true deferred compensation. And so if and
when there is something that happens with your employer, if there’s a lawsuit, if there’s a merger or acquisition,
those funds could be forfeited.
Speaker 1 – 05:51
So that’s really where you want to be specific. Tyler on is your plan a governmental or non governmental plan?
Speaker 2 – 05:57
Yeah, it’s a good point Ben, and honestly. I think we actually saw this in Pittsburgh, right. I think one of the hospitals
had got bought out by private equity or they were being considered to be bought out by private equity. And one of
the things on the table were the 457, the deferred comp plan. So that is definitely something you want to keep in
mind when you’re contributing to these plans or if you’re deciding.
Speaker 1 – 06:15
If you want to keep. Absolutely. And all of those features that I mentioned with the governmental 457, the Roth
option, the catch up contributions, those are not available in a non governmental plan. So there’s no Roth option. In
a non governmental plan there’s no catch up contributions. If you’re over 50 or that 60 to 63 sweet spot, you can’t
take any loans from it, unlike a 401k or a governmental plan. And then the issue is on the distribution side of
things. So if you have a non governmental 457 plan and you leave your employer and you want to roll that out, well,
they only accept rollovers to another non governmental 457 plan. So it’s not like you can just move a non
governmental balance into your IRA or your Roth IRA. It has to go to another non governmental 457 plan.
Speaker 1 – 07:05
So that, and we’ll get into this in more of a case study in a second but that can provide a significant tax increase
because if you need to take some of that money out early because there’s not a lot of structure for how you can
roll that out, that can cause a big tax increase in the years you’re taking those distributions. Right.
Speaker 2 – 07:24
It’s a good point. And usually you’re forced out, right? Like if you leave your employer, it’s like 90 days. Like here’s
your, however much money you put in there, if it’s a million dollars, that’s going to bump you up a couple of tax
brackets if you’re being forced out of the plan.
Speaker 1 – 07:36
Absolutely, absolutely. The rollover thing, it’s so important because on the governmental side you just have that
autonomy and flexibility to move that money into your individually held accounts whenever you leave. The, on the
non governmental side, no IRA access. So you can’t move it to a traditional ira. That means you can’t later convert
it to a Roth because that money has to go to another non governmental 457 or be distributed. So really any of that
money that’s been accumulating in a pre tax environment, there’s no other avenue to move that money to Roth.
That’s why it’s really important to be aware of which 457 plan you have access to, is it governmental or non
governmental and all the rules associated with it. So kind of what we just mentioned, there’s a, let’s assume you’re
a physician.
Speaker 1 – 08:22
You have about 300,000 in a non governmental 457 plan in your hospital system. You leave to go to a private
practice. A lot of these 457 again, the private practice doesn’t sponsor a non governmental 457 plan. So you can’t
just move it into your new employer. A lot of these old hospital systems say, well, hey, you have to take that money
out within a certain time period. Maybe it’s within 90 days, maybe it’s a year, maybe it’s two years. So if you’re
forced to take that 300,000 out of your non governmental 457 in that two year period, let’s say you’re making
500,000 at the private practice. Well, that if you’re taking out 150,000 a year, that’s bumping your income up, you’re
hitting that at the highest tax bracket. So it’s really going to cause that tax spike.
Speaker 1 – 09:09
If and when you’re taking distributions from a non governmental plan in those high income years, you don’t have
that flexibility to roll it into an IRA if it wasn’t a governmental plan, let that continue growing tax deferred. Look at
Roth conversions down the road. You’re kind of boxed in. You don’t have many options there. Tyler. Right.
Speaker 2 – 09:30
You’re kind of letting the, what do we always say on the podcast? The. You’re letting the tax tail wag the dog. Right.
Like you don’t really have a lot of options. You really, you’re trapped. You’re going to let the IRS dictate how you’re
going to take those funds out.
Speaker 1 – 09:42
Yeah. This has been very anti non governmental 457 really? This first few minutes. When would it make sense?
Because these plans exist for a reason. Like why? Like why would someone. Tyler. Like why would someone Fund
a non.
Speaker 2 – 09:56
Governmental 457Ben, I’m glad you bring that up because I feel like for the last 10 minutes we have just been kind
of crapping on nongovernmental plans. But brings up a good point. One would be sometimes there is a Roth
option available in these nongovernmental plans. So if there is a Roth option, you pay the taxes, you get the growth
tax free, you take it out tax free. Right. Second B. If you are close to retirement, you feel comfortable with the
hospital system or the nonprofit that you work for, it could still make sense to take the tax deduction when you’re in
a higher tax rate. If you’re making a million dollars a year and you’re in the highest tax rate, take the deduction.
Because you’re probably not going to be making a million dollars after you retire. Right.
Speaker 2 – 10:36
At least most likely if you’ve been doing your planning correctly and analyzing the tax bracket. So when you’re
taking it out, you might be paying taxes on 20 to 24% instead of the 35% when it was going in. So there are some
cases where you’re comfortable with the hospital system, with your employer or the nonprofit. And then if you are
retiring soon, you kind of take some of the risk off the table and it may make sense.
Speaker 1 – 10:59
Absolutely. If you’re a physician and you’ve been at the same hospital system for many years, you feel pretty
comfortable about the direction where it’s heading. Let’s say you’re a few years out from retirement. Well, that’s an
additional 24,500 that you can put into a non governmental plan. If it’s pre tax, that’s a tax deduction. If it’s a Roth,
that’s entirely tax free. But that goes alongside your current 401k contribution. So if you feel like you need to catch
up a little bit on retirement savings or you just want to kind of supercharge your retirement savings within a few
year period, knowing that you’re only a few years away from taking some of that money out, huge pro for a non
governmental plan.
Speaker 1 – 11:39
So again, case by case basis, if you’re young, just starting out, we kind of like to talk about order of operations, of
funding your accounts. And so if we’re sitting down with like a, a high net worth physician or a young, you know,
physician that’s just starting out, that’s, you know, figuring out what to do with their income, really, we’re looking at
first maxing out your Roth 401k or 403b, preferably that full deferral limit. So 24,500 if you’re under the age of 50, if
you’re on a high deductible health insurance plan, we’re looking at maxing out an hsa, whether that’s your single
contribution or for your family. If aggregation’s not a problem, we’re looking at funding a backdoor Roth IRA for you
and your family. So those three things, 1, 2 and 3, we would look at before any sort of 457 funding.
Speaker 1 – 12:30
If you’re not checking any of those boxes, I would say, or maybe you’re checking two of those three boxes, I would
say, before you fund to 457, make sure that all three of those boxes are checked. And then the second thing would
be making sure that any of your other goals are on track. So like if funding education for any of your kids is a
priority, making sure that goal is on track, whether it be through 529s or brokerage accounts, making sure that you
have your healthy emergency fund, all your short term goals are taken care of.
Speaker 1 – 12:59
So if all of those boxes are checked and you say, hey, I still have excess cash flow, I want to kind of supercharge
my retirement savings, then a governmental 457 would make a lot of sense, particularly if there’s a Roth option to
supplement some of those savings.
Speaker 2 – 13:13
Yeah, that’s a good point, Ben. I actually think we should spend some time because beginning part of the podcast I
brought up, it’s just kind of like a 401k. But there are some strategic ways that you can use your 457 if you have
access to one at your employer. One would be, and I don’t Know if we brought this up earlier, there is no 10%
penalty at separation, right? So yes, you pay income tax on that money if you don’t roll it out, but there is no penalty.
So if you’re retiring, say, let’s say you’ve done a great job of saving, you’ve put yourself into a position where you
can retire at 55.
Speaker 2 – 13:44
Well, you can use that 457 to pull some money out to fund those years before you can actually start taking money
out of your more traditional retirement assets where you have to wait until you’re 59 and a half. So there is a way to
be strategic and kind of fund that early retirement bridge if you are going to retire early.
Speaker 1 – 14:02
Yeah, that’s a really good point. Physicians that want to achieve that financial independence prior to 60. So if you’re
looking at 55 like you said, well, you’re not touching your Social Security or at least you can even take that as 62 if
you wanted to. And ideally you’re not touching any of your 401ks or your IRAs until you’re 59 and a half. So what
are you using to bridge that gap from when you retire at 55 to when you can start touching your qualified plans at
59 and a half? Well, a lot of people it’s, it’s a brokerage account. It’s in money that they’ve invested over time in an
after tax environment. Well, you’ve been paying tax on the dividends and interest every year you’re contributing to
that and then you’re subject to capital gains when you take that money out.
Speaker 1 – 14:43
If you properly structure a governmental 457, you haven’t paid tax on any of that growth along the way and then
you can bridge that gap. Exactly. Like you said, maybe it’s over a four year period, you’re able to supplement your
income with those 457 distributions or let your qualified accounts, and maybe even your brokerage accounts if the
situation allows, continue to accumulate and then touch those once you’re in your 60s. That’s a really strong bridge
to help preserve your other assets. You’re exactly right.
Speaker 2 – 15:12
Yeah. But I think one thing that we haven’t covered yet is kind of how EWA or how we would recommend to some
of our clients utilizing a governmental and a nongovernmental 457 plan. Governmental 457 plan. If you’re in a high
tax bracket, you’re making a bunch of money and you’re looking for other ways to save. We’d almost always
recommend using your governmental 457 plan, especially if there’s a Roth option. You kind of mentioned it earlier,
but that’s a great way to dump. What is that? That’s $49,000 if you’re under the age of 50. Suggested order.
Speaker 1 – 15:44
For the two types of plans, always.
Speaker 2 – 15:46
Recommend doing the 403B first and sometimes you have to fund that first. The second one would be then
dumping the money into the 457. So you’re able to use both for a non governmental point of view. It’s not always
an automatic no, but I kind of like how we’ve said the last couple minutes is you need to know the risks involved.
Speaker 1 – 16:03
Yeah, I, I, I would say like if you’re looking at a non, if your company or hospital sponsors a non governmental 457.
A couple things that you would want to definitely clarify before making any contributions. Where are the assets
held? So just confirming the custody, the investment options, making sure that it’s clarified that money is
technically still deferred comp. You want to know what happens at separation. So when you leave a lot. Oftentimes
your plan document will determine if there’s a timeline for when you need to move that money or distribute that
money. It’ll generally clarify. So we want to make sure that you have an idea if and when you leave your job, what
happens to Your non governmental 457. What’s your distribution schedule look like? Always want to clarify how
stable is the employer?
Speaker 1 – 16:51
I mean if you are at a brand new hospital system or you’re just not sure how stable it is, you really need to consider
that before you’re funding a non governmental plan. And then how long will you stay? I mean if this is something
that, if this is a job that you don’t see yourself staying at for a long time or if you’re young and you’re still bouncing
around. A non governmental 457 just comes with more headaches than a governmental plan would or just like a
standard 401K or 403B. So as long as you’re following those order of operations and you’re really analyzing the
plan documents for the 457, that would be our framework.
Speaker 1 – 17:29
But there are a lot of situations where a 457 would make sense like we said, particularly if you’re older, catching up
on retirement or just want that extra savings on top of your 401k, a governmental plan could make a lot of sense.
Speaker 2 – 17:43
Ben, if you were, I’M going to kind of put you on the spot here. We kind of said, like, you’ll have to look into this, but,
like, where.
Speaker 1 – 17:49
Do you think the.
Speaker 2 – 17:49
Where do you think an employee should go? Do you go to hr? Do you go to your advisor? Like, who would be able
to tell you what kind of type of plan you’re in?
Speaker 1 – 17:55
Yeah, so, like, your HR portal should have a summary plan description of your. All your retirement plans. So your
401k and your 457, they should be able to provide that information for you. Whether that’s in your benefits portal or
they can just send that to you. That would be the first place you would look. And then you can work with your
advisor on your particular situation, because everyone’s going to be different. These are not blanket
recommendations by any means. So analyzing your tax situation, your retirement goals, your budget, your cash
flow, and work with your advisor to make the best decision for you. It’s just really important that you have all those
questions answered before you make any contributions.
Speaker 2 – 18:36
All right, just to kind of recap some of the stuff we covered today. EWA or really our recommendation for
governmental 457 plans. Almost always. Great. Almost always. Another way to save additional dollars. Non
governmental. So if you’re working at the hospitals, surgery centers, nonprofits, it could make sense. But you really
want to keep in mind, like, how long you’re working at these places. Are you new to the area? Do you know anything
about these hospitals? Do you know what their balance sheet looks like? Are you comfortable with it? So I would
say before you contribute to those, and we might beating a dead horse a little bit here, but just do your homework,
talk to your advisor, talk to the other physicians there, and just kind of get a lay of the land.
Speaker 2 – 19:15
Another thing you kind of ask yourself is like, where’s my money actually sitting? Right? Is it on my balance sheet
or is it on the hospital’s balance sheet? And then, and kind of like Ben had mentioned, talk to hr, look into your
portal, talk to your advisor, try to figure out where these assets are sitting before you make any rash decisions.
Speaker 1 – 19:33
Perfect. If you have any questions about your particular 4:57 plan, or if it makes sense to you, feel free to reach
out. We’re happy to provide a free consultation.