How a 457 Deferred Compensation Plan Works

A 457 plan lets you set aside part of your paycheck before taxes, with the money growing tax-free until you withdraw it in retirement

A 457 deferred compensation plan is a retirement savings account offered by state and local government employers, and by some nonprofit organizations. You contribute a portion of your salary, which reduces your taxable income for the year. The money sits in the account and grows without being taxed on the earnings. When you withdraw the funds — typically after you leave your job or reach age 59½ — you pay income tax on the withdrawals.

The account is called "deferred" compensation because you are postponing the taxes on that income until later. It is called a "457 plan" because it is authorized under Section 457 of the Internal Revenue Code. If your employer offers one, you will find it listed alongside other retirement benefits in your employee handbook or benefits portal.

Key Takeaways

• You contribute pre-tax dollars, which lowers your taxable income in the year you contribute, and the earnings grow tax-free until withdrawal.
• Contribution limits are set by the IRS each year and are separate from limits on 401(k) plans or IRAs, so you can max out multiple accounts if your employer offers them.
• You can withdraw money without penalty after you separate from your employer, regardless of age — a major difference from 401(k) plans.
• The account belongs to you, not your employer, so the money is protected if your employer faces financial trouble.

How contributions and tax treatment work

When you enroll in a 457 plan, you choose a percentage of your paycheck to contribute. That amount is deducted before federal income tax is calculated, which means your taxable income for the year is lower. If you earn $60,000 and contribute $10,000 to a 457 plan, you only report $50,000 as taxable income on your federal return.

The money you contribute, plus any earnings it generates, is not taxed while it sits in the account. You pay income tax only when you withdraw the funds. This is called tax-deferred growth. The longer the money stays invested, the more it can grow before you owe taxes on it.

Your employer may also contribute to your account — this is called a match. The rules for employer contributions vary by plan. Some government employers match a percentage of what you contribute; others do not match at all. Check your plan documents or benefits summary to see whether your employer offers a match.

Annual contribution limits and catch-up contributions

The IRS sets a maximum amount you can contribute to a 457 plan each year. This limit changes annually and is indexed to inflation. For 2024, the limit is $23,500 for employees under age 50. If you are age 50 or older, you can contribute an additional $7,500 per year as a catch-up contribution, bringing your total to $31,000.

These limits are separate from limits on other retirement accounts. If you also have access to a 401(k) plan or a 403(b) plan through your employer, you can contribute the maximum to each account in the same year. However, if you have both a 457 plan and a 401(k) through the same employer, the IRS treats them as a combined limit in some cases — your plan administrator can clarify how this works at your organization.

If you are within three years of your planned retirement date, some 457 plans allow an additional catch-up contribution. This is called the final three-year catch-up, and it can allow you to contribute significantly more in those final years. Not all plans offer this feature, so check your plan documents.

Withdrawal rules and the separation-from-service advantage

One of the biggest advantages of a 457 plan is the withdrawal rule tied to your employment. You can withdraw money from your 457 plan without penalty once you separate from your employer — meaning you leave your job, retire, or are laid off — regardless of your age. A 401(k) plan, by contrast, typically charges a 10% early withdrawal penalty if you take money out before age 59½.

This does not mean you avoid taxes on the withdrawal. You still owe income tax on the amount you withdraw. But you avoid the early withdrawal penalty, which can make a significant difference if you retire at 55 or 58 and need access to your savings before age 59½.

You can also take a loan from your 457 plan while you are still employed, if your plan allows it. The loan must be repaid, typically through payroll deductions. If you leave your job before the loan is repaid, the outstanding balance is usually treated as a withdrawal and becomes taxable.

Employer protection and creditor claims

A 457 plan is held in trust for your benefit, which means the money belongs to you, not your employer. If your government agency or nonprofit faces financial hardship or bankruptcy, your 457 account is protected. Creditors of your employer cannot seize the funds.

However, there is one exception: if you owe back taxes or have unpaid child support or alimony, the government can garnish your 457 account to satisfy those obligations. Your plan administrator will notify you if a legal order is received.

Rollovers and transfers between plans

When you leave your job, you have options for what to do with your 457 balance. You can leave the money in the plan and take withdrawals as needed, roll it over to an IRA, or roll it to a 457 plan at a new government employer if you move to another public-sector job.

A rollover means moving the money from one account to another without cashing it out. If you roll your 457 balance into a traditional IRA, the money continues to grow tax-deferred. You will owe income tax when you withdraw from the IRA, but you avoid the immediate tax hit of cashing out.

One important rule: money from a 457 plan can be rolled only to another 457 plan, a traditional IRA, or a Roth IRA (though rolling to a Roth triggers taxes). You cannot roll a 457 balance into a 401(k) plan. If you move to a private-sector job with a 401(k), you will need to leave the 457 balance where it is or roll it to an IRA.

How a 457 plan compares to other retirement accounts

A 457 plan is similar to a 401(k) in structure — both are employer-sponsored, both offer tax-deferred growth, and both have annual contribution limits. The main differences are who offers them and the withdrawal rules. A 401(k) is offered by private employers; a 457 is offered by government and nonprofit employers. A 401(k) charges a 10% penalty for withdrawals before age 59½; a 457 does not, as long as you have separated from your employer.

A 403(b) plan is another tax-deferred account offered by nonprofits and some public schools. It works similarly to a 401(k) but has slightly different rules and is available only to employees of may have access to organizations.

An IRA is an individual retirement account that you open on your own, not through an employer. IRAs have lower contribution limits than 457 plans but offer more flexibility in investment choices. Many people use both an employer plan and an IRA to save for retirement.

Frequently Asked Questions

Can I withdraw from my 457 plan before I leave my job?

Most 457 plans do not allow withdrawals while you are still employed, except for loans or hardship withdrawals in specific situations. Check your plan documents to see whether your plan permits hardship withdrawals. Once you separate from your employer, you can withdraw at any time without penalty.

What happens to my 457 plan if I die before I retire?

Your beneficiary — the person you named when you enrolled — will inherit the account balance. They can either withdraw the funds as a lump sum and pay income tax, or roll the balance into an inherited IRA and take distributions over time. The plan administrator will contact your beneficiary with options.

Do I have to take required minimum distributions from a 457 plan?

Yes, once you reach age 73, you must begin taking required minimum distributions (RMDs) from your 457 plan. The amount is calculated based on your age and account balance. If you are still working, some plans allow you to delay RMDs until you actually retire. Check with your plan administrator about the rules at your organization.

Can I contribute to both a 457 plan and a 401(k) in the same year?

If your employer offers both plans, you can contribute to each one. However, the IRS limits the combined amount you can contribute across certain plan types. If you have both a 457 and a 401(k) through the same employer, ask your benefits department how the limits apply to your situation.

What if my employer stops offering the 457 plan?

If your employer terminates the plan, you will be notified and given options. You can typically roll your balance to an IRA or another 457 plan if you move to a different government employer. Your plan administrator will provide instructions and a deadline for making your decision.