457 Plans: Key Differences

457 plans are retirement plans offered by public-sector and select tax-exempt, non-profit employers that allow you to make pre-tax contributions towards your retirement.

Understanding the differences between 457 plans and the implications of their different provisions is key to effectively integrating them within your broader financial plan.

What is a 457(b) plan?

A 457(b) plan is a tax-deferred, employer-sponsored retirement plan available to government and tax-exempt nonprofit employees. A 457(b) plan is unique because it operates as a deferred compensation plan rather than a traditional retirement plan. Employers can match or make contributions on behalf of eligible employees. 457(b) plans can also be used in conjunction with other employer-sponsored retirement plans, up to an annual statutory limit with catch-up provisions, as a way to help employees in maximizing their retirement savings.

How does a 457(b) plan work?

The 457(b) plan allows employees to defer more of their pre-tax income to save for retirement. Once dollars are contributed to a 457(b) plan, the earnings grow tax-deferred until money is taken out in retirement, at which time, they are then taxed as ordinary income. The withdrawal rules for the 457(b) differ slightly from those in other retirement plans; withdrawals are allowed without penalties prior to age 59 1/2, though you will owe ordinary income tax on the withdrawn amount. Additionally, some governmental plans may allow for in-service distributions without penalty.

For individuals who have already maxed out their contributions to 403(b) or 401(a) plans, contributing to a 457(b) plan can help increase your retirement savings while while reducing your current taxable income.

What are the three types of 457 plans?

While governmental 457(b) plans are the most common, they aren’t the only type of 457 plan available. Given the differences between 457 plans, one should fully understand their plan’s specific rules and benefits ahead of time.

• Governmental 457(b) plans. These plans are offered to state and federal government workers. Both employer and employee contributions are permitted, though the sum of both types of contributions is limited to that year’s statutory maximum ($22,500 for 2023). Once a participant turns age 50, they are allowed an additional catch-up contribution of $7,500 per year. Additionally, many governmental employers allow Roth contributions to be made to the plan. Once a participant stops contributing to a governmental 457(b) plan the plan can be rolled into a IRA, 401(k), 403(b) or a different governmental 457(b) plan.
• Non-governmental 457(b) plans. These plans, sometimes referred to as “top-hat” plans, are typically for employees of non-profit organizations, and are not often available to all employees. Non-governmental 457(b) plan are subject to the employer’s creditors, meaning that these assets may not be protected in the case of litigation or bankruptcy. Once a participant leaves their employer, the plan cannot be rolled into a IRA, 401(k), 403(b) or a different 457(b) plan. The distributions options for a non-governmental plan differ from qualified plans. As such, these distributions are considered wage income, meaning FICA & Medicare tax must be paid.
• 457(f) plans. Lastly, 457(f) plans are deferred compensation plans for highly compensated employees at non-profit employers. Only employer contributions are permitted but there is no limit on the amount of money that can be deferred, and the eligibility requirements to receive distributions often depends on a number of conditions. The rules around when a participants benefits are vested and earned are detailed in each plans specific documents. Since 457(f) plans are more complicated and highly individualized, consult with a financial planning professional to see how this plan fits in within the context of your financial plan.

457(b) contribution limits & other considerations

As of 2023, a participant can contribute up to $22,500 per year into a 457(b) plan, though some employers offer their employees the option to make additional catch-up contributions. There are traditional and special catch-up contribution features that may be available within your plan, but are not required by law, so reviewing your 457(b) plan document will be necessary to confirm these are permitted.

• Traditional catch-up contribution. Workers over the age of 50 can contribute an additional $7,500 per year into their plan, which results in a maximum contribution limit of $30,000 in 2023.
• Special catch-up contribution. This provision allows a higher contribution amount for individuals who may not have maximized their contributions in prior years. Participants who are within three years of normal retirement age (as specified within the plan document) may contribute up to an additional $22,500 on top of the standard limit for a maximum contribution limit of $45,000 in 2023. This feature is not allowed in addition to the traditional catch-up contribution and is limited to the sum of unused deferrals in prior years. For individuals who didn’t maximize these contributions early on in their career, catch up contributions enable you to potentially backfill retirement savings.

Getting help with your 457 plans

Brighton Jones is here and ready to help individuals align all components of complex compensation package into your broader financial picture. Schedule time with our team to better understand the full risks and benefits of 457(b) deferred compensation plans in order to best leverage your portfolio options and avoid unpleasant tax surprises.