non-governmental 457 plans

Non-Governmental 457(b) Plans – The Ultimate Guide!

Should You Use your Non-Governmental 457(b) Plan?

This is the ultimate guide to non-governmental 457(b) Plans. If you are a highly compensated employee of a non-profit institution, and you want to know if you should use your 457 plan, chances are you are in the right spot.

Many physicians and executives have access to a non-governmental 457(b) plan. Also occasionally known as a Top Hat Plan, they can get confusing rather quickly.

First off, the following information is not for those with governmental 457 plans. If you work for the county or state government and have a governmental 457 plan, congratulations! You have another (and probably better) 403b plan. Use your 457 first and move on!

Secondly, if you have a non-governmental 457(f) plan—well, take plan documents home and plan to waste several hours trying to figure that puppy out. I’ll get into some detail on the differences between the 457(b) vs. 457(f) below.

Moreover, there are many more flavors of Non-Qualified Deferred-Compensation (NQDC) plans in the world. Look closely and discover what type of plan you have. NQDC is the broad category of plan. If you have a for-profit employer, you will need to dig deeper into the plan documents. All 457 plans are NQDCs but not all NQDCs are 457s.

In essence, this ultimate guide to top hat plans is for someone who works for a non-profit institution—a 501(c)(3)—who is highly compensated and considering investing in their employer’s non-governmental 457(b) plan.

Definition and Purpose of the Non-Governmental 457 Plan

A non-governmental 457 plan is defined as an extra or bonus tax-advantaged salary deferral plan for a select group of employees. They allow you to defer your salary during peak income years but have distinct distribution options compared to qualified plans (such as 401k and 403b). Since they are non-qualified, they cannot be offered to rank and file employees. Qualified plans cannot discriminate and must meet non-discrimination testing. Top Hat Plans must discriminate.

Why do employers offer non-governmental 457 plans?

Congress authorizes employers to offer non-governmental 457 plans with preferential tax treatment to encourage saving for retirement.

Why employers offer non-governmental 457 plans

Figure 1 (Why employers offer non-governmental 457 plans)

457 plans are often pitched with a figure similar to the one above. Note the “income replacement goal” is 80% in the figure. Social security income is green and qualified retirement benefits sit on top. As your current income increases, there is a larger and larger gap between replacement goals and your ability to put away money for retirement.

In short, if you make more money during your career, they expect you will spend more money in retirement and thus have a need to fill that “gap.”

While this figure can be criticized multiple ways, the idea that if you earn more money than you should save more money holds true.

Beyond the ability to put away more tax-deferred income, employers offer non-governmental 457 plans to retain talent and encourage loyalty.  These plans aim to keep executives and key employees happy and engaged.

Let’s move on to the basics of 457(b) plans.

Basics of the Non-Governmental 457(b) Plan

IRS Code Section 457 provides tax-deferred treatment for these non-qualified deferred-compensation plans. Sometimes called NQDC plans, sometimes Top Hat Plans—it can get confusing quickly.

Quickly, here are the basics of the non-governmental 457(b):

  • Limited to a select group of employees (thus not Qualified plans which, by definition, cannot discriminate against rank and file employees)
  • Plan is unfunded and all assets are the property of the employer
  • Assets are available to creditors of the employer due to bankruptcy or litigation
  • Total contribution limit of $19.5k in 2020
  • CANNOT be transferred to any other pre-tax plan (Such as IRA, 401k, etc.)
  • Have very different distribution options than qualified plans

There are a couple of important points above. The reason you don’t pay current income taxes with a 457 is because you do not have any access to the deferred income. The employer cannot separately hold the assets specifically for you. That is, they promise you future salary but hold the assets in their general funds, not in a special account with your name on it. The 457 plans are unfunded. Creditors and predators have the right to your assets before you do.

Those are the basics. What are the most important considerations before you defer your salary?

Most Important Consideration for a Non-Governmental 457 Top Hat plan

For most folks in their highest income earning years, a Top Hat plan is a chance to defer paying taxes on salary until later. This can be a good idea if:

  • You are in the top two or three tax brackets
  • Or, you are getting close to retirement
  • Or, you are considering funding options for early retirement
  • AND you are fully contributing to other pre-tax accounts
  • AND there are acceptable distribution options

In summary, a non-governmental 457 is NOT the plan you fund first.

You only invest in a non-governmental 457 plan if you have your other ducks in a row AND you have a need! Your ducks are: fully funding other retirement accounts, including HSA and backdoor Roth. The need is: highest tax brackets, within 5-10 years of retirement, or considering early retirement.

In addition, there must be good distribution options and you should have a plan for these distributions.

This is important to understand. As the money in the 457(b) is not your money, you don’t want to defer salary to one of these top hat plans without contemplation. There are significant downsides.

Downsides of Non-Governmental 457(b) Plans

What are the downsides to consider?

  • The deferred salary is subject to the creditors of your employer
  • These plans are unfunded, which means your employer does not have to set aside money to pay for these liabilities in the future
  • Unlike 403b plans, you pay Medicare and FICA taxes with 457 Plans
  • Distributions are reported on W-2 forms rather than 1099s
  • Most importantly, distribution options can make or break a top hat plan

The issue with Medicare and FICA taxes is different than qualified plans. Since this is considered deferred salary, you must pay Medicare and FICA taxes if owed. In addition, when you get distributions, you are issued a W-2 by your employer rather than a 1099 as from a qualified plan.  Usually the salary you defer is above the wage limit for social security, so you just pay the 1.9% FICA tax upon deferral.

Let’s discuss the most important potential downside separately.

Distribution Options in Nongovernmental 457 Plans

Since these plans are Non-Qualified Deferred-Compensation (NQDC) plans, they don’t have to follow ERISA guidelines. Importantly, this means they do not have Summary Plan Descriptions.

That said, nongovernmental 457 plans do need to have some sort of documentation. Ask your Employer for a copy of the plan documents.

In the plan documents, look for the distribution options. The default distribution option for a nongovernmental 457 plan is a lump sum distribution within 60-90 days of severance from the employer. Also known as separation from service, this means you get ALL of your deferred salary reported in a W-2 in a lump sum in one tax year. This can result in a major tax hit at higher rates than you deferred if you are not careful.

Employers can and usually do offer other distribution options. They may extend out distributions until you are 70, or start them after a different specified delay. It is important to note that the distribution decision is irrevocable; sometimes plans may offer you a one-time chance to change your mind.

Usually, you are forced to take distributions over 5-10 years. This is important—if you are still planning on working a highly compensated job after you leave your current employer, you will have to take the nongovernmental 457 salary on top of your current salary.

This is why it is important to wait to fund one of these plans until you are sure of your traditional or early retirement plans. It doesn’t do any good to defer income now just to take it soon while you are still earning income.

Tax Planning and Nongovernmental 457 plans

Tax planning is important for nongovernmental 457 plans since they are deferred salary.

If you plan to take distributions after you are 70, then the fully taxable distributions sit on top of the taxable portion of your social security, pensions and annuities, and required minimum distributions from your qualified retirement accounts. There are still significant tax arbitrage or tax savings possible if you are in the highest two or three tax brackets while you are working, or if you are near the end of your career.

For those considering early retirement, there are other considerations. People who retire early have an awesome Tax Planning Window, and deferred salary from nongovernmental 457 plans can be a blessing or a curse. If you need the income, great. Just remember you are going to pay ordinary income taxes on the distributions. Be aware this income may keep you from getting Premium ACA Tax Credits for health care insurance, and limit your ability to do Roth conversions.

Knowing your distributions options, thus, are key to tax planning with your nongovernmental 457 plan.

Employer Bond Ratings and Nongovernmental 457(b) Plans

Also, it is important to check your employer’s fiscal health. You can do this by searching for your employer and “bond ratings.” There are firewalls and paid services to wade through, but make sure you find a PDF report of your employer’s bond ratings.

If they have good bond ratings, you can be more confident and take a 5-10-year distribution. If they have poor bond ratings or significant lawsuit liabilities, consider taking a lump sum or 3-5-year distribution.

Advanced Concepts in Nongovernmental 457 plans

If your head is already spinning, you have the basics above to be able to confidently decide whether or not to invest in your nongovernmental 457(b) plan. There are other considerations, however, which I will address below for the advanced investor.

Rabbi Trusts

Occasionally nongovernmental 457 plans are placed in Rabbi trusts. These irrevocable trusts protect the assets if there is a change in management but not due to general creditors. Usually, if there is a change in management, they will assume the liabilities of the 457 plan, but they can force distribution of the assets or even claim them as their own. Remember, though, top management also invest in the nongovernmental 457 plan, so it is in their financial interest to see that a fair outcome is negotiated during a change in management.

Employer Contributions

IRC 457 allows employer and employee contributions to 457(b) plans for a total of $19.5k a year. Typically, at least in health care, nongovernmental 457(b) plans just have employee contributions. On the other hand, 457(f) plans are a different beast

Non-Governmental 457(f) Plans

Occasionally in health care you run across non-governmental 457(f) plans, which may be referred to as “Golden Handcuffs.” These are also called “ineligible” 457(f) plans and have both employee and/or employer contributions. If the employer is for-profit, these are often informally funded via permanent life insurance products. These life insurance products act as a wrapper to defer taxes on the growth of the assets, which otherwise would require trust income tax payments. In not-for-profit settings, either typical (stocks and bonds) products or life insurance products can be used. These 457(f) plans are complicated! For a comparison of 457(b) vs 457(f), see this.

Catch-Up Contributions

Plans may have “Catch-up” contributions within 3 years of normal retirement age. Check the plan documents.


Occasionally, upon separation of service, you can transfer your non-governmental 457(b) plan to your new employer’s 457(b) plan, if both plans allow it. This is the exception rather than the rule, so you should not utilize your 457(b) plan early in your career if planning on traditional retirement. So, what are the rollover options for a 457(b)? Usually you do not have the option to rollover a non-governmental 457(b) plan.


As mentioned above, you are provided a yearly W-2 form and generally 20-25% of your distribution is held back for taxes. You can adjust your W-4 plan with your ex-employer and affect withholding.

This is Not a SERP

A supplemental executive retirement plan (SERP) is a type of top hat plan that provides supplemental pension benefits. These plans typically look at your qualified and social security benefits, and provide a pension above and beyond those benefits. These are similar to direct benefit plans rather than 457 plans which are direct contribution plans.

Non-Qualified Deferred-Compensation (NQDC) Plans

Non-Qualified Deferred-Compensation plan include excess benefit plans (which attempt to give employees options above the IRC 415 limit) and top hat plans. NQDCs can have many different forms and depend on the goals of the employer or the employee. Section 457 covers NQDC plans specifically for government and tax-exempt organizations.

Conclusion: Ultimate Guide to Non-Governmental 457(b) Plans

What have we learned?

Well, congress gives our employer the chance to offer us non-qualified benefits to encourage us to save for retirement.

If you work for the government, you are on the gravy train if you have a governmental 457(b).

If you work for a non-profit, you need to be careful before you invest in your non-governmental 457(b). There are many considerations outlined above, but distribution options trump all other concerns.

If your 457 plan has good distribution options, then consider your need for additional tax-deferred savings. And remember the rollover rules or rollover options! Most of the time, you cannot rollover a non-governmental 457(b)!

Next, you must have a future tax plan in place. This is why the distribution options are important to consider.

Not all (or even most!) should consider using their non-governmental 457 plan. But if you do, make sure you understand the limitations and advantages to an additional tax-deferred plan.

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  1. This was a fantastic article and really provided clarity when I needed it as my husbands work recently decided to offer a 457. Thank you!

  2. Great article! What bond rating would you think would be safe enough to use a non-governmental 457? Does it have to be at least investment grade or should it be even higher?

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