What Is a 457(b) Plan and How Does It Work?

A 457(b) plan is a type of deferred compensation retirement plan available to employees of state and local governments and certain tax-exempt organizations. It allows eligible individuals to defer a portion of their current income, meaning taxes on these contributions and their earnings are postponed until a later date, typically retirement. The plan’s primary purpose is to provide a tax-advantaged savings vehicle, helping employees build financial security for their post-career years by reducing current taxable income and allowing savings to grow tax-deferred.

Understanding the 457(b) Plan

A 457(b) plan serves as a retirement savings tool for individuals working in specific sectors. It is distinct from other common retirement plans like 401(k)s and 403(b)s, primarily designed for employees of state and local governmental entities, including public schools, hospitals, and various government agencies. Additionally, certain non-governmental tax-exempt organizations, such as non-profit hospitals or charities, may also offer 457(b) plans to their employees. The core objective is to enable employees to defer a portion of their salary, delaying income taxes on those contributions until withdrawal, typically during retirement. This deferral allows invested money to grow over time without annual taxation on earnings.

A crucial distinction exists between governmental and non-governmental 457(b) plans regarding asset safety. In governmental plans, assets are held in a trust or custodial account for the exclusive benefit of participants, shielding funds from employer creditors. Conversely, for non-governmental plans, assets generally remain the employer’s property, meaning deferred compensation could be subject to employer creditors’ claims in bankruptcy.

Eligibility and Contribution Rules

Eligibility for a 457(b) plan is generally limited to employees of state and local governments, including agencies and political subdivisions, and certain tax-exempt organizations as defined under Section 501(c) of the Internal Revenue Code. Employees typically become eligible if they receive earned compensation reportable on a W-2 form and subject to federal, state, and FICA taxes.

For 2025, the annual contribution limit for employee deferrals to a 457(b) plan is $23,500. This limit applies to the total amount an employee contributes across all 457(b) plans if they participate in more than one. A significant advantage is that 457(b) contribution limits are separate from those of 401(k) or 403(b) plans, allowing eligible individuals to contribute the maximum to both and potentially doubling their annual tax-deferred retirement savings.

Two types of catch-up contributions are available. The standard Age 50 Catch-Up Contribution permits an additional $7,500 for those age 50 and older, bringing their total contribution to $31,000 in 2025 for governmental 457(b) plans. The Special 457(b) Catch-Up Rule allows participants in their final three years before their plan’s normal retirement age to contribute up to double the annual limit ($47,000 in 2025), provided they have not fully utilized prior contribution limits. This cannot be combined with the Age 50 catch-up in the same year. While primarily employee-funded, employer contributions are possible, but they reduce the amount an employee can defer, as a combined limit applies.

Taxation and Withdrawal Provisions

Contributions to a 457(b) plan are generally made on a pre-tax basis, reducing current taxable income, and earnings within the account grow tax-deferred. Taxes are only paid when distributions are taken, typically during retirement, and are then taxed as ordinary income. Some 457(b) plans, particularly governmental ones, may also offer a Roth contribution option, where contributions are made with after-tax dollars. Qualified distributions from a Roth 457(b) in retirement are tax-free, provided certain conditions, such as a five-year holding period and reaching age 59½, are met.

Withdrawals from a 457(b) plan are generally permitted upon specific triggering events. These events typically include separation from service, the participant’s death, disability, or an unforeseeable emergency. A distinct feature of governmental 457(b) plans is the absence of the 10% additional early withdrawal penalty that usually applies to most other qualified retirement plans for distributions taken before age 59½. This flexibility is a notable advantage, though distributions are still subject to ordinary income tax. This benefit typically does not extend to non-governmental 457(b) plans.

Required Minimum Distributions (RMDs) apply to 457(b) plans, similar to other retirement accounts. Participants generally must begin taking RMDs from their 457(b) by April 1 of the year following the calendar year they reach age 73, unless they are still employed by the plan sponsor.

Managing Your 457(b) Plan

Participants in a 457(b) plan typically have various investment options available through their plan administrator. These options often include mutual funds, annuities, and target-date funds, allowing participants to align their investments with their risk tolerance and financial goals. The growth of retirement savings within the plan is directly influenced by the performance of these chosen investments.

Upon separation from service, participants have several options for their accumulated funds. They may choose to leave the funds in the plan if permitted, take a lump-sum distribution, elect periodic payments, or roll over the funds into another eligible retirement account. Rollover rules differ significantly between governmental and non-governmental plans. Governmental 457(b) plans generally offer broad rollover flexibility, allowing funds to be rolled over into other qualified plans, such as 401(k)s, 403(b)s, or IRAs. Conversely, non-governmental 457(b) plans have more restrictive rollover rules, typically limiting rollovers to other non-governmental 457(b) plans.

The availability of loans from 457(b) plans also varies by plan type. Governmental 457(b) plans may permit participants to take loans against their vested account balance, subject to IRS limits, typically up to 50% of the vested balance or $50,000, whichever is less. Loan repayments are usually required within five years, or longer if used for a primary residence. Non-governmental 457(b) plans generally do not allow for participant loans. The portability of non-governmental 457(b) plans is also limited, making it difficult for employees moving to a new employer to transfer their funds, unlike the greater portability seen with governmental plans.