What deferred compensation means in a 457 plan

Deferred compensation is money your employer sets aside for you now, but you receive it later — usually after you leave the job or reach a certain age. In a 457 plan, you choose how much of your paycheck to defer (up to the annual limit set by the IRS), and that money grows tax-free until you withdraw it.

The word "deferred" describes the timing, not the account itself. You are deferring — postponing — when you get paid. Instead of taking the full amount in your paycheck today, you tell your employer to hold part of it in your 457 account and give it to you later. The money stays in the account and can be invested in mutual funds, bonds, or other options your plan offers.

This is different from a regular paycheck, where you receive money when ready and pay income tax on it right away. With a 457 plan, you do not pay income tax on the deferred amount until you actually withdraw it.

Key Takeaways

  • Deferred compensation in a 457 plan means you postpone receiving part of your salary, and that money grows tax-free until withdrawal.
  • You choose the deferral amount each year up to the IRS limit, which changes annually and differs from 401(k) limits.
  • You pay income tax on the money only when you withdraw it, not when you defer it, which can lower your tax bill in high-earning years.
  • Most 457 plans allow withdrawals after you separate from employment, but some plans also permit withdrawals at age 59½ while still employed.
  • If you leave your job before retirement, you can roll over your 457 balance to an IRA or another employer's plan in some cases, but rules vary by plan type.

How much you can defer each year

The IRS sets an annual deferral limit for 457 plans. This limit applies to the total amount you can contribute across all 457 plans you participate in during a single calendar year. The limit changes most years based on inflation.

For 2024, the standard deferral limit is $23,500. For 2025, it is $24,000. These figures explore to most participants. If you are age 50 or older, you may be able to make an additional catch-up contribution — a second deposit allowed only for older workers. The catch-up amount for 2024 is $7,500 and for 2025 is $8,000, though your specific plan must permit catch-up contributions for you to use this option.

Some 457 plans offer a special rule called the final three-year catch-up. In the last three years before your plan's normal retirement age, you may be able to defer up to twice the standard limit (if your plan allows it and you have not used catch-up contributions in prior years). Check your plan documents or contact your plan administrator to see which catch-up options your employer's plan permits.

When you can access your deferred money

The timing of withdrawals depends on your plan type and your situation. Most 457 plans are governmental 457 plans (run by state and local governments). These plans generally allow you to withdraw your balance after you separate from employment — meaning you leave your job, retire, or are laid off.

Some governmental 457 plans also permit withdrawals at age 59½ even if you are still working for the same employer. This is called an in-service distribution. However, not all plans offer this option, so you need to check your plan documents.

Non-governmental 457 plans (also called 457(b) plans, typically offered by nonprofits and certain private employers) have stricter withdrawal rules. These plans usually allow withdrawals only after you separate from employment or reach age 59½. Some non-governmental plans do not permit in-service withdrawals at all.

Hardship withdrawals are possible in some 457 plans if you face an when ready and heavy financial need, but the rules are strict and vary by plan. You would need to contact your plan administrator to learn whether your plan permits hardship withdrawals and what documentation is required.

Tax treatment when you withdraw

When you withdraw money from your 457 plan, you pay ordinary income tax on the full amount withdrawn in that year. The tax is calculated at your regular income tax rate, which depends on your total income for the year and your filing status.

If you withdraw a large sum in a single year, that withdrawal could push you into a higher tax bracket, meaning you pay a higher percentage on some of your income. Some people spread withdrawals over several years to keep their annual income lower and reduce their tax rate.

You do not pay the 10 percent early withdrawal penalty that applies to 401(k)s and IRAs if you withdraw before age 59½. This is one of the key differences between a 457 plan and other retirement accounts. However, you still owe income tax on the withdrawal regardless of your age.

Rolling over your balance to another account

If you leave your job, you may be able to move your 457 balance to another retirement account. The rules depend on your plan type and the receiving account.

Governmental 457 plans offer more flexibility. You can roll over your balance to a traditional IRA, a Roth IRA, or another employer's 401(k) or 403(b) plan (if that plan accepts rollovers). You can also roll over to another governmental 457 plan if you take a job with a different government employer.

Non-governmental 457 plans are more restrictive. You can roll over to another non-governmental 457 plan or to a traditional IRA, but you cannot roll over to a 401(k), 403(b), or Roth IRA. This limitation is set by federal tax law and applies regardless of what your plan administrator might prefer.

A rollover is not a withdrawal. When you roll over, the money moves directly from your 457 plan to the new account without you receiving a check. This avoids when ready taxation and the 60-day important date that applies to indirect rollovers. Ask your plan administrator about the rollover process and whether your plan permits the type of rollover you want.

Loans from your 457 plan

Some 457 plans allow you to borrow from your own balance. A plan loan lets you access money without withdrawing it permanently, so you do not trigger when ready taxation. You repay the loan to your own account over time, typically through payroll deductions.

The rules for plan loans vary widely. Some plans set the interest rate at prime rate plus one percent; others use a different formula. Repayment periods typically range from two to five years, though longer periods may be allowed for loans used to buy a primary residence.

If you leave your job before repaying the loan, the remaining balance usually becomes a taxable withdrawal. This means you owe income tax on the unpaid amount in the year you separate from employment. Some plans allow a grace period to repay before treating it as a withdrawal. Check your plan documents or ask your administrator about the loan rules and what happens if you leave your job.

How deferred compensation affects your current taxes

When you defer money into a 457 plan, that amount is subtracted from your taxable income for the year. This reduces your federal income tax bill in the year you defer. For example, if you earn $60,000 and defer $10,000 into your 457 plan, you pay federal income tax only on $50,000.

This tax reduction happens when ready, in the year you make the deferral. You do not have to wait until retirement to see the benefit. This can be especially valuable if you have a high-income year and want to lower your tax burden.

However, you will owe tax on that money eventually — when you withdraw it in retirement. Deferring does not eliminate the tax; it postpones it. If you expect to be in a lower tax bracket in retirement than you are now, deferring can save you money overall because you will pay tax at a lower rate.

Frequently Asked Questions

Can I withdraw my deferred money before I leave my job?

In most governmental 457 plans, yes, if you reach age 59½ and your plan permits in-service withdrawals. Non-governmental 457 plans rarely allow this. Some plans permit hardship withdrawals for when ready financial needs, but the criteria are strict. Contact your plan administrator to learn what your specific plan allows.

What happens to my 457 balance if I die before retirement?

Your beneficiary — the person you named on your plan documents — receives the balance. They can usually roll it over to an inherited IRA or take it as a lump-sum distribution. The tax treatment depends on whether they are your spouse and which options your plan permits. Confirm your beneficiary designation is current with your plan administrator.

Can I move my 457 balance to a Roth IRA?

If you have a governmental 457 plan, yes, you can roll over to a Roth IRA, though you will owe income tax on the converted amount in the year of the rollover. If you have a non-governmental 457 plan, you cannot roll over to a Roth IRA. You can only roll over to a traditional IRA or another non-governmental 457 plan.

Do I have to start withdrawing at a certain age?

Yes. You must begin taking required minimum distributions (RMDs) from your 457 plan by April 1 of the year after you reach age 73 (as of 2023; this age increases to 75 in 2033 under current law). The amount is calculated based on your age and account balance. However, if you are still employed, some plans allow you to delay RMDs until you actually separate from employment.

What is the difference between deferring and investing?

Deferring is the act of postponing when you receive your salary. Investing is what happens to that deferred money while it sits in your account. Your 457 plan holds your deferred money and lets you invest it in funds of your choice. The deferral is the timing decision; the investment is what you do with the money during that time.