A 457 plan is a “non-qualified, deferred compensation plan” that allows employees to defer up to 100% of their income up to the permitted dollar amount per year. This means that any compensation placed into such a retirement account grows on a tax-deferred basis and is not taxed until the funds are distributed. As the investor is likely to be at retirement age at that time, taxes are likely to be much lower than they are when the account is funded, which can add up to significant tax savings.
This type of plan is made available to government employees and some types of non-governmental workers as well. Typically run in much the same fashion as a 403(b) or 401k, the main difference is the lack of penalty for early withdrawal. While individuals don’t face the 10% penalty associated with taking money from their account before the age of 59 ½, the funds are subject to normal income taxation. Another difference is that independent contractors can also participate in such plans; they can’t in 401(k)s or 403(b)s.
In recent years the limits on 457 plans have been brought into line with other retirement accounts. Contribution limits are now identical to those set on 401(k) accounts. However, qualified individuals can contribute to both types of plans at maximum levels.
The least common type of employee plan used, it has often been the “red headed stepchild” of retirement planning, but the simplification of the rules has made it more appealing to many employers. They remain the only non-qualified group plan which offers tax-deductible contributions.