A457 Deferred Compensation Plan is a supplemental retirement savings program that allows participants to make contributions on a pre-tax basis. A 457(b) plan is a nonqualified tax-deferred compensation plan that works very much like other retirement plans such as the 403(b) and 401(k). Created in 1978 the name refers to the relevant section  in the Internal Revenue Code that governs the plan. Two main types of 457 plans exist: governmental and tax-exempt 457(b) plans.
To participate in 457(b) plan, the organization must be a state or local government or a tax-exempt organization under IRC 501(c). Employers or employees through salary reductions contribute up to the IRC 402(g) limit on behalf of participants under the plan.
There are significant tax advantages for participants in a 457(b) plan:
•Contributions to a 457(b) plan are tax deferred.
•Earnings on the retirement money are tax deferred.
How a 457 Plan Works
The law allows public school districts and other governmental employers to sponsor voluntary savings plans for their employees under Section 457 of the Internal Revenue Code. These plans are technically “nonqualified deferred-compensation plans.” However, Congress has effectively given them the same characteristics as qualified retirement plans, such as 401(k) plans, through a series of changes in federal laws made from 1996 through 2001.
A 457 plan is sponsored by the local employer and in some ways works like a 401(k) plan. The employer can pick the vendors offering investments in the plan and remove them if they do not do a good job. The employer can set all of the other rules. Federal laws make compliance for such plans much easier than for 401(k) plans since there are no “non-discrimination tests” to perform.
Federal law allows an employee to defer up to the lesser of 100 percent of compensation or $17,500 to a 457 plan on a tax-deferred basis. For individuals age 50 or older, the dollar limit goes up to a maximum amount determined annually. This limit is in addition to the limit for any other plan.
Thus, an employee can defer up to a maximum of $17,500 under a 457 plan and also defer the same maximum amount to a 403(b) or other salary deferral plan. There is also a “Catch-up” provision that if the employee is in their last three years of employment they may contribute up to a maximum per year. There are restrictions on this provision, so please consult with your tax advisor. Also, the participant’s 457 plan document would need to allow use of these catch-up provisions.
457 Plan Highlights and Advantages
Employers or employees through salary reductions contribute up to the IRC 402(g) limit on behalf of participants under the plan.
•Contributions are payroll deducted on a before-tax basis.
•Distributions are taxed when received. Contribution limits are in addition to any existing 403(b) contributions.
•There are a variety of savings products to choose from.
•Plan payout upon retirement or separation from service without tax penalty.
Roth 457 Plan
With Roth 457(b) plans, participants can contribute after-tax dollars to save for retirement, without the AGI limitations imposed on Roth IRA accounts. Contributions and earnings for Roth 457(b) accounts are tax-free upon withdrawal as long as the participant has a qualified withdrawal reason and the account has been in existence for 5 years.
These types of plans may benefit employees who would like to access tax-free money in retirement. If you need money prior to the five year holding period, remember contributions made to a Roth can be withdrawn without penalty before retirement, however, the earnings are taxable and subject to penalty.