What Is a 457 Retirement Plan and How Does It Work?

The 457 retirement plan is a type of deferred compensation plan designed to assist certain public sector and tax-exempt organization employees in building their retirement nest egg. These plans allow eligible workers to defer a portion of their current income, potentially reducing their taxable income in the present while growing their savings for future use.

Fundamental Characteristics of 457 Plans

A 457 plan is a non-qualified, deferred compensation arrangement established under Internal Revenue Code Section 457. Contributions to a 457 plan are typically made on a pre-tax basis, meaning the deferred income is not subject to federal income tax until it is withdrawn in retirement. This pre-tax contribution allows for tax-deferred growth of the invested funds, as earnings within the account accumulate without being taxed annually. The employer offering the plan facilitates these deferrals, and the funds are invested according to the plan’s available options. This structure provides a mechanism for participants to reduce their current tax burden while systematically saving for their post-employment years.

Eligibility and Contributions

Eligibility for a 457 plan is generally limited to employees of state and local governmental entities, including public schools, police departments, and municipal agencies. Additionally, certain non-governmental tax-exempt organizations, such as hospitals and charities, can offer these plans to their employees. Private for-profit companies are typically not permitted to offer 457 plans.

Contributions to a 457 plan are primarily made through employee salary deferrals. For 2024, the IRS allows participants to contribute up to $23,000 to their 457(b) plan. This limit applies to the total elective deferrals made by the employee for the year.

Beyond the standard limit, 457 plans offer specific catch-up contribution provisions. Employees aged 50 or older in governmental 457(b) plans can contribute an additional $7,500 in 2024, bringing their total possible contribution to $30,500. Separately, a unique “special 457 catch-up” rule may apply to participants in their last three years before their plan’s normal retirement age. This provision allows for contributions of up to double the normal limit, or $46,000 in 2024, provided the participant has not maxed out their contributions in previous years. Participants typically cannot utilize both the age 50+ catch-up and the special 457 catch-up in the same year.

Accessing Your Funds

Accessing funds from a 457 plan is generally permitted upon certain life events, such as retirement, separation from service, death, or an unforeseeable emergency. The rules governing withdrawals and their tax implications are distinct, especially when comparing governmental and non-governmental 457(b) plans. Funds withdrawn from a 457 plan are taxed as ordinary income in the year they are received, as contributions were typically made on a pre-tax basis and grew tax-deferred.

A notable advantage of governmental 457(b) plans is that distributions taken before age 59½ are generally not subject to the 10% early withdrawal penalty imposed by Section 72(t), provided the participant has separated from service. This differs from many other retirement plans, offering greater flexibility for early retirees in the public sector. However, non-governmental 457(b) plans typically are subject to this 10% penalty for early withdrawals, making the employer type a significant factor in distribution planning.

Participants typically have several options for receiving distributions, including a lump sum, periodic installment payments, or annuity payments, though specific options depend on the plan’s provisions. Funds from governmental 457(b) plans can often be rolled over into other qualified retirement plans, such as a 401(k), 403(b), or an Individual Retirement Account (IRA). This rollover flexibility allows participants to maintain the tax-deferred status of their savings and consolidate their retirement accounts.

Key Distinctions from Other Retirement Plans

While 457 plans share similarities with other common retirement savings vehicles, such as 401(k)s and 403(b)s, they possess unique characteristics that set them apart.

Another distinct feature is the ability for individuals eligible for both a 457(b) plan and another employer-sponsored plan, like a 401(k) or 403(b), to contribute the maximum amount to each plan. This “contribution stacking” allows for potentially higher overall tax-deferred savings than if only one plan type were available. For example, in 2024, an individual could contribute $23,000 to a 457(b) and an additional $23,000 to a 401(k) or 403(b), effectively doubling their elective deferral capacity.

Creditor protection also varies among plan types. Governmental 457(b) plans typically offer strong creditor protection, similar to 401(k)s and 403(b)s, because their assets are held in trust for the exclusive benefit of participants. In contrast, non-governmental 457(b) plans may offer less protection, as the assets often remain subject to the claims of the employer’s general creditors until distributed. The type of employer offering the plan is a key determinant of these protections.

Types of 457 Plans

There are two primary types of 457 plans, each with distinct regulatory frameworks and implications for participants: governmental 457(b) plans and non-governmental 457(b) plans. A third, less common type, the 457(f) plan, also exists for specialized circumstances. Understanding these distinctions is important for participants.

Governmental 457(b) plans are offered by state and local government entities, including public schools and municipalities. A significant characteristic of these plans is their general exemption from the Employee Retirement Income Security Act (ERISA). This exemption is a primary reason for some of their unique features, such as the absence of the 10% early withdrawal penalty. Assets in governmental 457(b) plans are held in trust or custodial accounts for the exclusive benefit of the participants, providing a layer of security against the employer’s creditors.

Non-governmental 457(b) plans, also known as “tax-exempt organization plans,” are offered by certain non-profit organizations. Unlike their governmental counterparts, these plans are generally subject to ERISA, though they often operate under an exemption for “top hat” plans, which are designed for a select group of management or highly compensated employees. A crucial difference is that the assets in non-governmental 457(b) plans are typically not held in trust for the employees but remain subject to the claims of the employer’s general creditors. This means the plan is “unfunded” from the employee’s perspective, and these plans generally are subject to the 10% early withdrawal penalty for distributions taken before age 59½.

A 457(f) plan is another type of non-qualified deferred compensation arrangement, primarily used by tax-exempt organizations to provide benefits to highly compensated executives. These plans often involve a “substantial risk of forfeiture,” meaning the employee must meet certain conditions, such as remaining with the employer for a specified period, to receive the deferred compensation. Once the risk of forfeiture is removed, the entire vested amount becomes taxable to the employee. These plans are more complex and are typically reserved for a select group of key employees rather than the general workforce.