Do 457 Contributions Reduce AGI for Tax Purposes?

A 457 plan is a retirement savings account for government employees and certain non-profit workers. A common question is whether contributions lower adjusted gross income (AGI) for tax purposes. Since AGI affects eligibility for tax credits and deductions, understanding how 457 contributions impact it is important for tax planning.

The effect on AGI depends on whether contributions are pre-tax or after-tax. Other factors, such as the type of 457 plan and coordination with other retirement accounts, also influence tax benefits.

Pre-Tax and After-Tax 457 Options

The tax treatment of 457 plan contributions depends on whether they are pre-tax or after-tax. Pre-tax contributions reduce taxable income in the year they are made, while after-tax (Roth) contributions do not lower taxable income but allow for tax-free withdrawals in retirement if conditions are met.

Governmental Plans

Governmental 457(b) plans, available to state and local government employees, offer more flexibility than non-governmental versions. Pre-tax contributions lower taxable income in the year of contribution, but withdrawals in retirement are taxed as ordinary income. Some plans also offer Roth contributions, which are taxed upfront but allow for tax-free withdrawals if the holding period and age requirements are met.

A key advantage of governmental 457(b) plans is that withdrawals after separation from service are not subject to the 10% early withdrawal penalty, regardless of age. Funds in these plans can often be rolled over into other retirement accounts, such as an IRA or 401(k), providing more options for managing savings.

Non-Governmental Plans

Non-governmental 457(b) plans, offered by tax-exempt organizations like hospitals and universities, have stricter rules. Pre-tax contributions reduce taxable income, but Roth options are less common. Unlike governmental plans, funds cannot be rolled over into an IRA or other retirement accounts. Instead, distributions follow employer-set payout schedules, which may require full withdrawal over a set period.

Another drawback is that assets in a non-governmental 457(b) remain part of the employer’s general assets until distributed, meaning they could be at risk if the employer faces financial difficulties. This makes these plans less flexible for long-term tax planning.

Salary Deferral Terms

Employees can contribute a portion of their earnings to a 457 plan, subject to annual IRS limits. For 2024, the contribution limit is $23,000, with an additional $7,500 catch-up contribution for those aged 50 and older.

A unique feature of 457(b) plans is the special catch-up provision, which allows employees within three years of retirement age to contribute up to twice the standard limit if they have unused contribution room from previous years. Contributions must be elected before compensation is earned, and employers may impose their own restrictions, so employees should review plan-specific rules before making adjustments.

Relationship to AGI Calculation

Pre-tax 457 contributions lower AGI by reducing taxable wages. A lower AGI can increase eligibility for tax credits such as the Earned Income Tax Credit (EITC) and the Premium Tax Credit (PTC), both of which phase out as income rises. It can also help reduce exposure to the 3.8% Net Investment Income Tax (NIIT), which applies to individuals with modified AGI above $200,000 ($250,000 for married couples filing jointly).

A lower AGI may also reduce the portion of Social Security benefits subject to taxation. Up to 85% of benefits can be taxed if income exceeds certain thresholds, so reducing AGI can lower this tax burden.

Pre-tax 457 contributions also affect deductions that are subject to AGI limits. Medical expenses are only deductible to the extent they exceed 7.5% of AGI, so lowering AGI increases the amount of expenses that qualify. Deductions for student loan interest and traditional IRA contributions phase out at higher income levels, meaning a lower AGI can help taxpayers qualify for these benefits.

Coordination with Multiple Retirement Accounts

A 457(b) plan has a separate contribution limit from 401(k) and 403(b) plans, allowing individuals with access to both to contribute the full annual limit to each. For 2024, this means up to $23,000 in a 457(b) and an additional $23,000 in a 401(k) or 403(b), plus applicable catch-up contributions.

For high earners, this can significantly reduce taxable income while increasing retirement savings. However, unlike 401(k) and 403(b) plans, 457(b) plans generally do not offer employer matching contributions. This may influence prioritization, as maximizing an employer match in a 401(k) or 403(b) could take precedence before contributing to a 457(b).

Withdrawals from 457(b) plans are also treated differently. Governmental 457(b) funds can be accessed penalty-free upon separation from service, unlike 401(k) and 403(b) accounts, which typically impose a 10% early withdrawal penalty before age 59½ unless an exception applies.

Required minimum distributions (RMDs) apply to pre-tax 457(b), 401(k), and 403(b) plans starting at age 73 under the SECURE 2.0 Act. Roth 401(k) and Roth 403(b) accounts are no longer subject to RMDs beginning in 2024, but Roth 457(b) accounts still require RMDs unless rolled into a Roth IRA, which does not have mandatory distributions. Rolling funds into a Roth IRA can provide greater flexibility in retirement.

Tax Forms for Reporting

Employers report pre-tax 457(b) contributions on Form W-2 in Box 12, using code “G.” These amounts are excluded from taxable wages in Box 1 but are still subject to Social Security and Medicare taxes, unlike traditional 401(k) contributions. If Roth contributions are available, they are included in taxable wages and reported separately under code “EE.”

When funds are withdrawn, the issuing financial institution provides Form 1099-R, detailing the distribution amount and any taxes withheld. Box 2a specifies the taxable portion, while Box 7 contains a distribution code indicating the nature of the withdrawal. For governmental 457(b) plans, distributions after separation from service are coded “2” (early distribution, exception applies) or “7” (normal distribution), meaning they are not subject to the 10% early withdrawal penalty. Non-governmental 457(b) plans may have different coding depending on the employer’s payout structure.