What Is a 457 Plan? Rules, Limits, and Distinctive Features
Understand 457 plans: their unique rules, contribution limits, and distribution features for specific employee retirement savings.
A 457 plan is a deferred compensation arrangement, primarily for employees of state and local governments and certain tax-exempt organizations. These plans help individuals save for retirement in a tax-advantaged manner. Participants contribute a portion of their income, which grows over time. A 457 plan is a distinct retirement vehicle with specific rules governing contributions and distributions.
Understanding 457 Plans
A 457 plan operates as a non-qualified deferred compensation plan, meaning it is not subject to the Employee Retirement Income Security Act (ERISA). This structure permits participants to defer a portion of their current income, delaying taxation until distribution, typically during retirement. The deferred compensation, along with any investment earnings, accumulates on a tax-deferred basis.
Eligibility for 457 plans is primarily divided into governmental and non-governmental categories. Governmental 457(b) plans are the most common, offered by state and local government entities, including municipalities, public education systems, and various state agencies. All employees of these governmental bodies are generally eligible to participate. These plans often complement other employer-sponsored retirement programs such as pension plans or 401(a) defined contribution plans.
Non-governmental 457(b) plans are established by tax-exempt organizations, such as non-profit hospitals or charitable foundations. Participation is typically restricted to a select group of management or highly compensated employees. These employers offer a competitive benefits package to aid in recruiting and retaining top executive talent.
A distinct, less common, variant is the 457(f) plan, also offered by non-governmental tax-exempt organizations. These “ineligible” deferred compensation plans are primarily designed for a very limited number of senior executives. A defining feature of a 457(f) plan is the “substantial risk of forfeiture,” meaning deferred funds are not irrevocably vested until specific conditions, such as continued employment for a predefined period, are satisfied.
For employees, the purpose of participating in a 457 plan is to save for retirement in a tax-efficient manner. Contributions made on a pre-tax basis reduce current taxable income, and earnings within the plan grow without immediate taxation. This tax deferral mechanism helps participants accumulate retirement savings while managing their annual tax liability.
Contribution and Distribution Rules
Annual contribution limits for 457 plans are set by the IRS and are subject to periodic adjustments. For 2025, the maximum an employee can contribute to a 457(b) plan through elective deferrals is $23,500. This limit, outlined in Internal Revenue Code Section 457, encompasses both employee salary deferrals and any employer contributions made on the employee’s behalf.
Governmental 457(b) plans offer two forms of catch-up contributions. The Age 50+ catch-up allows participants aged 50 or older to contribute an additional $7,500 for 2025, raising their total potential contribution to $31,000. This provision does not depend on prior contribution history. A higher catch-up of $11,250 may be available for those aged 60-63 due to SECURE 2.0 Act of 2022, if adopted by the plan.
The special 3-year catch-up permits governmental 457(b) plan participants to contribute up to double the regular annual limit, potentially $47,000 for 2025, during the three years immediately preceding their normal retirement age. This option is contingent on having under-contributed in previous years. Participants cannot combine the Age 50+ catch-up with the special 3-year catch-up in the same year. Non-governmental 457 plans do not offer the Age 50+ catch-up provision.
Traditional 457 plan contributions are pre-tax, reducing current taxable income. Earnings within the plan grow tax-deferred, with taxes postponed until withdrawal. Upon distribution in retirement, both contributions and earnings are taxed as ordinary income at the participant’s applicable tax rate. Some governmental 457(b) plans also provide a Roth contribution option, where after-tax contributions are made. Qualified distributions from Roth 457(b) accounts, after a five-year holding period and meeting certain conditions, are entirely tax-free.
Distributions from 457 plans are generally available upon specific events, including separation from service, reaching age 70½, death, or an unforeseeable emergency. For governmental 457(b) plans, participants typically have flexibility after leaving employment, including leaving funds in the plan, taking payments, or rolling over assets into other qualified retirement plans like 401(k)s, 403(b)s, or IRAs. Non-governmental 457(b) plans offer more restricted rollover options, generally only to another non-governmental 457(b) plan.
Distinctive Characteristics of 457 Plans
A notable feature of governmental 457(b) plans is the absence of the 10% early withdrawal penalty. Unlike many other retirement accounts, such as 401(k)s or IRAs, distributions from a governmental 457(b) plan are not subject to this additional tax if taken before age 59½, provided the distribution occurs after separation from service. While withdrawals remain subject to ordinary income tax, this provision offers earlier access to funds for participants.
Governmental 457(b) plans also provide creditor protection for participant assets. Under Internal Revenue Code Section 457, all assets and income of a governmental 457(b) plan must be held in trust for the exclusive benefit of participants and their beneficiaries. This trust arrangement shields retirement savings from claims by the employer’s general creditors, similar to ERISA-qualified plans.
Conversely, non-governmental 457 plans, including both 457(b) and 457(f) variants, lack ERISA protection. Since these plans are not governed by ERISA, deferred compensation is often an unfunded liability on the employer’s books, not held in a separate trust. These funds are subject to the claims of the employer’s general creditors. If the tax-exempt organization faces financial distress, participants could risk losing their deferred compensation.
A key distinction for 457(f) plans is the “substantial risk of forfeiture.” Participants do not gain a vested right to their deferred compensation until specific conditions are met, such as continued employment for a set period or achieving performance metrics. Taxation occurs when the substantial risk of forfeiture lapses, meaning the employee obtains a vested right, even if funds are not immediately received.
Rollover options differ between governmental and non-governmental 457 plans. Governmental 457(b) plans permit participants to roll over funds into other qualified retirement accounts, such as IRAs, 401(k)s, or 403(b)s. Non-governmental 457 plans have limited portability. Non-governmental 457(b) plans cannot be rolled over into IRAs or other traditional qualified plans, allowing rollovers only to another non-governmental 457(b) plan. Similarly, 457(f) plans do not allow rollovers into IRAs or other retirement accounts, often resulting in a taxable distribution upon separation from service.