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

A 457(b) plan is a retirement savings vehicle for employees of state and local governments and certain tax-exempt organizations. It allows individuals to defer a portion of their current income and its associated taxes until retirement. By participating, employees can supplement traditional retirement benefits, such as pensions, building a more robust financial future.

Understanding 457(b) Plans

A 457(b) plan is a non-qualified deferred compensation plan established under Internal Revenue Code Section 457. It allows eligible employees to defer a portion of their salary and investment earnings until a future date, such as retirement or separation from service. This arrangement defers income taxes on contributions and earnings until funds are withdrawn.

There are two categories of 457(b) plans: governmental and non-governmental. Governmental plans are sponsored by state and local government entities, including their agencies. Non-governmental plans are offered by tax-exempt organizations, such as hospitals, universities, and other non-profit entities. Both types have distinct rules regarding asset protection and other characteristics.

Deferred compensation means income is earned now but taxed later. Contributions to a 457(b) plan are pre-tax, reducing current taxable income. The money grows tax-deferred, with investment gains not taxed until distributions begin. Some plans offer a Roth option, allowing after-tax contributions and potentially tax-free withdrawals in retirement.

Eligibility for 457(b) Plans

Eligibility for a 457(b) plan depends on the type of employer. Governmental 457(b) plans are available to employees of state and local governments, including police officers, firefighters, public school teachers, and municipal workers. These plans generally cover all employees of the governmental entity.

Non-governmental 457(b) plans, offered by tax-exempt organizations, are typically limited to highly compensated employees or a select group of management. This restriction avoids triggering certain funding requirements under the Employee Retirement Income Security Act (ERISA). Thus, not all employees of a non-profit organization offering a 457(b) plan will necessarily be eligible.

Contributions to 457(b) Plans

Contributions to a 457(b) plan are made through salary deferrals, reducing the participant’s taxable income. For 2025, the annual contribution limit is $23,500, or 100% of includible compensation, whichever is less. This limit applies to combined employee and, if offered, employer contributions.

Participants aged 50 and over are eligible to make additional “catch-up” contributions. For 2025, this age-based catch-up is $7,500, bringing the total possible contribution to $31,000. This age-50 catch-up is available only for governmental 457(b) plans; non-governmental plans do not offer it.

A unique feature for both governmental and non-governmental 457(b) plans is the “special 457(b) catch-up” provision, also known as the “pre-retirement catch-up.” This allows participants to contribute up to twice the annual limit in the three years immediately preceding their plan’s normal retirement age. This special catch-up is limited to the lesser of twice the annual limit or the current year’s limit plus any unused contribution amounts from prior years. The age-50 catch-up and the special 457(b) catch-up cannot be combined in the same year; participants can only utilize the higher of the two.

Accessing 457(b) Funds

Accessing 457(b) funds occurs upon a triggering event. Common events allowing distributions include separation from service (retirement or leaving employment), reaching age 70½, death, or an unforeseeable emergency. An unforeseeable emergency is a severe financial hardship from illness, accident, property casualty, or funeral expenses.

Distributions from a traditional 457(b) plan are taxed as ordinary income when received, subject to federal income tax at the participant’s marginal rate. Governmental 457(b) plans offer the absence of the 10% early withdrawal penalty that typically applies to other retirement plans before age 59½. This penalty exemption applies unless the distribution is from a rollover. Non-governmental 457(b) plans also avoid this penalty upon separation from service.

Participants usually have several options for receiving distributions, such as a lump sum payment, periodic installments, or an annuity. Required Minimum Distribution (RMD) rules also apply to 457(b) accounts, generally requiring participants to begin taking withdrawals by age 73, unless still employed by the plan sponsor. Funds from governmental 457(b) plans can typically be rolled over into other qualified retirement plans, such as an IRA or 401(k). However, non-governmental 457(b) plans generally do not permit rollovers to other types of retirement accounts, only to another non-governmental 457(b) plan.

Important Plan Characteristics

Governmental 457(b) plans are notable for their early withdrawal flexibility. Distributions before age 59½ are not subject to the 10% early withdrawal penalty common to other retirement accounts, a distinguishing feature compared to 401(k)s and 403(b)s.

How funds are held within a 457(b) plan varies between governmental and non-governmental versions. Governmental 457(b) plans must hold assets in a trust, custodial account, or annuity contract for the exclusive benefit of participants and beneficiaries. This structure protects assets from the employer’s creditors.

Non-governmental 457(b) plans are “unfunded.” This means deferred compensation remains a general asset of the employer, subject to creditor claims in financial distress or bankruptcy. While employers often use “rabbi trusts,” these do not protect assets from general creditors. Participants are not in “constructive receipt” of funds until distributed, which defers taxation. This maintains the tax-deferred status despite funds remaining employer assets.