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Understanding 457 Retirement Plans: The Basics

A 457 retirement plan is a type of savings account offered by certain employers that lets workers set aside money for retirement before taxes are taken out of their paychecks. These plans exist specifically for employees of state and local governments, as well as certain non-profit organizations. The name "457" comes from the section of the Internal Revenue Code that created these plans.

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Unlike 401(k) plans that many private company employees use, 457 plans work slightly differently. When you put money into a 457 plan, that money reduces your current taxable income. This means if you earn $50,000 a year and contribute $5,000 to your 457 plan, you only pay income taxes on $45,000. You will pay taxes on that $5,000 when you withdraw it during retirement, which is typically when your income is lower.

The 457 plan was created to help government workers and non-profit employees build retirement savings in a way similar to what private sector workers could do with 401(k) plans. These plans have contribution limits set by the federal government that change slightly each year. For 2024, most workers can contribute up to $23,500 per year. Workers age 50 and older can contribute an additional $7,500 per year, bringing their total to $31,000.

An important feature of 457 plans is that they do not have the same early withdrawal penalties that 401(k) plans have. With a 401(k), if you withdraw money before age 59½, you typically face a 10% penalty. With a 457 plan, you can withdraw money penalty-free once you separate from your employer, regardless of your age. However, you still owe income taxes on the money you withdraw.

457 plans can be set up in two ways: governmental 457 plans and non-governmental 457 plans. Governmental plans are offered by state and local government employers. Non-governmental plans are offered by non-profit organizations. Both types follow similar rules, though there are some differences in how the money must be handled and what happens if your employer goes out of business.

Practical Takeaway: Understanding that a 457 plan is a tax-deferred savings account specific to government and non-profit workers is your foundation. Knowing the annual contribution limits and that withdrawals are penalty-free after you leave your job helps you plan whether this tool fits your retirement strategy.

How Contributions Work and What You Can Save

Contributing to a 457 plan works through payroll deduction, similar to how many people set up savings accounts. You decide what percentage of your paycheck you want to contribute, and your employer automatically transfers that amount to your 457 plan account before you receive your paycheck. This "pre-tax" contribution means the money going into the plan is not counted as taxable income for that year.

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The contribution limits are important to understand because they determine the maximum amount you can save each year. In 2024, the standard limit is $23,500 per year. This applies whether you work full-time or part-time. If you have multiple employers, the limit applies to your total contributions across all employers—you cannot contribute $23,500 to each plan. Your employer's payroll department will track your contributions across all jobs you work.

For workers age 50 and older, there is an additional catch-up contribution opportunity. These workers can contribute an extra $7,500 per year beyond the standard limit, for a total of $31,000 in 2024. This catch-up provision recognizes that older workers may want to save more as they approach retirement. The age 50 rule applies based on your age as of December 31st of that year.

Many 457 plans also offer employer matching contributions. Some employers match a portion of what you contribute—for example, an employer might match 50% of your contributions up to 3% of your salary. Not all 457 plans offer matching, so you should check with your employer's benefits office to see if your plan includes this feature. Free employer money through matching is a significant advantage of participating in a 457 plan.

Investment choices within 457 plans vary by employer. Most plans offer a selection of mutual funds, stable value funds, and sometimes target-date funds that automatically adjust as you get closer to retirement. Some plans offer investment advice through third-party advisors, though the guide will explain that this advice comes at a cost. You can typically change your investment choices once or several times per year, depending on your plan's rules.

Tracking your contributions is straightforward because employers provide regular statements showing how much you have contributed, how much your employer has contributed, and the current value of your account based on the investments you chose. Many plans offer online access so you can check your balance anytime.

Practical Takeaway: Knowing your plan's specific contribution limits and whether your employer offers matching means you can calculate exactly how much you can save each year and whether you should contribute enough to get any matching money your employer offers.

Investment Options and Risk Considerations

Once money enters your 457 plan account, it must be invested in something—it cannot simply sit as cash. Your plan will offer a menu of investment choices, typically ranging from conservative to aggressive options. Conservative investments prioritize safety and steady returns, while aggressive investments seek higher returns but with more ups and downs in value. Most plans offer multiple options so you can create a mix that matches your comfort level with risk.

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Common investment types in 457 plans include stable value funds, which aim to preserve your money and provide a modest return. These are often similar to money market funds and typically return 4% to 5% in normal economic conditions. Stable value funds are appropriate for people who are very close to retirement and cannot afford significant losses. Bond funds are another conservative option that typically invest in government and corporate bonds and provide returns of 4% to 6% depending on current interest rates.

Stock mutual funds represent the other end of the spectrum. These invest in shares of companies and historically have provided returns around 10% per year over long periods, though the year-to-year returns vary significantly. Growth stock funds focus on companies expected to grow quickly, while value stock funds focus on companies believed to be underpriced. International stock funds invest in companies outside the United States. Stock funds are generally appropriate for people who have many years until retirement and can tolerate seeing their account balance fluctuate.

Target-date funds are a middle-ground option that automatically adjusts from stocks to bonds as you approach a specific retirement year. A target-date 2045 fund, for example, is designed for someone planning to retire around 2045. The fund starts with a higher percentage in stocks when you are young and gradually shifts to more bonds as the target year approaches. This automatic adjustment removes the need to constantly rebalance your account yourself.

Risk considerations are important because investment performance directly affects your retirement savings. Someone investing entirely in stable value funds will see slow but predictable growth. Someone investing entirely in stock funds will see faster growth over time but will experience periods where their account value declines significantly. The right choice depends on your age, how soon you plan to retire, and your comfort level with seeing your account balance change.

A key concept to understand is that investment risk increases with time horizon certainty. If you will not need the money for 20 years, you have time to recover from market declines, so stock funds may be appropriate. If you will need the money in 3 years, a decline in stock value could be permanent, so conservative investments make more sense.

Practical Takeaway: Choosing investments based on your age and retirement timeline—not based on fear of market changes—is crucial. A target-date fund matching your expected retirement year often provides a reasonable balance without requiring constant attention.

Withdrawal Rules and Tax Implications

Understanding when and how you can withdraw money from your 457 plan is essential because these rules differ significantly from other retirement accounts. The primary rule is that you can withdraw your 457 plan money without a 10% early withdrawal penalty once you have separated from service with your employer. "Separated from service" means you have left your job or retired. This applies regardless of your age, unlike 401(k) plans where early withdrawals before age 59½ typically trigger a 10% penalty.

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If you are still employed by the same organization, you generally cannot withdraw money from your 457 plan, with limited exceptions. Some plans allow loans against your 457 balance or allow withdrawals for unfore