How Does an IRS Section 457 Plan Work?

A Section 457 plan is a non-qualified, tax-advantaged deferred-compensation plan available to employees of specific governmental and non-governmental employers. It allows employees to set aside a portion of their salary for retirement, supplementing other savings accounts. The funds contributed to the plan are invested and can grow over time.

These plans operate by allowing an employee to defer a portion of their compensation. This process reduces the employee’s current taxable income, as the deferred amount is not included in their wages for the year. The tax on both the contributions and any investment earnings is postponed until the funds are withdrawn, which helps savings accumulate more rapidly than in a taxable account.

Plan Eligibility and Types

Participation in a Section 457 plan is limited to employees of state and local governments and certain tax-exempt organizations. This includes civil servants, public school teachers, and employees of non-profits like hospitals or charities. The plans are categorized by employer type, which alters the rules for assets, security, and portability.

The most common type is the governmental 457(b) plan. Under Internal Revenue Code Section 457, all plan assets must be held in a trust or custodial account for the exclusive benefit of participants. This structure protects employee funds from the employer’s creditors, similar to a 401(k) plan.

The second type is the tax-exempt 457(b) plan, offered by non-governmental organizations under Internal Revenue Code Section 501. The plan’s assets remain the property of the employer until distributed, making them subject to the claims of the employer’s creditors. Due to this risk, tax-exempt plans are restricted to a select group of management or highly compensated employees.

A less common variation is the ineligible 457(f) plan, which can also be offered by non-governmental, tax-exempt organizations. These plans are used to provide deferred compensation benefits that exceed the standard contribution limits of a 457(b) plan. The defining characteristic is that the deferred amounts are subject to a “substantial risk of forfeiture,” meaning the employee’s right to the money is not secured until certain conditions, such as a specific length of service, are met. Once this risk is removed and the benefits vest, they become immediately taxable to the employee, regardless of whether the funds have been paid out.

Contribution Rules and Limits

The Internal Revenue Service sets annual limits on the amount an employee can defer into their 457(b) plan.

General Contribution Limit

For 2025, the general contribution limit is $23,500, which includes both employee and any employer contributions. This limit is independent of the limits for 401(k) or 403(b) plans. An employee with access to both a 457(b) and another plan, like a 403(b), can contribute the maximum amount to each.

Catch-Up Contributions

Participants in governmental 457(b) plans who are age 50 or older can make additional “catch-up” contributions. For 2025, this amount is $7,500, allowing a total contribution of $31,000. A higher catch-up contribution is also available for participants ages 60, 61, 62, and 63, which allows for an additional $11,250 for 2025 if adopted by the plan. This age-based catch-up is not available to participants in non-governmental, tax-exempt 457(b) plans.

Special 457 Catch-Up

Both governmental and tax-exempt 457(b) plans offer a “Special 457 Catch-Up” provision. This allows a participant to contribute an increased amount for the three years leading up to their normal retirement age. For 2025, this could allow a contribution of up to $47,000, which is double the standard annual limit.

This special limit is based on the standard limit plus any underutilized contributions from prior years. A plan administrator can assist in calculating this amount and confirming eligibility.

A participant cannot use both the Age 50+ Catch-Up and the Special 457 Catch-Up in the same tax year. An eligible employee must choose the provision that allows for the larger contribution. For example, the Special 457 Catch-Up could allow a far greater contribution than the standard Age 50+ Catch-Up if the participant has a large amount of underutilized funds.

Taxation of Contributions and Distributions

When an employee makes traditional, pre-tax contributions, the amount is deducted from their gross pay before income taxes are calculated. This reduces their current taxable income for the year, which is reflected on their Form W-2.

Some governmental 457(b) plans offer a Roth option, where contributions are made with after-tax dollars and do not reduce current taxable income. Regardless of the contribution type, any earnings within the plan grow on a tax-deferred basis. This means no taxes are paid on investment gains as they accumulate.

Distributions from a traditional 457(b) plan are taxed as ordinary income in the year the money is received. Withdrawals from a Roth 457 account are tax-free if they are “qualified.” A qualified distribution is one made after the participant has held the Roth account for at least five years and has reached age 59½, become disabled, or passed away.

An advantage of governmental 457(b) plans is the absence of the 10% early withdrawal penalty that applies to other retirement plans. Under Internal Revenue Code Section 72, distributions from a governmental 457(b) are not subject to this penalty if the withdrawal occurs after the employee has separated from service. This rule does not apply to funds rolled into the 457 plan from another plan type, as those assets retain their original penalty rules.

Rollovers and Portability

The ability to move funds from a 457(b) plan upon leaving a job depends on the plan type. The rules for governmental plans are more flexible than those for tax-exempt plans.

Participants in a governmental 457(b) plan have a high degree of portability. Upon separation from service, they can roll over their account balance to several other retirement accounts, including:

• A Traditional IRA or Roth IRA
• A 401(k) plan
• A 403(b) plan
• Another governmental 457(b) plan

This allows former public employees to consolidate their retirement savings. A direct rollover is a non-taxable event unless converting pre-tax funds to a Roth IRA.

In contrast, rollovers from a tax-exempt 457(b) plan are highly restricted. Funds from these plans cannot be rolled over into an IRA, 401(k), or 403(b). Portability is limited to a direct transfer to another tax-exempt 457(b) plan, if available, which means many participants must begin taking taxable distributions upon leaving their job.

Funds can also be rolled into a governmental 457(b) plan from other eligible retirement plans like IRAs, 401(k)s, and 403(b)s. These incoming rollover assets must be held in a separate account within the 457(b) plan. This separate accounting is necessary because the rolled-in funds retain the rules of their original plan type.