What Is a 457(b) Deferred Compensation Plan?

A 457(b) deferred compensation plan is a specialized retirement savings vehicle available primarily to employees of state and local governments, as well as certain tax-exempt organizations. These plans allow eligible individuals to defer a portion of their current income, enabling that money to grow on a tax-deferred basis until retirement or separation from service. The general purpose of a 457(b) plan is to provide a supplemental retirement savings option, often complementing other pension plans or retirement accounts.

This type of plan distinguishes itself from more common retirement vehicles like 401(k)s or 403(b)s through specific rules governing its contributions, withdrawals, and overall operation. Participants benefit from reducing their current taxable income by contributing pre-tax dollars, with taxes only becoming due when distributions are taken in retirement.

Key Features of 457(b) Plans

These plans are sponsored by eligible employers, which include state and local governmental entities, such as police departments, fire departments, public schools, and municipal offices. Additionally, certain tax-exempt organizations, typically non-profits under IRC Section 501(c), can offer 457(b) plans to their employees.

The annual contribution limit for 457(b) plans is set by the IRS and can include both employee elective deferrals and any employer contributions. For 2025, the standard elective deferral limit is $23,500. This limit applies to the total amount an employee can contribute, whether through salary reductions or employer contributions.

Beyond the standard contribution limit, 457(b) plans offer unique “catch-up” contribution provisions. For participants aged 50 or older, governmental 457(b) plans allow an additional catch-up contribution, which is $7,500 for 2025, bringing the total potential contribution to $31,000. Non-governmental 457(b) plans do not offer this age 50+ catch-up provision.

Another distinct feature is the special 3-year catch-up provision, available to both governmental and non-governmental 457(b) plans. This provision allows participants within three calendar years of their plan’s normal retirement age to contribute up to twice the annual limit, or the annual limit plus any unused contribution amounts from prior years. For 2025, this could mean contributing up to $47,000, provided specific criteria regarding prior under-contributions are met. A participant generally cannot utilize both the age 50 catch-up and the special 3-year catch-up in the same year; they must choose the one that provides the greater deferral opportunity.

How 457(b) Plans Operate

Once contributions are made to a 457(b) plan, participants typically have various investment options available, allowing them to direct how their deferred compensation is invested. These options often include a range of mutual funds, annuities, or other investment vehicles, similar to those found in other employer-sponsored retirement plans.

Accessing funds from a 457(b) plan is generally restricted to specific events. Distributions are typically permitted upon separation from service, which includes retirement, termination of employment, or a change in employment. Other qualifying events for distribution can include the participant’s death, disability, or an unforeseeable emergency.

An unforeseeable emergency is a severe financial hardship resulting from events beyond the participant’s control, such as a sudden illness or accident, loss of property due to casualty, or imminent foreclosure or eviction from a primary residence. The amount withdrawn for an unforeseeable emergency must be limited to what is reasonably necessary to satisfy the hardship, potentially including amounts to cover taxes on the distribution. Plans may also have provisions for small account balances, allowing a one-time withdrawal if the account is below a certain threshold and no recent contributions or withdrawals have occurred.

Required Minimum Distributions (RMDs) apply to 457(b) plans, similar to other tax-deferred retirement accounts. Participants are generally required to begin taking withdrawals from their 457(b) plan once they reach age 73, unless they are still employed by the plan sponsor and are not a 5% owner. The specific distribution schedule and options, such as lump-sum payments, periodic payments, or annuities, are determined by the individual plan’s provisions.

Loan provisions may be available in some 457(b) plans, though they are not universally offered. If permitted, loan amounts are typically limited to the lesser of 50% of the vested account balance or $50,000, with a minimum loan amount often set at $1,000. Some plans may allow borrowing up to the full vested balance if it is less than $10,000. Loans generally must be repaid within five years, but a longer term, such as up to 30 years, may be allowed for the purchase of a primary residence. Loan repayments are made with after-tax dollars, and the interest paid on the loan goes back into the participant’s own account.

Tax Implications of 457(b) Plans

Contributions to 457(b) plans are made on a pre-tax basis, which means they reduce the participant’s current taxable income. This deferral of taxes allows the contributions and any investment earnings to grow tax-free until they are distributed from the plan. When distributions are taken, they are taxed as ordinary income in the year they are received.

A significant distinction for governmental 457(b) plans is the absence of the 10% early withdrawal penalty. Unlike many other retirement plans, governmental 457(b) plans generally do not impose this penalty if funds are withdrawn after separation from service, regardless of the participant’s age. This provides a degree of flexibility for individuals who may retire or change careers before age 59½. However, this penalty exemption typically does not apply to distributions attributable to rollovers from other types of plans or IRAs into the 457(b) plan.

Rollover options from 457(b) plans can vary depending on whether the plan is governmental or non-governmental. Governmental 457(b) plans offer substantial flexibility, allowing participants to roll over their account balances into other qualified retirement plans, such as 401(k)s, 403(b)s, or Individual Retirement Accounts (IRAs). This portability allows individuals to consolidate their retirement savings or move funds to an account that better suits their needs.

In contrast, non-governmental 457(b) plans historically have had more limited rollover options. While they might allow rollovers to another non-governmental 457(b) plan, direct rollovers to IRAs or other qualified plans were not always permitted. Regardless of the plan type, any direct rollovers of pre-tax amounts from a 457(b) plan to an eligible retirement plan or IRA are not immediately taxable. However, if a participant opts for a direct distribution instead of a rollover, it may be subject to mandatory federal tax withholding, typically 20%.

Governmental Versus Non-Governmental 457(b) Plans

Governmental and non-governmental 457(b) plans differ due to differences in their regulatory oversight and participant protections. Governmental 457(b) plans are sponsored by state and local government entities, including public schools, municipalities, and state agencies. Non-governmental 457(b) plans, on the other hand, are offered by certain tax-exempt organizations, such as non-profit hospitals, charities, and private universities.

One difference lies in creditor protection. Governmental 457(b) plans generally hold assets in a trust or custodial account for the exclusive benefit of the participants. This structure provides a level of creditor protection similar to plans covered by the Employee Retirement Income Security Act (ERISA), safeguarding participant funds from employer creditors. Conversely, non-governmental 457(b) plans are typically “unfunded,” meaning the assets remain the property of the employer and are subject to the employer’s general creditors until distributed to the participant. This lack of trust funding in non-governmental plans presents a theoretical risk to participants if the sponsoring employer faces bankruptcy or financial distress.

Regarding rollovers, governmental 457(b) plans offer broad flexibility for transfers to other qualified retirement plans or IRAs. This portability allows individuals to consolidate their retirement savings or move funds to an account that better suits their needs. Non-governmental plans, however, have more restricted transfer rules, often limited to other non-governmental 457(b) plans and not generally permitting rollovers to IRAs or other qualified plans.

For early withdrawals, governmental 457(b) plans are generally exempt from the 10% additional tax before age 59½ after separation from service. This provides governmental employees with greater access flexibility without penalty. Non-governmental 457(b) plans typically face this 10% penalty unless another exception applies.

Non-governmental 457(b) plans are often structured as “top-hat” plans, which means their eligibility is limited to a “select group of management or highly compensated employees.” This contrasts with governmental 457(b) plans, which can be offered to a broader range of employees.