457 Plan: A Retirement Savings Option for Government and Nonprofit Employees

A 457 Plan is a type of tax-advantaged, non-qualified retirement savings plan offered to employees of state and local governments, as well as certain nonprofit organizations. Similar to 401(k) and 403(b) plans, the 457 Plan allows participants to contribute a portion of their salary to the plan on a pre-tax or Roth basis, with the savings growing tax-deferred until withdrawn in retirement.

The 457 Plan is crucial for government and nonprofit employees as it provides a flexible and beneficial way to save for retirement. Unlike other retirement plans, the 457 Plan does not impose an early withdrawal penalty for distributions taken before age 59½, making it an attractive option for those who may need access to their funds earlier.

457 Plans have specific contribution limits and rules that govern how much participants can save and under what conditions:

• Basic Annual Contribution Limits: For 2025, participants can contribute up to $23,500 to a 457(b) plan, which is adjusted annually for inflation. This limit is separate from contribution limits for other retirement plans like 401(k) or 403(b) plans, creating a unique “double-dipping” opportunity.

• Catch-Up Contributions: Participants age 50 and older can make additional catch-up contributions of $7,500 in 2025, allowing for a total contribution of $31,000.

• Special Catch-Up Provision: Unique to 457 plans, this provision allows participants in their final three years before retirement age to contribute the lesser of twice the annual limit ($47,000 in 2025) or the sum of the current year’s limit plus unused contribution amounts from previous years. This provision cannot be used simultaneously with the age 50+ catch-up.

• Coordination with Other Plans: A significant advantage of 457 plans is that their contribution limits are not coordinated with other retirement plans. An employee who has access to both a 457 plan and another type of retirement plan (such as a 401(k) or 403(b)) can contribute the maximum amount to both plans.

• Employer Contributions: While employers can contribute to governmental 457(b) plans, these contributions count toward the same annual limit as employee deferrals, unlike in 401(k) and 403(b) plans where employer and employee contributions have separate limits. Non-governmental 457(b) plans typically do not include employer contributions.

• Governmental 457(b) Plan: These plans are offered by state and local governments to their employees. They provide tax-deferred growth on contributions and earnings until withdrawal. Governmental 457(b) plans are subject to less stringent regulations compared to their non-governmental counterparts, particularly regarding distribution options.

• Non-Governmental 457(b) Plan: These plans are available to highly compensated or management employees of tax-exempt organizations such as hospitals, charitable organizations, and private foundations. Unlike governmental plans, these are considered unfunded and remain part of the employer’s general assets, potentially accessible to creditors if the organization faces financial difficulties.

• 457(f) Plan: Sometimes called “supplemental plans,” these are designed for highly compensated executives in tax-exempt organizations. They allow for contributions above the standard limits of 457(b) plans but require a “substantial risk of forfeiture” to qualify for tax deferral. The executive must typically remain employed for a specified period or meet performance goals to receive the benefits.

457 Plans offer several tax benefits along with considerations that participants should understand:

• Pre-Tax Contributions: Contributions to traditional 457 plans reduce taxable income in the year they are made, providing immediate tax savings. For example, a participant in the 24% tax bracket who contributes $20,000 would save $4,800 in federal income taxes for that year.

• Tax-Deferred Growth: Investment earnings within the plan grow tax-deferred, allowing for potentially greater accumulation over time through the power of compounding.

• Roth Option: Many governmental 457(b) plans now offer a Roth option, which allows for after-tax contributions. While this provides no immediate tax benefit, qualified withdrawals in retirement are completely tax-free, including earnings.

• No Early Withdrawal Penalty: Unlike 401(k) and 403(b) plans, 457 plans do not impose the 10% early withdrawal penalty for distributions taken before age 59½. However, withdrawals are still subject to ordinary income tax.

• Required Minimum Distributions (RMDs): Like other retirement plans, 457 plans generally require participants to begin taking distributions by age 73 (as of 2025, following SECURE 2.0 Act adjustments).

• FICA Tax Considerations: While 457 plan contributions reduce federal income tax, they remain subject to FICA taxes (Social Security and Medicare), which is important for participants to factor into their tax planning.

457 Plans offer various distribution options with unique flexibility compared to other retirement vehicles:

• Separation from Service: Unlike other qualified retirement plans, 457 plan participants can take distributions without penalty upon separation from service, regardless of age. This provides significant flexibility for early retirees or those changing careers.

• Rollover Options: Funds from governmental 457(b) plans can be rolled over to other tax-qualified retirement plans like IRAs, 401(k)s, or 403(b)s. However, non-governmental 457(b) plans have more restrictive rollover rules, generally only permitting rollovers to other non-governmental 457(b) plans.

• In-Service Withdrawals: Generally, 457 plans do not permit in-service withdrawals while employed, except in cases of unforeseeable emergency, de minimis distributions (small account balances), or after reaching age 73.

• Unforeseeable Emergency Distributions: Participants facing severe financial hardship may qualify for emergency withdrawals if they meet strict criteria defined by the IRS, including medical emergencies, casualty losses, or other extraordinary circumstances that could not have been anticipated.

• Loan Provisions: Some governmental 457(b) plans offer loan provisions, though this is less common than in 401(k) plans. Loans must generally be repaid within five years, except for loans used to purchase a principal residence.

457 Plans typically offer a range of investment options to help participants build a diversified retirement portfolio:

• Mutual Funds: Most plans include a selection of mutual funds across various asset classes, including domestic and international stocks, bonds, and balanced funds. These provide instant diversification and professional management.

• Target-Date Funds: These popular “set it and forget it” options automatically adjust asset allocation based on the participant’s expected retirement date, becoming more conservative as retirement approaches.

• Fixed Income Options: Many plans offer stable value funds or guaranteed investment contracts (GICs) that provide capital preservation and steady, albeit lower, returns compared to equity investments.

• Self-Directed Brokerage Accounts: Some plans offer a self-directed brokerage window, allowing participants to access a broader range of investments beyond the core lineup, including individual stocks and a wider selection of mutual funds.

• ESG Investment Options: Increasingly, plans are incorporating Environmental, Social, and Governance (ESG) investment options for participants who wish to align their investments with their values.

The administration and governance of 457 Plans involve several key aspects:

• Plan Sponsor Responsibilities: The governmental entity or non-profit organization sponsoring the plan is responsible for establishing and maintaining the plan in compliance with IRS regulations, selecting investment options, monitoring performance, and ensuring proper record-keeping.

• Third-Party Administrators (TPAs): Most plan sponsors engage TPAs to handle day-to-day operations, including participant enrollment, contribution processing, investment elections, distributions, and compliance testing.

• Fiduciary Duty: Plan administrators and committee members have a fiduciary duty to act solely in the best interest of plan participants and beneficiaries, requiring prudent selection and monitoring of investment options and reasonable control of plan expenses.

• Fee Structure: 457 plans incur various fees, including administrative fees, investment management fees, and potential advisor fees. Transparency in fee disclosure is essential for participants to understand the cost impact on their retirement savings.

• Compliance Requirements: Plans must adhere to various regulatory requirements, including submission of Form 5500 (for non-governmental plans), adherence to contribution limits, and proper handling of distributions.

Understanding how 457 Plans work in practice can be helpful through concrete examples:

• Dual Plan Contribution Strategy: A 52-year-old school administrator who has access to both a 403(b) and a 457(b) plan could contribute the maximum to both plans in 2025, including catch-up contributions. This would allow for total retirement contributions of $62,000 ($23,500 + $7,500 to the 403(b) and another $23,500 + $7,500 to the 457(b)), significantly accelerating retirement savings.

• Early Retirement Distribution: A police officer retiring at age 55 after 25 years of service could begin taking distributions from their 457(b) plan immediately upon retirement without facing the 10% early withdrawal penalty that would apply to distributions from a 401(k) plan before age 59½. This flexibility can be crucial for bridging the gap until other retirement income sources become available.

• Special Catch-Up Scenario: A city manager planning to retire at age 65 could utilize the special catch-up provision in their final three years before retirement. If they had contributed $15,000 less than the maximum over their career, they could contribute up to $47,000 per year for three years, allowing them to significantly boost their retirement savings in their final working years.

• Non-Governmental Plan Consideration: An executive director of a non-profit hospital participating in a non-governmental 457(b) plan must consider that their retirement funds remain part of the hospital’s general assets and could be at risk if the hospital faces financial difficulties or bankruptcy. This executive might balance their retirement savings between the 457(b) and other protected retirement vehicles.

457 Plans have several distinctive features when compared to other common retirement plans:

• Separate Contribution Limits: Unlike 401(k) and 403(b) plans, which share a combined contribution limit if an employee participates in multiple plans, 457 plans maintain their own separate contribution limit. This allows participants with access to both a 457 plan and another employer-sponsored plan to contribute the maximum to each.

• No Early Withdrawal Penalty: 457 plans do not impose the 10% early withdrawal penalty on distributions taken before age 59½, which is a significant advantage for those who may need to access funds earlier.

• Catch-Up Provisions: 457 plans offer a unique “final three years” catch-up provision that differs from the age-based catch-up options in other plans, potentially allowing for significantly higher contributions near retirement.

• Employer Contribution Treatment: In 457 plans, employer contributions count toward the same annual limit as employee deferrals, unlike in 401(k) and 403(b) plans where employer contributions have a separate limit.

• Creditor Protection: Governmental 457(b) plans offer protection from creditors similar to other qualified plans. However, non-governmental 457(b) plans do not provide the same protection, as these assets remain part of the employer’s general assets.

The landscape for 457 Plans continues to evolve with regulatory changes and emerging trends:

• SECURE 2.0 Act Impact: The SECURE 2.0 Act, passed in December 2022, introduced several changes affecting 457 plans, including the increase of the age for required minimum distributions to 73 in 2023 and eventually to 75 in 2033, providing more flexibility for retirees.

• Enhanced Roth Options: There is an increasing trend toward offering Roth options within 457(b) plans, allowing participants to diversify their tax treatment in retirement and providing tax planning flexibility.

• Financial Wellness Integration: Many plan sponsors are integrating 457 plans into broader financial wellness programs, recognizing that retirement planning is just one aspect of overall financial health.

• Increased Automation: Features like automatic enrollment, automatic escalation, and qualified default investment alternatives (QDIAs) are becoming more common in 457 plans, mirroring trends in the 401(k) world to improve participation and savings rates.

• Simplified Plan Designs: There is a trend toward streamlining investment menus and simplifying plan designs to make participation less overwhelming for employees and reduce administrative burden for employers.

• Increased Focus on Decumulation Strategies: Plan sponsors and providers are placing greater emphasis on helping participants develop effective strategies for drawing down their retirement assets, not just accumulating them.

• Maximize Contributions: To fully benefit from the tax advantages and potential employer matching contributions, participants should aim to contribute the maximum allowable amount each year.

• Consider Roth Contributions: If you expect to be in a higher tax bracket in retirement, Roth 457 contributions may provide significant tax savings.

• Coordinate with Other Retirement Accounts: For those eligible to contribute to both a 457 Plan and a 403(b) or 401(k), consider maximizing contributions to all available accounts to boost retirement savings.

The 457 Plan is a versatile and valuable retirement savings option for employees of government and nonprofit organizations. With its flexible withdrawal rules, significant tax advantages and the potential for Roth contributions, the 457 Plan can play a key role in a well-rounded retirement strategy.

These plans offer unique advantages, including separate contribution limits from other retirement plans, no early withdrawal penalties, and special catch-up provisions that can significantly enhance retirement readiness. For eligible employees, understanding the nuances of 457 plans—including their tax implications, investment options, distribution rules, and how they complement other retirement vehicles—is essential for optimizing retirement strategy. The flexibility of these plans makes them particularly valuable for those contemplating early retirement or career transitions.