457(b) Retirement Plan

What Is a 457(b) Retirement Plan?

Also called a deferred compensation plan, a 457(b) retirement plan is a tax-advantaged benefit that allows employees to save for the future.

Under this plan, participating employees contribute pre-tax deductions from each paycheck to help the account grow over time.

457(b) plans are available for two types of participants: government employees and certain nonprofit employees.

Types of 457(b) Retirement Plans

Internal Revenue Service (IRS) rules and regulations differ depending on which type of organization sets up the account. The types of 457(b) retirement plans include:

• Governmental 457(b) plans established by state and local governments
• Tax-exempt 457(b) plans established by nonprofit entities considered tax-exempt under Internal Revenue Code (IRC) Section 501 (c).

These plans are typically just for common-law employees. In certain instances, independent contractors for these organizations may also be eligible to participate.

How Does a 457(b) Retirement Plan Work?

A 457(b) retirement plan works similarly to other types of employer-sponsored benefit plans. Eligible employees can elect to automatically deduct money from their paychecks on a pre-tax basis, where it’s put into their retirement and investment accounts. Employees may be given the option to invest their contributions in mutual funds or annuities.

Both are tax-deferred, meaning the interest and earnings are not taxed until employees withdraw their funds during retirement.

A governmental 457(b) plan may also include a Roth contribution program. Under this provision, all or some elective deferrals can be designated as after-tax Roth contributions.

What Are the Contribution Limits for a 457(b) Plan?

Like other plans, maximum contribution limits apply. According to the IRS, employers or employees can contribute annually the lesser of:

• Up to the $22,500 elective deferral limit (2023), or
• 100% of the employee’s includible compensation

Some plans allow employees aged 50 and over to make annual catch-up contributions up to a certain amount (e.g. $7,500 in 2023). This allows participants to accrue more money before they retire.

Additionally, employees may be allowed to make higher contributions during the three years just before they reach retirement age. These special catch-up contributions must not exceed:

• Twice the annual limit ($45,000 in the 2023 tax year), or
• The basic annual limit plus the basic limit unused in prior years (this is only allowed if the participant is not using age-50 catch-up contributions)

Do Employers Match 457(b) Plans?

Some employers match the amount their employees contribute to their 457(b) plans, but this feature is optional. For example, if they match 40% and an employee contributes $1,000 a month, the employer contributes $400 a month to their account.

Employer contributions count toward the annual limit for this plan.

What Is the Difference between a 401(k) and a 457(b) Plan?

While some features overlap, these retirement plans are not identical. Key differences between 401(k) and 457(b) plans include:

• Provider/participants: 457(b) plans are provided by governmental and certain non-profit entities, while 401(k) plans are provided by private employers.
• Employee Retirement Income Security Act of 1974 (ERISA): Many 457(b) plans are not governed by ERISA rules, so specific features are handled differently.

For further reference, the IRS outlines other distinctions in a handy 401(k) vs. 457(b) comparison chart.

What Is the Difference Between a 403(b) and a 457(b) Plan?

Though they’re both given to public-sector and non-profit employees, 403(b) and 457(b) plans hold key differences employers should be aware of, such as:

• Contribution limits. 403(b) plans have higher total contribution limits than 457(b) plans. The annual limit for a 457(b) plan (employee plus employer contributions) is $22,500 (2023), but 403(b) plan limits can reach up to $66,000.
• Catch-up contributions: Many 403(b) plans feature a 15-year rule, allowing employees with 15 years or more of service with the same employer to add up to $15,000 in catch-up contributions. Special rules for 457(b) plans apply during the 3 years before the federal retirement age.

While these are the most prominent distinctions between the two plans, others exist. Based on plan type and provisions, they include early withdrawal allowances, penalties, and investment options. Additional information is publicly available from the IRS.

What Are the Pros and Cons of a 457(b) Plan?

The pros and cons of having a 457(b) plan depend largely on the individual circumstances of the employee and employer. If you’re qualified to offer more than one retirement option, carefully consider the advantages and disadvantages of participating from both an employer and employee perspective.

Pros and Cons of 457(b) Plans for Employers

The Pros

• 457(b) contains provisions that can be used as a recruitment tool to help employers attract talent, such as the three-year catch-up contribution rule.
• Employers aren’t required to contribute, making this a flexible plan option.
• 457(b) plans are not covered by ERISA, which means employers aren’t responsible for providing detailed information regarding their employees’ plans. This helps save HR teams valuable time.

The Cons

• Since employers are not required to flesh out all the details of their 457(b) plans, they may not be well-equipped to answer questions regarding their employees’ retirement options. This lack of knowledge and accuracy can negatively impact participation and employer-employee relationships.

Pros and Cons of 457(b) Plans for Employees

The Pros

• Employees contribute to a tax-advantaged retirement account.
• The 10% tax penalty other retirement/investment plans usually have doesn't apply to many 457(b) plans.
• This plan offers catch-up contributions. So, an individual who may have had a late start in their career can contribute additional amounts to help them catch up on their retirement savings.

The Cons

• Because 457(b) plans are not governed by ERISA, employees miss out on some benefits 401(k) participants have. For instance, it protects employees in the event a fiduciary doesn’t uphold their responsibilities or misuses funds.