How a 457(b) Deferred Compensation Plan Works

When it comes to employer-sponsored retirement accounts, 401(k)s get a lot of attention—and with good reason. They offer a tax-advantaged way to grow your nest egg and may come with an employer match to boot.  But there are other retirement savings options out there that are also worth a look, like a 457(b).  

A 457(b) is another type of deferred compensation plan that’s available to public employees and those who work for certain tax-exempt organizations. It’s similar to a 401(k) but has some key differences that make it a unique retirement savings vehicle. 

We’ll explain what a 457(b) deferred compensation plan is and how it works to help you understand how it compares to other retirement savings plans.  

What is a 457(b) plan?  

A 457(b) retirement plan is designed for eligible employees of state and local governments, such as firefighters, police officers and civil servants. Employees of certain tax-exempt organizations may also have access to 457(b) plans.  

It’s similar to a 401(k) in that you can make pre-tax contributions, allowing you to enjoy tax-deferred growth until you withdraw funds. However, there are a few notable differences between these two savings plans and how they work.  

How does a 457 deferred compensation plan work?  

Like with a 401(k), contributions to a 457(b) are typically made through automatic payroll deductions. The money you put in is tax-deductible, which reduces your taxable income during your working years and 457(b) funds grow tax-deferred. That means you won’t have to pay any taxes on these funds until you withdraw them. Some employers also may offer a Roth option, which you’d fund with after-tax dollars and then typically be able to withdraw funds tax-free.  

457(b) plans have the same contribution limits as 401(k)s. In 2024, you can contribute up to $23,000 to a 457(b), and if you’re 50 and older, you can put in an extra $7,500 for a total annual contribution of $30,500.   

One major perk of a 457(b) plan is that it doesn’t charge early withdrawal penalties if you retire ahead of schedule or change employers; you can withdraw funds from a 457(b) without penalty whenever you leave your employer, whether it's due to retirement or changing jobs. And if you leave your employer and don’t want to withdraw funds, you could roll the money into a 401(k), IRA, a 403(b) or another 457(b) and continue to save.   

If you’re unsure what to do with a 457(b) plan, you can always consult a Northwestern Mutual financial advisor who can help you look at the big picture to show you how the different pieces of your financial picture fit together while identifying any gaps you may have.   

Differences between a 457(b), 401(k) and 403(b) 

In some ways, a 457(b) plan mirrors a 401(k) or 403(b). Contribution limits are the same and you’ll eventually be required to withdraw your funds (required minimum distributions (RMDs) beginning a t age 73[1]). But a 457(b) is a unique type of deferred compensation plan. Here are some qualities that are specific to a 457(b):  

There are no withdrawal penalties for early retirees.

Pulling money from a 401(k) or 403(b) before age 59½ typically triggers a 10 percent early withdrawal penalty. If you retire early or leave your employer, you can withdraw 457(b) funds penalty-free; however, distributions will still be taxed as ordinary income.  

457(b) plans allow for hardship distributions.

If you run into a financial emergency and you’re still working for the employer that’s sponsoring your 457(b), you may be able to take a special hardship distribution without penalty—but there are stipulations. The money must be used to cover an unexpected and significant financial situation. A 457(b) loan may also be available, depending on your plan details. 

Employer matching is rare. 

One of the perks of a 401(k) or 403(b) is that your employer may match some or all of your contributions. This isn’t as common with 457(b) plans. If your employer does make contributions on your behalf, the money they put in will count toward your annual contribution limit. 

What are the pros and cons of a 457(b) plan?  

Like other retirement accounts, 457(b) plans have their benefits and drawbacks. Here are some important things to consider. 

What are the advantages of a 457(b)? 

It has tax advantages.

Contributing to a 457(b) will reduce your taxable income today. That can help decrease your tax liability ahead of retirement. Your funds will also grow tax-deferred, meaning you won’t owe taxes on them until you begin taking distributions. 

There is no early withdrawal penalty.

If you part ways with your employer, either by retiring or changing jobs, you can tap into 457(b) funds without penalty—although given that these funds are for your retirement, it’s typically a good idea to leave these funds in a retirement plan until you need them in retirement.  

It allows for a hardship distribution.

This can come in handy if you experience a serious financial hiccup and don’t have a healthy emergency fund to draw on.  

What are the disadvantages of a 457(b)?  

Employer matching is uncommon.

While employer matching is typical of 401(k)s and 403(b)s, it isn’t the norm for most 457(b) plans. And if it is an option, those employer-added funds will count toward your annual contribution limit. 

Vesting schedules may apply.

If your employer contributes to your 457(b), vesting schedules may apply. That means you may have to stay with the organization for a certain amount of time before those funds truly become yours.   

Investment options may be limited*.

401(k)s typically offer a variety of investment options including mutual funds, exchange-traded funds (ETFs), bond funds and more. 457(b) plans tend to be more limited and may only provide access to certain annuities and mutual funds.  

What is a 457(f) plan?  

A 457(f) is a special type of 457 plan for highly compensated employees at certain nonprofits and hospitals. It’s usually reserved for top-level executives. 457(f) plans allow for employer contributions only, and there are no contribution limits. Vesting schedules are also typically a critical part of these plans, meaning employees may lose these funds if they don’t stay with the organization for a certain period of time.  

How much should I put in my 457(b) plan?  

Though you’re eligible to put in up to $23,000 per year (or $30,500 if you’re 50  or older), how much you choose put in will ultimately depend on your retirement plan and situation. You’ll want to think about things like: How much do you need to cover your goals in retirement? How else are you saving for retirement?  

Chances are, a 457(b) is not the only financial tool you’re using to save for retirement. If you’re a public employee, there's a chance you also may have a pension. Or perhaps you’re contributing to an IRA in addition to your 457(b).   

To determine how much to put in a 457(b), you’ll need to take a higher-level look at how much you want to save for retirement and how you’ll get there. This is where a financial advisor can be really helpful.  

A Northwestern Mutual financial advisor can help you review your financial goals and develop a retirement plan with savings vehicles that make the most sense for you. An advisor can also show you how to balance those plans to maximize their benefits as you decide how much to save.  

*All investments carry some level of risk, including loss of principal invested. No investment strategy can guarantee a profit or protect against a loss. 

This publication is not intended as legal or tax advice. It must not be used as a basis for legal or tax advice, and is not intended to be used and cannot be used to avoid any penalties that may be imposed on a taxpayer. Northwestern Mutual and its Financial Representatives do not give legal or tax advice. Consult with a tax professional for tax advice that is specific to your situation.  
 

[1] The age to begin taking RMDs will increase to age 75 beginning in 2033.