Contributions to a 457 plan are tax-deferred, meaning that the amount contributed reduces a participant’s taxable income. Retirement savings in a 457 plan are not subject to income tax until the funds are withdrawn.
Any earnings or profit made on the plan’s investments are also tax-deferred. After retiring, participants are often in a lower tax bracket then when they were employed, so when they begin to receive withdrawals, the income is taxed at that lower income-tax rate.
Employers offering 457 plans are responsible for providing employees with their available investment choices. Typically, investment options are similar to those in a 401(k): mutual funds, bond funds, annuities and money markets.
Participants select an appropriate percentage of their salary to be paid into their 457 plan, and then those funds are regularly deducted from their paychecks and allocated to their chosen investments. The employee elective deferral limit for 2010 is $16,500 or up to 100 percent of compensation, whichever is less. The total amount participants can contribute is updated annually for inflation.
Participants can withdraw funds from a 457 plan at retirement or after they leave their job (for any reason). Unlike a 401(k) plan, no penalty is assessed. It is also permissible to withdraw funds during certain unforeseeable emergency circumstances that result in financial hardship, such as disability, accidental property loss or sudden illness. Owners of 457 account either can withdraw their money over time or all at once in a lump-sum. In a governmental 457 plan, the first required minimum distribution (RMD) must be taken for the year the account owner turns 70 1/2.
In addition to 403(b) plans, non-profit organizations can also set up 457 plans for certain high-income employees, normally upper-management. Non-governmental 457 plans are subject to many restrictions that do not affect government plans and have varying rules for distribution and eligibility. Non-governmental 457 plans cannot be transferred or rolled-over into any other type of tax-deferred plan, only another non-governmental 457 plan. Additionally, the Internal Revenue Code requires that the funds in a non-governmental 457 plan remain the property of the employer and are available to employer’s creditors in bankruptcy or other legal proceedings.