Understanding 457 Plans

Updated: Oct. 6, 2020, 2:24 p.m.

A 457 is a type of employer-sponsored tax-advantaged retirement account available to state and local government employees, as well as certain (usually highly paid) nonprofit employees. Plans may allow employees to defer up to 100% of their income, and employers may make contributions to these accounts as well.

For those lucky enough to have access to 457 plans, this type of account can be an excellent retirement savings vehicle. In addition to high contribution limits, account holders can use them in conjunction with other tax-advantaged accounts to supercharge their savings.

How Does a 457 Plan Work?

A 457 plan is a lot like a 401(k) plan, except for state and local government employees, and for employees of qualified nonprofits. Employees can elect to defer some of their salary from their paychecks, and that money is put into an investment account in their name.

There are two types of 457 plans. The 457(b) is most common, allowing both participant and plan sponsor contributions. It’s chiefly the plan available to state and local government employees. The 457(f) is available only for highly compensated employees, and only the plan sponsor can make contributions.

Nongovernmental 457 plans face additional restrictions. While governmental 457 accounts can be rolled over into practically any other type of retirement account, money deferred into a nongovernmental 457 plan cannot be rolled over into another retirement account unless it’s another nongovernmental 457 plan.

Additionally, non-governmental 457 accounts are technically the employer’s property until the employee withdraws funds. That means those funds are available to its general creditors in the event of litigation or bankruptcy. Governmental 457 accounts are held in individual trusts similarly to a 401(k).

457 Contribution Limits

The basic 457(b) plan contribution limit for 2020 is $19,500. This limit includes both employee and employer contributions.

Participants age 50 or older may be allowed to make catch-up contributions. The standard catch-up contribution for 2020 is $6,500, bringing the total limit to $26,000.

Certain plans may allow for a special catch-up contribution. The plan may permit participants in their last three years before retirement to contribute either twice the annual contribution limit ($39,000 in 2020) or the basic limit plus the amount of basic limit the participant didn’t use in prior years, whichever is lesser. Participants cannot use the special catch-up contribution limit in conjunction with the standard catch-up contribution.

A 457(f) plan has no contribution limit, though only plan sponsors can make payments. In order to qualify for the tax deferral, all 457(f) contributions must be subject to “substantial risk of forfeiture.” That means an employee’s claim to those tax-deferred funds is subject to their future performance at the company. For example, if a participant leaves their job before the funds in the 457(f) vest, they won’t keep those funds.

Importantly, 457 plan contributions are not limited by contributions to other employer-sponsored retirement plans. So, if an employer offers both a 457 and another type of retirement plan, such as a 401(k) or 403(b), employees can contribute the maximum to both accounts in the same year ($19,500 each in 2020).

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457 vs 401k and 403b

On the whole, 457(b) plans have a lot in common with 401(k) plans and 403(b) plans. They are all employer-sponsored retirement savings accounts, they have the same basic contribution limits, and they use similar investment accounts in order to secure funds for retirement.

All three retirement accounts also offer Roth options, for people who would rather pay taxes now and withdraw funds tax free.

The biggest difference between a 457(b) plan and accounts like the 401(k) or 403(b) is that employer contributions in the 457(b) plan count toward the same annual contribution limit as employee contributions. Both 401(k) and 403(b) plans have much higher limits when accounting for employer contributions as well as after-tax contributions.

Employer contributions to a 457(b) plan are also subject to FICA tax. Participants in 401(k) and 403(b) plans won’t pay FICA tax on employer contributions since they’re deducted as a business expense on the corporate tax return.

On the plus side, 457(b) plan participants can withdraw funds at any time without penalty. They’ll still owe income tax on withdrawals, but they aren’t subject to the usual 10% early withdrawal penalty.

Also, 457 plans allow independent contractors to participate in employer-sponsored retirement plans. 401(k) and 403(b) plans are limited to employees.