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

A 457(b) plan serves as a deferred compensation retirement savings option, primarily designed for employees of state and local governments and certain tax-exempt organizations. This type of plan allows eligible individuals to set aside a portion of their current income, deferring taxation on these contributions and their earnings until a later date, typically during retirement. The fundamental purpose of a 457(b) plan is to offer a supplemental avenue for employees to build their retirement nest egg on a tax-deferred basis, complementing other potential retirement benefits.

Understanding 457(b) Plan Basics

A 457(b) plan is formally recognized under Internal Revenue Code Section 457(b) as a non-qualified deferred compensation plan. It is established by eligible employers, which include state and local governmental entities, as well as certain tax-exempt organizations, such as hospitals, universities, and charities. The core concept involves participants deferring a portion of their current salary, which then grows tax-deferred until distribution.

There are two distinct types of 457(b) plans: governmental and non-governmental. Governmental 457(b) plans are offered by state and local governments, their agencies, and instrumentalities. Participation in these plans is generally open to all employees of the sponsoring governmental entity.

Non-governmental 457(b) plans, sometimes referred to as tax-exempt or private non-profit 457(b) plans, are offered by organizations exempt from tax under IRC Section 501(c). Unlike their governmental counterparts, non-governmental 457(b) plans are typically limited to a “select group of management or highly compensated employees.” This distinction is important because the way assets are held within each plan type differs significantly, impacting creditor protection.

Contributing to a 457(b) Plan

Contributions to a 457(b) plan are primarily made through employee salary deferrals, allowing participants to reduce their current taxable income. Some governmental employers may also make contributions on behalf of their employees. These contributions, along with any earnings, grow tax-deferred until withdrawn.

The Internal Revenue Service (IRS) sets annual elective deferral limits for 457(b) plans. For 2025, the standard annual elective deferral limit is $23,500. A notable advantage of 457(b) plans is that these contribution limits are separate and independent of limits for other retirement plans like 401(k)s, 403(b)s, or IRAs. This allows eligible employees to potentially contribute the maximum to both a 457(b) and another employer-sponsored plan, significantly increasing their total tax-deferred retirement savings.

457(b) plans also offer specific catch-up contribution provisions. Participants aged 50 or older can make an additional catch-up contribution, which is $7,500 for 2025. This age 50+ catch-up is similar to those found in other defined contribution plans.

Beyond the age 50+ catch-up, 457(b) plans feature a unique “special 457(b) catch-up” provision. In the three years immediately preceding a participant’s normal retirement age, as defined by the plan, individuals may be eligible to contribute up to double the standard annual limit, provided they did not contribute the maximum in prior years. For 2025, this could allow a participant to contribute up to $47,000. A participant generally cannot utilize both the age 50+ catch-up and the special 457(b) catch-up in the same year; they must choose the one that provides the higher allowable contribution.

Accessing 457(b) Plan Funds

Accessing funds from a 457(b) plan is generally permitted upon the occurrence of specific “distributable events.” These events typically include separation from service (which means terminating employment), reaching age 70½ (or 72/73 depending on birth year for Required Minimum Distributions), the participant’s death, or an unforeseeable emergency. An unforeseeable emergency is defined by IRS regulations as a severe financial hardship resulting from an illness or accident of the participant, their spouse, or dependent, property loss due to casualty, or other similar extraordinary circumstances beyond the participant’s control.

Distributions from a 457(b) plan are generally taxed as ordinary income in the year they are received. This means that the entire amount withdrawn, including both contributions and accumulated earnings, is subject to federal and state income taxes. The plan administrator will typically report these distributions to the IRS on Form 1099-R.

A distinguishing feature of governmental 457(b) plans is the absence of the 10% early withdrawal penalty. Unlike 401(k)s, 403(b)s, or IRAs, distributions from governmental 457(b) plans are not subject to this additional penalty for withdrawals made before age 59½, provided a distributable event has occurred. This can be a significant advantage for individuals who separate from service and need access to their funds prior to reaching the traditional retirement age. However, this penalty exemption does not apply to funds rolled into a 457(b) from other plan types, like a 401(k), if those funds are subsequently withdrawn early.

Required Minimum Distribution (RMD) rules also apply to 457(b) plans. These rules mandate that participants begin taking distributions from their accounts once they reach a certain age, generally age 73 for those who turn 72 after December 31, 2022, or upon separation from service, whichever is later. The purpose of RMDs is to ensure that deferred funds are eventually distributed and taxed.

Governmental 457(b) plans may also permit participants to take loans from their accounts, though this feature is not universally available and is less common or structured differently in non-governmental plans. The ability to take a loan can provide participants with access to funds for short-term needs without triggering a taxable distribution, provided the loan adheres to IRS regulations. Non-governmental 457(b) plans generally cannot offer loans.

Key Characteristics of 457(b) Plans

The structure of 457(b) plans presents unique operational characteristics that differentiate them from other common retirement savings vehicles. A primary distinction lies in how plan assets are held, particularly between governmental and non-governmental plans. In governmental 457(b) plans, assets are typically held in a trust or custodial account for the exclusive benefit of participants and their beneficiaries. This arrangement provides strong creditor protection, meaning the assets are generally shielded from the claims of the employer’s creditors.

Conversely, in non-governmental 457(b) plans, the assets generally remain subject to the claims of the employer’s general creditors until they are distributed to the participant. While this is a structural aspect of non-qualified plans, and the risk is often theoretical, it means the assets are not held in a separate trust that protects them from employer insolvency. Non-governmental plans are also limited to a select group of management or highly compensated employees.

A significant advantage of governmental 457(b) plans is the absence of the 10% early withdrawal penalty, which applies to distributions from other types of retirement accounts if taken before age 59½. This feature allows individuals who separate from service to access their deferred compensation without incurring the additional penalty tax, although distributions remain subject to ordinary income tax. This can offer greater financial flexibility for those considering early retirement or a career change.

The contribution limits for 457(b) plans are independent of those for other employer-sponsored retirement plans, such as 401(k)s and 403(b)s. This means an eligible employee can contribute the maximum amount to a 457(b) plan and simultaneously contribute the maximum to a 401(k) or 403(b) plan. This dual contribution opportunity allows for a substantial increase in tax-deferred savings for individuals with access to both types of plans.

The special 457(b) catch-up rules also provide a distinct savings opportunity. In the three years preceding a participant’s normal retirement age, they may be able to contribute up to twice the standard annual limit. This provision differs from the age 50+ catch-up available in other plans, offering a unique avenue for boosting retirement savings during the final years of a career, especially for those who may not have maximized contributions in earlier years.

Upon separation from service, governmental 457(b) plan funds typically offer rollover options, allowing participants to transfer their assets to an Individual Retirement Account (IRA) or another eligible employer-sponsored retirement plan, such as a 401(k) or 403(b). Non-governmental 457(b) plans, however, generally have more limited rollover options, often restricting transfers to similar plans with other tax-exempt employers or requiring a lump-sum distribution. These characteristics collectively define the unique role of 457(b) plans in the landscape of retirement savings.