Non-Qualified 457b Plan Rules and Limitations

Deferred compensation plans allow employees to set aside a portion of their income for retirement by postponing some of their salary until a future date. One specific type is the 457b plan, which provides a tax-advantaged savings opportunity for employees of particular organizations.

Defining the Non-Qualified 457b Plan

A non-qualified 457b plan is offered by non-governmental, tax-exempt organizations under Internal Revenue Code Section 501(c), such as hospitals, charities, and private universities. These plans are also made available to a select group of management or highly compensated employees within state and local governments.

The “non-qualified” status means the plan’s assets are not held in a trust for the employee’s exclusive benefit. The funds legally remain the employer’s property until distributed and are often held in a “rabbi trust.” This structure means assets are reachable by the employer’s creditors, unlike in qualified plans like 401(k)s where savings are protected.

This ownership structure creates a “substantial risk of forfeiture.” If the employer files for bankruptcy, the employee’s deferred funds are subject to the claims of the organization’s general creditors, meaning the employee could lose their savings. Participation is limited to a “select group of management or highly compensated employees” to avoid certain funding requirements under the Employee Retirement Income Security Act of 1974 (ERISA).

Contribution Limits and Rules

The amount an employee can defer into a non-qualified 457b plan is subject to an annual limit set by the Internal Revenue Code, which is $23,500 for 2025. This limit applies to the combined total of employee and employer contributions. This limit is independent of those for 401(k) or 403(b) plans, allowing eligible employees to contribute to both types of plans concurrently.

A provision allows participants to increase their contributions in the three years before their normal retirement age. This “3-year catch-up contribution” can be as much as double the annual deferral limit, allowing a contribution of up to $47,000 in 2025. The actual catch-up amount is limited to the total of unused deferral amounts from previous years.

An employee cannot use both the 3-year catch-up and the standard age 50+ catch-up contribution in the same tax year. The age 50+ catch-up is not available to participants in a non-governmental 457b plan. Any contributions that exceed the annual limits must be returned to the participant, along with any earnings, by April 15 of the following year.

Rules for Withdrawals and Taxation

Distributions from a non-qualified 457b plan are permitted upon specific triggering events, and the timing and form are determined by the plan’s terms. In-service distributions are not allowed. Triggering events include:

• Separation from service
• Death
• Disability
• Reaching a specified age as outlined in the plan’s document

When funds are distributed, they are taxed as ordinary income to the recipient in the year they are received and are reported on a Form W-2 or Form 1099-MISC. This applies to both the original deferrals and any earnings.

A feature of these plans is the absence of the 10% early withdrawal penalty that applies to many other retirement plans. An employee who separates from service can take distributions regardless of age without this penalty. Plans may also permit distributions for an “unforeseeable emergency,” defined as a severe financial hardship from events like an illness, accident, or property loss.

Understanding Rollover Limitations

The rules for moving funds from a non-qualified 457b plan are highly restrictive. Assets from a non-governmental 457b plan cannot be rolled over into an Individual Retirement Account (IRA), a 401(k), a 403(b), or a governmental 457b plan. This is a direct consequence of the plan’s non-qualified status.

The only transfer option is a direct trustee-to-trustee transfer to another non-qualified 457b plan. This is only possible if the employee moves to a new employer that offers such a plan and that new plan accepts the transfer.