How a 457 Plan Works After Retirement

If you are a state or local government employee – or an employee of a a non-profit, 501(c) tax-exempt organization – you may have a 457 retirement plan. Just like a 401(k) or 403(b) plan, this plan has allowed you to invest a portion of your salary on a pretax basis. The money in this account has grown, tax-free, waiting for you to decide what to do with it when you retire.

You're about to retire. So what do you do with it?

Your options depend, in part, on the type of 457 plan you have: a 457(b) or "eligible" plan, and 457(f) or "ineligible."

Eligible 457(b) plans are the most common, and are generally available to all employees of a state or local government entity. Assets in these plans are held in trust, and have rollover privileges similar to those of a 401(k) or 403(b). Non-governmental or 501(c) organizations can also offer eligible 457(b) plans, but only to certain “highly compensated employees.” In addition, assets in these plans are not held in trust, but remain with the employer until distribution. The rollover privileges are much more restricted, too.

Ineligible 457(f) plans are available only to “highly compensated employees” of non-governmental organizations: charities, private non-profits, etc. Here too, assets are not held in trust, but kept by the employer until they are distributed. 

Since contributions to a 457(f) are virtually unlimited, the IRS requires that the funds be at a “substantial risk of forfeiture.” If, for example, you have a 457(f) plan and leave your employer before an agreed-upon date or before reaching normal retirement age, you could risk losing all the money you've invested in the plan. Sounds harsh, but that's the price you pay for the sweet deal of being able to invest as much as you want on a tax-deferred basis and have it grow tax-free.

For more on the specifics, see: 457 Plans: The Pros and Cons.

If you have a governmental or non-governmental 457(b) plan, you can withdraw some or all of your funds upon retirement, even if you are not yet 59½ years old. There is no 10% penalty as there is with other types of plans. All you will owe is income tax on the amount you withdraw. 

However, you will get dinged if you never take any money out. Both governmental and non-governmental 457(b) plans fall under the IRS required minimum distribution (RMD) rule that says at age 70½ you must begin withdrawing a specified portion of the funds in your account. Failure to take these distributions will result in a 50% non-deductible excise tax. 

If you have a 457(f) plan at a private non-profit, the entire amount in your account is considered taxable upon your retirement (separation from service). In most cases, fund assets will be distributed to you in a lump sum, and be subject to FICA, federal and state taxes at that time. As noted below, rollovers are not possible.

You can roll over funds in your governmental 457(b) plan to a traditional IRA, a 401(k),a 403(b) or another 457 governmental plan. The rules for 457(b) plans at a private tax-exempt organization are much more restrictive. Your funds in such a plan can only be rolled over into another non-governmental 457 plan. 

With a 457(f) plan, the limits are similar: You may not rollover funds from a 457(f) plan to a 457(b) or any other qualified retirement plan (such as an IRA).

If you wish to transfer funds from your governmental 457(b) plan, it may be done to another governmental 457(b) plan only. Your only option for transferring a non-government 457(b) is to another non-government 457(b).

There is no option for transferring a 457(f) fund.

Some tax-exempt organizations are qualified to offer both 403(b) and 457(b) plans. If such is the case at your job, and you have elected to contribute to both, you need to be aware of differences when it comes to withdrawal, rollover and transfer of your funds. For more see: 457 Plans and 403(b) Plans: A Comparison.  

Although recent legislation has made them easier to understand, 457 retirement plans are complicated. In fact, they remain among the most complex of retirement plans available. Don't assume that the rules regarding 401(k)s and other tax-advantaged plans offered in the for-profit world apply (see What is the difference between a 401(k) plan and a 457 plan?). Even 403(b) plans, that other vehicle of choice for public sector and non-profit employees, function differently in some key ways.

If you have a 457 plan of any type, consult with a financial advisor or other tax-planning expert well ahead of your retirement date, in order to be sure you don't run afoul of any regulations – but do make the best strategic use of those tax-deferred dollars.