How a Section 457 Plan Works: Deferred Compensation for Government and Nonprofit Employees

A Section 457 plan is a tax-deferred savings account for employees of state and local governments and certain nonprofits

A Section 457 plan is a retirement savings account that lets you set aside money from your paycheck before taxes are taken out. The money grows tax-free until you withdraw it, usually in retirement. Unlike 401(k) plans, which are common in the private sector, 457 plans are offered only by state agencies, local governments, and some tax-exempt organizations.

The account is named after Section 457 of the Internal Revenue Code, the tax law that created it. If your employer is a government agency or a nonprofit hospital, university, or other tax-exempt organization, you may have access to one. The rules are similar to 401(k) plans in some ways but differ in others—particularly in how much you can contribute and what happens if you leave your job.

Key Takeaways

• A 457 plan lets you contribute pre-tax money from your paycheck, and that money grows without being taxed until you withdraw it.
• The contribution limit for 2024 is $23,500 per year if you work for a government employer, or $23,500 per year if you work for a nonprofit, though some employers offer a catch-up provision that doubles this in your final three years before retirement.
• Money in a 457 plan remains the property of your employer until you withdraw it, which is different from 401(k) plans where the money is held in trust for you.
• If you leave your job, you can roll your 457 balance into an IRA or another employer plan, but the rules depend on whether your employer is a government or nonprofit entity.
• Withdrawals before age 59½ are generally subject to a 10 percent penalty, though government employees have more exceptions to this rule than nonprofit employees do.

How contributions work and what you can set aside

You contribute to a 457 plan through payroll deduction. Your employer withholds the amount you choose from each paycheck before income tax is calculated, which reduces your taxable income for that year. For 2024, the annual contribution limit is $23,500 if your employer is a government agency. If your employer is a nonprofit, the limit is also $23,500, but the rules around catch-up contributions differ.

Many government employers offer a catch-up provision that allows you to contribute significantly more in your final three years before you reach your plan's normal retirement age. This catch-up limit can be as high as $47,000 per year (double the regular limit) if you have not contributed the maximum in prior years. Nonprofit employers are not required to offer this catch-up option, so check your plan documents to see what your employer provides.

The money you contribute reduces your gross income, so you pay less in federal income tax that year. However, you still pay Social Security and Medicare taxes (FICA) on the full amount of your salary, even the portion going into the 457 plan.

Tax treatment and when you pay taxes on withdrawals

The money in your 457 plan grows tax-free while it sits in the account. You do not pay income tax on the contributions or the investment earnings until you withdraw the money. When you do withdraw, the entire amount—both what you contributed and the growth—is taxed as ordinary income in the year you take it out.

If you withdraw money before age 59½, you generally owe a 10 percent early withdrawal penalty on top of the regular income tax. However, government employees have an important exception: if you separate from service (leave your job) at any age, you can withdraw without the 10 percent penalty. Nonprofit employees do not have this exception and must wait until age 59½ to avoid the penalty, with limited exceptions for disability or medical hardship.

You are required to begin taking withdrawals from your 457 plan by April 1 of the year after you turn 73 (this age changed from 72 under the SECURE 2.0 Act). These are called required minimum distributions, or RMDs. The IRS calculates how much you must withdraw each year based on your age and account balance.

Key differences between government and nonprofit 457 plans

The rules for 457 plans vary depending on whether your employer is a government entity or a nonprofit organization. Government 457 plans are more flexible in several ways. If you leave a government job, you can withdraw your money without the 10 percent early withdrawal penalty, regardless of your age. You can also roll your balance into an IRA or another employer plan without restrictions.

Nonprofit 457 plans are stricter. If you leave a nonprofit job before age 59½, you cannot withdraw your money without owing the 10 percent penalty, except in cases of disability or substantial financial hardship (which the IRS defines narrowly). You also cannot roll a nonprofit 457 balance into an IRA; you can only roll it into another nonprofit 457 plan or a 403(b) plan if your new employer offers one.

Another difference: government 457 plans must keep your money in a trust or custodial account separate from the employer's general funds. Nonprofit 457 plans do not have this requirement, which means your money technically remains the property of the nonprofit until you withdraw it. This is a credit risk you should understand before enrolling.

What happens to your 457 when you leave your job

If you work for a government employer and leave your job, you have several options for your 457 balance. You can leave the money in the plan and let it continue to grow, withdraw it in a lump sum, take periodic withdrawals, or roll it into a traditional IRA or another employer plan. You can also roll it into a Roth IRA if you convert the funds, though you will owe income tax on the amount converted.

If you work for a nonprofit and leave, your options are more limited. You cannot roll the money into an IRA. You can leave it in the plan, withdraw it, or roll it into another nonprofit 457 plan or a 403(b) plan if your new employer offers one. If you withdraw before age 59½, you owe the 10 percent early withdrawal penalty unless you meet a narrow exception.

Some employers allow you to keep your money in their plan even after you leave, but others require you to move it within a certain time frame. Check your plan's rules or contact your plan administrator to understand your specific options.

How a 457 plan compares to a 401(k) or 403(b)

A 457 plan works similarly to a 401(k) in that both are employer-sponsored, tax-deferred accounts with annual contribution limits and required minimum distributions. However, the contribution limits are separate. If you have both a 401(k) and a 457 plan through different employers, you can contribute the maximum to each in the same year (though this is rare).

The biggest difference is the early withdrawal rule. With a 401(k), you generally owe a 10 percent penalty if you withdraw before age 59½, with limited exceptions. With a government 457 plan, you can withdraw without penalty if you separate from service at any age. This makes government 457 plans more flexible for people who plan to retire before 59½.

A 403(b) plan is similar to a 401(k) but is offered by nonprofits, schools, and hospitals. If your nonprofit employer offers both a 457 and a 403(b), you can contribute to both in the same year, but the combined total cannot exceed the annual limit (currently $23,500 for 2024).

Investment options and how your money grows

Your 457 plan holds investments that you choose from a menu your employer provides. Common options include mutual funds, target-date funds (which automatically shift from stocks to bonds as you approach retirement), stable value funds, and sometimes individual stocks or bonds. The specific investments available depend on your employer's plan.

The growth of your account depends on how your money is invested and how the markets perform. If you choose conservative investments like a stable value fund, your money grows slowly but with less risk. If you choose stock-based mutual funds, your account can grow faster over time but may lose value in down markets. Most plans offer a range of risk levels so you can match your investments to your timeline and comfort with risk.

You can usually change your investment choices once per year or after certain life events (like a marriage, birth, or job change). Some plans allow more frequent changes. Check your plan documents or contact your plan administrator to understand how often you can rebalance your investments.

Frequently Asked Questions

Can I withdraw money from my 457 plan before retirement?

If you work for a government employer, you can withdraw without the 10 percent penalty if you separate from service (leave your job) at any age. If you work for a nonprofit, you generally cannot withdraw before age 59½ without the penalty, except for disability or narrow hardship cases. In both cases, you owe income tax on the amount withdrawn.

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

Your beneficiary (the person you named on your plan form) receives the balance. They can roll it into an inherited IRA or take withdrawals over time, depending on the plan rules and their relationship to you. If you did not name a beneficiary, the money goes to your estate and may be subject to probate.

Can I borrow from my 457 plan?

Government 457 plans may allow loans, but nonprofit 457 plans generally do not. If your government plan allows loans, you typically can borrow up to 50 percent of your balance (or $50,000, whichever is less) and must repay it within five years. Check your plan documents to see if loans are available.

Do I have to enroll in my employer's 457 plan?

No, enrollment is voluntary. If your employer offers a 457 plan, you decide whether to participate and how much to contribute. If you do not enroll, you cannot save through this plan, though your employer may offer other retirement savings options.

What is the difference between a 457(b) and a 457(f) plan?

A 457(b) plan is the standard deferred compensation plan for government and nonprofit employees. A 457(f) plan is a nonqualified deferred compensation plan for highly paid executives and is much less common. Most employees have access to a 457(b) plan only.