There are two types of IRC 457 deferred compensation arrangements that are available to state and local government or tax-exempt organizations.
The first plan is a 457(b) plan which is a nonqualified retirement plan. Under this plan all employees are able to defer income on a pre-tax basis up to $20,500 for 2022. Additionally, an age 50 and above catch-up contribution is allowed for 2022 of $6,500.
Contributions are pre-tax and tax deferred and will be taxable to the participant when received. Account balances are vested and these contributions can be in addition to 401(k) or 403(b) qualified plan contributions providing a major advantage over for-profit entities that can only have 401(k) plans. The employer can also contribute into a 457(b) plan but only up to the limit.
The second approach is a 457(f) nonqualified deferred compensation arrangement which is only available to the highly compensated executives of the organization. There is no limit on the amount of money that can be deferred on behalf of qualifying executives. Executives can invest up to 100% of their compensation. Deferred amounts and their earnings are employer assets and are subject to the claims of general creditors.
Under 457(f) the executive pays income taxes, Social Security (FICA) and Federal Unemployment (FUTA), when they are vested in the account balance. This differs greatly from a 457(b) plan which is fully vested from day one. Ordinary income tax is paid on the entire value of the fund when there is no longer a risk that the money will be forfeited for non-performance of the agreement. This means that ordinary income tax will be paid on the entire amount in the plan in the year of vesting. Generally, 457(f) plans are employer funded as employees do not want to defer income that will become unvested.