What Is a Section 457 Plan and How Does It Work?

A Section 457 plan is a non-qualified, tax-advantaged deferred compensation retirement plan. These are not available to all employees; instead, they are offered by specific employers, namely state and local governments and certain non-profit organizations that are tax-exempt under the Internal Revenue Code. The plan permits employees to set aside a portion of their salary for retirement, deferring income taxes on these savings until a later date.

The structure allows contributions and any investment earnings to grow on a tax-deferred basis. This means the funds are not subject to income tax as they are earned or as they appreciate in value. The tax obligation is postponed until the funds are withdrawn, which is during retirement.

Plan Types and Eligibility

Section 457 plans are categorized into two types: 457(b) and 457(f) plans. The 457(b) plan is the most common, available to employees of state and local governments and certain non-governmental employers that are tax-exempt under IRC Section 501(c). These plans allow employees to contribute a portion of their salary on a pre-tax basis, reducing their current taxable income.

A distinction exists within 457(b) plans based on the employer. Governmental 457(b) plans, offered by public sector employers, hold plan assets in a trust for the exclusive benefit of participants and their beneficiaries. This structure provides protection, ensuring the funds cannot be accessed by the employer’s creditors.

In contrast, non-governmental 457(b) plans operate differently. The assets in these plans are not held in a 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 risk for the employee not present in governmental plans.

The second type of plan, a 457(f) plan, is reserved for a select group of management or highly compensated employees and is often used to provide benefits beyond the limits of a 457(b) plan. A characteristic of a 457(f) plan is a “substantial risk of forfeiture.” This means the employee’s right to the funds is contingent upon the future performance of substantial services, and the funds are not accessible until this risk no longer exists.

Contribution Rules and Limits

The Internal Revenue Code sets limits on the amount that can be contributed to a 457(b) plan each year. For 2025, the maximum contribution is $23,500, which encompasses both employee salary deferrals and any employer contributions. The total from both sources cannot exceed this annual cap.

Governmental 457(b) plans offer participants two ways to contribute more through catch-up provisions. The first is the Age 50+ catch-up, which allows participants age 50 or older to contribute an additional amount. For 2025, the limit varies by age: those who are age 60, 61, 62, or 63 can make a larger catch-up contribution of $11,250, while the limit for other participants age 50 and over is $7,500.

Another feature of 457(b) plans is the “special 457 catch-up” contribution. This provision is available to participants in the three years leading up to their designated normal retirement age. It allows an employee to contribute the lesser of twice the annual deferral limit or the basic annual limit plus the amount of the basic limit not used in prior years. A participant is not permitted to use both the Age 50+ catch-up and the special 457 catch-up in the same tax year.

Distributions and Taxation

Participants can access funds from their 457(b) plan upon experiencing certain life events. The most common trigger for a distribution is separation from service, which includes retirement, resignation, or termination of employment. Other qualifying events include the participant’s death or disability, and some governmental plans may permit in-service distributions once a participant reaches age 70½.

An advantage for participants in governmental 457(b) plans relates to early withdrawals. Unlike many other tax-deferred retirement plans, distributions from a governmental 457(b) plan taken after a separation from service are not subject to the 10% early withdrawal penalty, regardless of the participant’s age. All distributions from any 457 plan are taxed as ordinary income in the year they are received.

Plans also provide for distributions in cases of an “unforeseeable emergency.” This is defined as a severe financial hardship resulting from an illness or accident, loss of property due to casualty, or other similar extraordinary circumstances. The amount withdrawn is limited to the amount necessary to satisfy the emergency need.

Rollover Rules

The ability to move funds from a 457 plan to another retirement account, known as a rollover, depends on the type of plan. For participants in a governmental 457(b) plan, the rollover options are broad. These funds can be rolled over into other tax-advantaged retirement accounts, including:

• Traditional IRAs
• Roth IRAs
• 401(k)s
• 403(b)s
• Another governmental 457(b) plan

The rules for non-governmental 457(b) plans are more restrictive. Funds from these plans can only be rolled over into another non-governmental 457(b) plan and cannot be moved into an IRA or 401(k).

For 457(f) plans, the situation is even more constrained. Due to the “substantial risk of forfeiture” provisions, funds in a 457(f) plan cannot be rolled over to any other type of retirement account. Once the risk of forfeiture is removed, the funds become taxable to the employee and must be taken as a distribution.