What Is a Code Section 457 Deferred Compensation Plan?

A Section 457 deferred compensation plan is a retirement savings plan available to employees of state and local governments and certain non-profit organizations. It allows participants to contribute a portion of their salary on a pre-tax basis, which reduces their current taxable income. The funds in the plan can grow through various investment options, and this growth is tax-deferred. This structure allows investment returns to compound without being reduced by annual taxes, enhancing long-term savings potential. Taxes are not paid on contributions or earnings until the money is withdrawn, which usually happens during retirement.

Plan Eligibility and Types

Eligibility to participate in a Section 457 plan is determined by the employer. The two primary categories of employers that can offer these plans are state and local governments and certain tax-exempt organizations under Internal Revenue Code Section 501. This includes public sector employees such as police officers, firefighters, and municipal workers, as well as employees of some non-profit hospitals and charities.

The most common type is the governmental 457(b) plan. In these plans, assets are held in a trust or custodial account for the exclusive benefit of participants and their beneficiaries. This provides a layer of protection for the employees’ savings by shielding them from the employer’s creditors.

Another type is the tax-exempt 457(b) plan, offered by non-profit organizations. Unlike governmental plans, the assets are not held in a separate trust and remain the property of the employer until distributed. This means the funds are subject to the claims of the employer’s general creditors, which introduces a level of risk for the employee.

A 457(f) plan is an ineligible deferred compensation plan offered to a select group of management or highly compensated employees. The deferred amounts are subject to a “substantial risk of forfeiture.” This means an employee must meet certain conditions, such as remaining with the employer for a specified period, to become fully entitled to the funds.

Contribution Rules and Limits

The Internal Revenue Service (IRS) sets annual limits on the amount that can be contributed to a 457(b) plan. For 2025, the regular employee contribution limit is $23,500, and this limit applies to the total of both employee salary deferrals and any employer contributions. Participants can contribute up to 100% of their includable compensation, as long as it does not exceed the annual dollar limit.

Many governmental 457(b) plans offer an age 50+ catch-up provision. This allows participants who are age 50 or older to contribute an additional amount, which is $7,500 for 2025, bringing their total possible contribution to $31,000.

A unique feature is the “special 457 catch-up” provision, which allows a participant to contribute more in the three years leading up to their designated normal retirement age. Under this rule, a participant can contribute up to twice the regular annual limit, for a total of $47,000 in 2025. The exact amount is the lesser of twice the annual limit or the basic annual limit plus any unused contribution amounts from prior years.

A participant cannot use both the age 50+ catch-up and the special 457 catch-up in the same year. Additionally, the SECURE 2.0 Act introduced another option for some plans, allowing participants aged 60, 61, 62, or 63 to make a higher catch-up contribution of $11,250 for 2025.

Distributions and Taxation

Funds can be withdrawn from a 457(b) plan upon certain triggering events, including separation from service, death, disability, or reaching the plan’s normal retirement age. Some plans also permit distributions for an unforeseeable emergency, which is defined by the IRS as a severe financial hardship. When a participant takes a distribution from a traditional 457(b) plan, the amount is taxed as ordinary income, similar to wages. If the plan offers a Roth 457(b) option, qualified distributions are tax-free.

A primary benefit of governmental 457(b) plans is the absence of the 10% early withdrawal penalty for distributions taken before age 59½. This allows a participant who separates from service to access their funds without this additional tax. This flexibility is particularly beneficial for public safety officers who may retire earlier than other workers.

This penalty-free treatment does not apply to all funds in the account. If money was rolled into the governmental 457(b) plan from another retirement account, like a 401(k) or an IRA, those specific funds remain subject to the 10% penalty if withdrawn before age 59½. The plan must track these assets separately to ensure proper tax treatment.

Rollovers and Plan Portability

The ability to move funds from a 457 plan to another retirement account, known as a rollover, provides portability when an employee changes jobs. For a governmental 457(b) plan, the rules are flexible. Upon separation from service, a participant can roll over their funds to a traditional IRA, a Roth IRA, a 401(k), a 403(b), or another governmental 457(b) plan.

The process can be done as a direct rollover, where funds are transferred from one financial institution to another, which avoids mandatory tax withholding. An indirect rollover involves the participant receiving a check, which they must then deposit into another eligible retirement account within 60 days.

The rollover rules for a tax-exempt 457(b) plan are more restrictive. Funds from a non-governmental 457(b) plan can only be rolled over into another non-governmental 457(b) plan. They cannot be moved into an IRA, 401(k), or other types of retirement accounts.

It is also possible to roll funds into a governmental 457(b) plan from other eligible retirement plans. However, a plan is not required to accept these roll-ins. If a plan does accept them, it must account for these assets separately, as they may be subject to different withdrawal rules than the original 457(b) contributions.