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

A 457(b) retirement plan is a deferred compensation arrangement, allowing eligible employees to save for retirement on a tax-advantaged basis. These plans are offered by state and local governments, and certain tax-exempt organizations. Participants contribute a portion of their income, which grows over time, with taxes typically deferred until withdrawal in retirement.

Types of 457(b) Plans and Eligibility

There are two primary categories of 457(b) plans: governmental and non-governmental. The type of employer sponsoring the plan determines its classification and operational rules.

Governmental 457(b) plans are established by state and local governments, including public schools, cities, counties, and other government agencies. Any employee of such an entity is generally eligible to participate.

Non-governmental 457(b) plans are offered by tax-exempt organizations, such as hospitals and charities, that are exempt from tax under Internal Revenue Code Section 501(c). Eligibility for these plans is typically restricted to a select group of management or highly compensated employees. This limitation arises from regulatory requirements that differentiate non-governmental plans from broader retirement offerings like 401(k)s or 403(b)s.

While both types fall under Internal Revenue Code Section 457(b), this distinction also leads to significant differences in how assets are held and their protection from creditors.

Funding and Accessing Your Funds

Contributions to a 457(b) plan are typically made through pre-tax salary deferrals, reducing an employee’s current taxable income. The standard annual contribution limit for elective deferrals to a 457(b) plan is $23,500. Participants age 50 or older can contribute an additional catch-up amount of $7,500, bringing their total possible contribution to $31,000.

Beyond the age-based catch-up, 457(b) plans offer a special 3-year pre-retirement catch-up contribution. This allows participants within three years of their plan’s normal retirement age to contribute up to double the standard annual limit, provided they have unused deferral limits from prior years. This could allow contributions up to $47,000. Some governmental 457(b) plans may also permit Roth contributions, where contributions are made with after-tax dollars, and qualified withdrawals are tax-free.

Employee contributions to a 457(b) plan are always 100% immediately vested. If an employer also makes contributions to the plan, those funds may be subject to a vesting schedule. Employer contributions are less common in 457(b) plans compared to other retirement vehicles.

Funds in a 457(b) plan are generally not accessible without penalty until a qualifying event occurs, such as separation from service, reaching age 70.5, death, or disability. Withdrawals may also be permitted in cases of an unforeseeable emergency. Pre-tax contributions and their earnings are taxed as ordinary income upon withdrawal, while qualified distributions from Roth 457(b) accounts are tax-free.

Distinctive Features of 457(b) Plans

Governmental 457(b) plans are exempt from the 10% early withdrawal penalty that typically applies to distributions from other retirement accounts before age 59½. This penalty does not apply to distributions from governmental 457(b) plans taken after a participant separates from service, regardless of their age. However, this early withdrawal penalty exemption generally does not extend to non-governmental 457(b) plans.

A significant difference between the two types of 457(b) plans lies in how assets are held and their protection from creditors. For governmental 457(b) plans, assets are held in trust, custodial accounts, or annuity contracts for the exclusive benefit of participants and their beneficiaries. This structure provides strong creditor protection, safeguarding the retirement savings from the employer’s creditors. Conversely, assets in non-governmental 457(b) plans remain the property of the employer and are subject to the claims of the employer’s general creditors, even if held in a separate account. This means that if the employer faces financial difficulties, plan assets could be at risk.

457(b) plans offer various rollover options, allowing participants to transfer their funds to other qualified retirement plans. Funds from a 457(b) plan can typically be rolled over into an Individual Retirement Account (IRA), or other employer-sponsored plans like a 401(k) or 403(b), if the receiving plan permits. Similarly, rollovers from other eligible retirement plans into a 457(b) are generally allowed.

Plan loan provisions are more commonly available in governmental 457(b) plans, permitting participants to borrow against their vested account balance. These loans must adhere to specific rules regarding repayment terms and interest. While some non-governmental 457(b) plans may offer loans, it is less typical, and the availability often depends on the specific plan’s design.