Quick guide to 457(b) deferred compensation plans

Have questions about how to save for retirement? If you work in state or local government, in a tax-exempt nonprofit or in certain other nonprofit organizations, you may have the option to contribute to a 457(b) plan. 

A 457(b) deferred compensation plan is a savings option for retirement that lets you reduce your annual taxable income. The 457(b) plan is similar to plans found in the private sector but has some key differences. Read on to find out how a 457(b) works, how it differs from a 401(k) and if it might be an option for you.

Key takeaways

• 457(b) deferred compensation plans let public service employees or employees of nonprofits under an IRC 501(c) save pre-tax wages for retirement.
• 457(b)s can be government plans (local and state government) or nongovernment plans (nonprofit organizations). 
• A 457(b) lets you contribute up to 100% of your income up to a certain annual limit.

A 457(b) plan is a deferred compensation plan for employees of state and local government and nonprofits under a 501(c). It lets eligible employees direct a certain amount of their pre-tax wages from each paycheck into a retirement fund, lowering the amount of income that’s taxable.

The plans come in two forms: governmental (for state and local government employees) and nongovernmental (for employees of nonprofits). 

Plan participants can contribute up to 100% of their income up to an annual contribution limit that’s decided by the IRS.

Early distributions in emergency situations

Like many retirement plans, the 457(b) lets you withdraw funds before retirement in emergency situations. The emergency has to meet specific requirements, though.

Examples of eligible emergency situations are property damage not covered by insurance, funeral expenses and unforeseen medical bills. The plan participant must show that they can’t pay for the emergency even if they were to sell off any available assets. 

Things that wouldn’t be considered an emergency expense are credit card debt or any other event that was foreseeable and that the participant could have planned for. 

Deferred compensation plans like the 457(b) are designed for employees who don’t work in the private sector. This includes roles like: 

• Municipal workers. 
• City employees. 
• Civil servants, like postal workers and law enforcement officers.
• Hospital staff. 
• Nonprofit administrators.

A 457(b) deferred compensation plan allows you to save up to 100% of your paycheck. But the annual limit you’re able to save is $22,500 for 2023—the same as with a 401(k). For people over 50, an additional $7,500 can be saved annually as a “catch-up” contribution. 

Retirement savings plans like 401(k)s and 457(b)s are designed for specific tax situations. Here are some of the similarities and differences between a 457(b) and a 401(k) retirement plan: 

• 401(k)s are usually offered by private employers, while 457(b)s are offered by some government and nonprofit organizations. 
• Both plans let you grow your savings, tax-deferred, over time.
• Both plans place a limit on how much you can defer per year that’s tied to cost-of-living indexes, but both plans also let workers older than 50 contribute more than that limit if they need to catch up.
• Employers often match contributions to a 401(k). That’s less common with a 457(b).
• Early withdrawals from a 401(k) carry a 10% penalty. Under some circumstances, early withdrawals from a 457(b) aren’t subject to a penalty.

What is a 403(b) plan? 

A 403(b) plan is similar to a 401(k) and a 457(b), but it’s designed for public education employees as well as other tax-exempt organizations. The contribution limits for 403(b) plans are the same as for 457(b) and 401(k) plans. The 403(b) plan simply allows organizations with unique tax situations a better way to support employee retirement savings. 

What is a 457(f) plan?

A 457(f) plan is supplemental to a 457(b) plan. But a 457(f) plan is only offered with nongovernmental 457(b)s to executives and other highly compensated individuals at nonprofit organizations, such as hospitals, credit unions or universities. The 457(f) allows an employer to contribute an annual sum to the executive’s plan that’s above the normal 457(b) contribution limit.

Still considered a deferred salary contribution, this executive retention tool is typically locked into a vesting period—meaning the executive must stay employed for a certain number of years to earn the additional contribution. Contribution amounts are determined in a contract at the start of the relationship.

A 457(b) deferred compensation plan is similar to a 401(k), except it’s for employees working for organizations with special tax situations. Like many retirement plans, a 457(b) lets you save money without immediately paying taxes on the funds, which reduces your taxable income overall. Like a 401(k), the money will be taxed when you start making withdrawals. 

Savings plans aren’t the only way to prepare for retirement. When applying for jobs, you can ask about other retirement options offered by employers. If your company offers a pension plan, it can increase your retirement income significantly. If you’re unsure how much you need to save, find out how much money you need to retire.