457 plans fall into two categories: governmental 457(b) plans and "top hat" 457 plans.
- Governmental 457(b) plans can be offered by state and local governments and public schools, and all employees who meet the plan's eligibility criteria can typically participate. Governmental 457(b) plans must comply with the IRS annual contribution limits, and both employees and employers can make contributions.
- Unlike governmental plans, top hat plans are only made available to a select group of managers or highly compensated employees and usually by tax-exempt organizations, such as nonprofit hospitals and charities. Additionally, assets in top hat plans are owned by the employer until distributed, and as a result, are subject to the credit risk of the employer while in the plan. There are two types of top hat 457 plans:
- Tax-exempt 457(b) plans must comply with the IRS annual contribution limits, and both employees and employers can make contributions.
- 457(f) plans are not subject to the IRS annual contribution limits, but only employers can make contributions. These plans are typically offered as an additional perk in recruitment efforts to further entice potential executives and are often tied to performance goals or length of service requirements. As such, benefits under these plans may be subject to forfeiture if performance goals or other stipulations are not met.
It's important to note that while all these plans are called 457, the provisions for each plan type vary widely. Our focus here is the Governmental 457(b) plan since it’s the most common among those mentioned.
457(b) plans work like many other retirement plans. Employees who enroll in the plan can contribute a percentage of their income up to the annual contribution limit. Depending on the type of contribution you make (see below for more details.), you can receive a tax benefit when you contribute or when you take a withdrawal from the plan. However, unlike other employer retirement plans, the annual contribution limit for governmental 457(b) plans applies to contributions from both the employee and the employer.
You can invest your assets among the investment choices offered by your plan. The dollars you contribute and the earnings on those dollars belong to you – your employer must keep these assets separate from their own and cannot use them for any other purpose. The dollars your employer contributes (and the earnings on those dollars) must be kept separate for your benefit as well, but you may forfeit these assets if you leave your employer before they're vested. Vesting schedules (or in other words, the amount of time you have to stay with your employer to keep the employer contributions) are defined by each plan.
You can contribute up to 100% of your includible compensation or the annual contribution limit, whichever is less. Generally, includible compensation is any compensation from your employer that's included in your gross income when you file your taxes. The annual contribution limit for 2022 is $20,500.
Additionally, your Governmental 457(b) plan may offer two types of catch-up contributions to eligible participants:
- The age-based catch-up, which adds $6,500 to the annual limit for a total of $27,000 in 2022.
- You are eligible for this if you are age 50 or older by year-end.
- The service-based catch-up, which is up to two times the annual contribution limit ($41,000 in 2022).
- You are eligible for this if you are in the last three years of service, prior to normal retirement age (as defined by your employer’s retirement plan document). Since this requires a special calculation, you may want to consult with a tax professional.
If your plan offers both catch-up options, you cannot use both in the same year – you get the higher of the two.
Keep in mind that your employer’s contributions count toward your contribution limit. For example, if your employer contributes $4,500, the maximum amount you can contribute in 2022 is $16,000 (plus catch-up contributions if eligible).
It depends on the terms of your plan. Governmental 457(b) plans are allowed to offer Roth contributions, but each plan determines whether to make this option available.
If your plan offers a Roth option, your combined pre-tax and Roth contributions cannot exceed the annual contribution limits described above.
With pre-tax contributions, you defer taxes on your contribution and earnings until you take a distribution from the plan.
Roth contributions are made with after-tax dollars, so you do not receive a tax benefit when you make the contribution. However, earnings and distributions of Roth dollars are generally tax-free in retirement.
Typically, you may only take a distribution from a Governmental 457(b) plan when a specific triggering event occurs, such as:
- Separation from service (employment)
- Attainment of age 70 ½
- Plan termination (all participants/employees become 100% vested)
- Divorce when a qualified domestic relations order (QDRO) is issued
Depending upon the terms of your plan, it may be possible to take a distribution:
- For unforeseeable emergencies
- While still employed, once you're 59 ½ or older
- For a qualified birth or adoption (up to $5,000 per birth/adoption per taxpayer)
- Of account balances less than $5,000 (excluding rollover dollars) if you have not actively contributed to the plan for two years.
Generally, you must begin taking a required minimum distribution (RMD) from your plan by April 1 following the year you turn age 72 and by December 31 each subsequent year. If you are still working for the employer sponsoring the plan, you may delay your RMDs until April 1 of the year following retirement if the option is available in your plan.
Determining what's taxable when taking a distribution from a Governmental 457(b) depends on what type of money you have in the plan. Of course, eligible rollovers to an IRA are not subject to taxation.
- Pretax money – Any distribution not rolled over will be taxed as ordinary income. Unlike other employer retirement plans, distributions from a Governmental 457(b) are not subject to an early withdrawal penalty, regardless of your age. If you are younger than 59 ½, it may be beneficial to leave assets in your 457(b) if you expect to take a distribution before reaching 59 ½.
- Roth money – Qualified distributions of Roth contributions and earnings can be taken tax-free.
When an individual participates in more than one salary deferral plan, their employee salary deferral contributions to both plans are usually limited to the IRC 402(g) limit which is $20,500 (2022).
However, 457 plans are not subject to the 402(g) limit. This allows you to participate in a 457 plan in addition to another salary deferral plan and contribute up to the salary deferral limit in each plan. For this reason, some public school districts offer Governmental 457(b) plans in addition to a 403(b) or 401(k) plan, to allow employees to take advantage of the contribution limits in both plans, potentially doubling their salary deferral contributions.
Some of the biggest differences between Governmental 457(b) plans and 401(k)/403(b) plans are:
- 401(k) plans are not available to state or local governments unless they were adopted before May 5, 1986. 403(b) plans are also not offered to government employees – just public education employees and employees of 501(c)(3) organizations.
- A Governmental 457(b) plan may allow independent contractors (not just employees, as is the case with other plans) who perform services for the employer to participate.
- The contribution limit for a Governmental 457(b) plan includes employer and employee contributions, whereas the contribution limit for 401(k)/403(b) plans includes employee contributions only.
- A Governmental 457(b) plan’s service-based catch-up contribution (if offered by the plan) is double the annual contribution limit for the last three years prior to reaching normal retirement age (as defined by the plan). 401(k) plans do not offer a service-based catch-up contribution (only age-based catch-up contributions). 403(b) plans may offer a service-based catch-up contribution of up to $3,000 for five years to individuals with 15 or more years of service. Unlike Governmental 457(b) plans, participants in 403(b) plans may use the service-based catch-up contribution and age-based catch-up contribution in the same year.
- No early withdrawal penalty applies if you take a withdrawal/distribution before age 59½ from a Governmental 457(b) plan. If you take a withdrawal before age 59 ½ from a 401(k)/403(b) plan, a 10% early withdrawal penalty will apply unless you qualify for a penalty exception.