What is a 457 plan? And how does it work?

A 457 plan allows employees working for the state, local government, or specific nonprofits to save and invest money for retirement with tax benefits. It works like a 401K or 403 (b) retirement or deferred compensation plan. If you work for a tax-exempt organization (nonprofit), you may be saving for retirement with a 457 plan.

There are two different types of 457 tax-deferred plans

Tax-exempt organization 501 (c) can offer eligible 457 (b) and ineligible 457 (f) plans. The 457 (f) ineligible plan is for only certain highly-compensated employees in nonprofits. Participants in a 457 (b) plan can defer a portion of their annual compensation or bonuses into the 457 (b) plan before taxes. Also, participants can make discretionary contributions to the 457 (b) plan. In a qualified retirement plan, the employer typically sets up a vesting schedule based on years of service.

A 457(f) nonqualified deferred compensation plan is a nonqualified retirement strategy that allows the nonprofit employer to supplement the retirement income of its top management team or highly compensated employees by contributing to a plan that will be paid to the executive at vesting. It is considered ineligible because this plan does not satisfy the limitations of eligible plans under section 457 (b). There are no specific dollar limits for contributions. Since all benefits under a 457(f) plan must be subject to a substantial risk of forfeiture, these plans typically hold employer contributions only. Participants’ contributions are not allowed in this plan. In this plan, the benefits are taxed when they vest, not when they are paid out.

One of the advantages of offering this type of 457 (f) plan to top employees is to use this plan as a tool for increasing morale, retention, and loyalty. Assets in a 457 deferred compensation plan become available for withdrawal once the employee leaves employment.

The payments under exempt plans are not subject to income tax until the benefits are paid. A  457(f) plan is the only plan under which the benefits are subject to income tax upon vesting, even if they are not paid out at that time.

457 (b) and 457 (f) Plans Comparison