Deferred Compensation in California: Plans, Limits, and Taxes

Deferred compensation in California covers any arrangement that lets you set aside part of your pay now and receive it later, usually in retirement. For most workers that means a qualified plan — a 401(k), 403(b), or governmental 457(b) — with a 2026 salary deferral limit of $24,500 and additional catch-up amounts after age 50.¹ For highly paid executives, it often means a non-qualified plan with no contribution cap but real creditor risk. California generally follows federal tax treatment, with a few costly exceptions: a 5% state penalty stacked on top of the federal 20% penalty for non-qualified plan violations, and sourcing rules that can reach former Californians who have moved to a no-tax state.

Qualified and Non-Qualified Plans Work Very Differently

The first fork in the road is whether a plan is “qualified” under the Internal Revenue Code. The answer determines your contribution limit, how safe your money is, and what happens if your employer fails.

Qualified plans — 401(k), 403(b), and governmental 457(b) — satisfy strict IRS rules, including nondiscrimination testing that prevents the plan from favoring highly compensated employees over rank-and-file workers.² In return, contributions get favorable tax treatment and the money sits in a trust that creditors of the employer cannot reach.

Non-qualified deferred compensation (NQDC) plans are contractual arrangements, usually offered to executives. There is no legal cap on how much you can defer, which is the main appeal. But the deferred amounts stay on the employer’s books as general assets. If the company goes bankrupt, you are an unsecured creditor and may recover little or nothing.³

Plans Available to California Public Employees

If you work for the state, a city, a county, a school district, or a public university, you likely have access to one or more deferred compensation plans. Many public employees can participate in a 457(b) and a 401(k) at the same time, and because the contribution limits are separate, you can max out both.

Governmental 457(b) Plans

The governmental 457(b) is the standard deferred compensation vehicle in California’s public sector. You can defer pre-tax or Roth money from each paycheck, up to $24,500 for 2026.¹ CalPERS runs the CalPERS 457 Plan, available through participating public agency and school employers.⁴

One feature sets governmental 457(b) plans apart from everything else: there is no 10% early withdrawal penalty on distributions taken after you leave the job, no matter your age. Most retirement plans tax early withdrawals before age 59½ under IRC Section 72(t), but governmental 457(b) plans are not classified as qualified plans under Section 4974(c) and fall outside that penalty.⁵ Leave your government job at 50, and you can start drawing from the 457(b) right away. You still owe ordinary income tax on pre-tax withdrawals.

Savings Plus and CalSTRS Pension2

State of California and California State University employees use the Savings Plus Program, administered by CalHR. Savings Plus offers both a 401(k) and a 457(b), and you can contribute to either or both.⁶ Because the limits are separate, a state employee could theoretically defer up to $49,000 in regular contributions across both plans in 2026.

Educators covered by CalSTRS can save through CalSTRS Pension2, which offers 403(b), Roth 403(b), and 457(b) options on top of the CalSTRS defined-benefit pension.⁷

The Special 457(b) Three-Year Catch-Up

Governmental 457(b) plans have a catch-up provision you will not find in a 401(k) or 403(b). During the three years before your plan’s normal retirement age, you can contribute up to double the standard limit — $49,000 for each of those years in 2026. The extra amount is based on contributions you did not make in prior years, so it is capped at the lesser of twice the annual limit or the sum of your unused deferrals from earlier years.⁸ You cannot combine this with the age-based catch-up in the same year; the plan applies whichever gives you the bigger deferral.

Non-Qualified Plans for Private-Sector Executives

Private companies in California often offer Supplemental Executive Retirement Plans (SERPs) and other NQDC arrangements. These exist because qualified-plan limits cap out well below what a senior executive might reasonably want to defer. The rules governing them are strict and the penalties for getting them wrong are severe.

Section 409A Controls Elections and Distributions

Every private-sector NQDC plan must comply with IRC Section 409A. Your deferral election generally has to be made before the start of the year the compensation is earned. Distributions can only happen on a limited list of events: separation from service, disability, death, a fixed date specified in the plan, a change in company ownership, or an unforeseeable emergency.³

When a plan fails 409A, all vested deferred amounts become immediately taxable. On top of ordinary income tax, the IRS imposes a 20% federal penalty, plus interest at 1% above the IRS underpayment rate running back to the year of the original deferral.³ California adds its own 5% penalty, so the combined penalty alone reaches 25% of the non-compliant amount before you count the ordinary tax and interest. A plan design mistake can wipe out the entire economic benefit of deferring in the first place.

Section 457(f) for Tax-Exempt and Government Employers

Tax-exempt organizations and government employers sometimes use 457(f) plans to recruit senior executives. These have no annual contribution limit, which is useful for large packages. The tax treatment is different from a 457(b): deferred amounts become taxable the year the participant’s “substantial risk of forfeiture” lapses, typically when a service requirement or performance milestone is met. The tax hits at vesting whether or not the money has been paid out. If the plan does not maintain a genuine risk of forfeiture, the entire deferral can be taxed immediately at the time of the promise.

Rabbi Trusts Protect Against Reluctance, Not Insolvency

Some employers set up a rabbi trust to give NQDC participants comfort that funds will be there when distributions come due. The employer transfers assets to a trust run by an independent trustee, and the trust agreement spells out how the money is paid out. The structural catch is that, to preserve tax deferral, the trust assets must remain subject to the claims of the employer’s general creditors in insolvency. Participants are still unsecured creditors. If the employer goes bankrupt, the trust assets get pooled with other corporate assets to pay secured creditors first. A rabbi trust protects you from an employer that is solvent but reluctant to pay. It does not protect you from one that is broke.

2026 Contribution Limits and Catch-Ups

The IRS adjusts deferral limits each year for inflation. For 2026:¹

Standard deferral limit for 401(k), 403(b), and 457(b): $24,500.
Age 50-and-over catch-up (and ages 64 and over): an additional $8,000, for a total of $32,500.
Enhanced catch-up for ages 60 through 63: an additional $11,250, for a total of $35,750.
457(b) special three-year catch-up: up to $49,000 total in each of the three years before normal retirement age.

The enhanced catch-up for people turning 60, 61, 62, or 63 during 2026 came out of the SECURE 2.0 Act and replaces the standard age-50 catch-up for those specific years. If you fall in that window and your plan has adopted the provision, you get the larger $11,250 catch-up instead of $8,000. At 64 you revert to the standard catch-up.¹

How Deferrals Are Taxed Federally

Income Tax Timing and the Roth Choice

Pre-tax contributions to qualified plans and governmental 457(b) plans reduce your taxable income in the year you make them. The money grows untaxed, and you owe ordinary income tax when you take distributions.⁹ Roth contributions reverse the order: you pay income tax now, and qualified withdrawals in retirement come out tax-free, earnings and all.

FICA Follows a Special Timing Rule for Non-Qualified Plans

Social Security and Medicare taxes on NQDC follow a timing rule that trips up a lot of participants. FICA is due at the later of (1) the date you perform the services that produced the deferral or (2) the date the deferred amount is no longer subject to a substantial risk of forfeiture. For fully vested deferrals, FICA hits in the year you earn the compensation, even though you will not receive the money for years. Social Security tax applies up to the taxable wage base ($184,500 for 2026); Medicare’s 1.45% applies to the full amount with no cap.¹⁰

The nonduplication rule is the upside: once FICA has been paid under the special timing rule, neither the principal nor the earnings on it are taxed again for FICA when they are eventually distributed. For a high earner already past the Social Security wage base, this often means only the 1.45% Medicare tax actually applies at deferral. Getting the timing wrong can result in FICA being assessed on both the deferral and the distribution.

California-Specific Tax Rules

State Follows Federal, With Exceptions

California generally conforms to federal treatment of deferred compensation, so pre-tax 401(k) and 457(b) contributions reduce both your federal and California adjusted gross income in the year you make them.¹¹ Conformity is not total, however, and the Franchise Tax Board publishes guidance on where state and federal rules diverge.

California’s Extra 5% Penalty on 409A Violations

When a non-qualified plan violates Section 409A, the federal government imposes a 20% penalty on the non-compliant amount.³ California adds a 5% state penalty, bringing the combined penalty to 25% before ordinary income tax and interest. For an executive with several hundred thousand dollars at stake, a 409A failure can produce a tax bill that exceeds the value of the original deferral benefit many times over.

Nonresident Sourcing Can Follow You Out of State

If you leave California after accumulating deferred compensation here, this is the rule to pay attention to. Federal law generally stops states from taxing retirement income received by nonresidents, and California follows that rule for qualified plans, governmental 457 plans, IRAs, and 403(b) plans. For private non-qualified deferred compensation, though, the exemption only applies if payments are structured as substantially equal periodic payments over the participant’s life or life expectancy, or over a period of at least 10 years.¹²

If your NQDC pays out in a lump sum or over fewer than 10 years, California can source that income back to the state and tax it after you have moved. Plan design matters here. An executive negotiating an NQDC arrangement should think about the distribution schedule with California sourcing in mind, because a five-year payout after a move to a no-income-tax state could still produce a California tax bill on every payment.

Dividing Deferred Compensation in a California Divorce

California is a community property state, so deferred compensation earned during a marriage is generally community property subject to equal division. The practical problem is obvious: the money has not been paid yet, and there is no cash to split.

For qualified plans like a 401(k) or 403(b), division is done through a Qualified Domestic Relations Order. The QDRO directs the plan administrator to pay a specified amount or percentage to the former spouse. It must name both the participant and the alternate payee and specify the amount or percentage transferred, and it cannot award benefits the plan does not offer.¹³ The receiving spouse reports QDRO payments as their own income and can roll the distribution into their own retirement account.

Non-qualified plans are harder. NQDC arrangements are contractual and typically not subject to the ERISA QDRO framework, so the court may need other tools: awarding the non-employee spouse an offsetting asset of equal value, ordering a constructive trust over future payments, or issuing a domestic relations order the plan may or may not honor depending on its terms. A badly drafted order can trigger 409A consequences for both parties, so this is a place to use an attorney who knows both family law and executive compensation.

Death Benefits and Beneficiary Designations

A beneficiary designation on a retirement plan overrides your will. If you named an ex-spouse years ago and never updated the form, the ex-spouse gets the money regardless of what your will says. Keeping these forms current is one of the simplest ways to prevent a mess.

When a participant dies with deferred compensation still owed, the tax treatment of payments to a beneficiary depends on timing. Amounts paid in the same calendar year as the participant’s death are subject to Social Security and Medicare withholding but not income tax withholding. Payments in any later year are not subject to FICA or income tax withholding; the employer reports them to the beneficiary on Form 1099-MISC, and the beneficiary pays income tax on their own return.

A surviving spouse who receives a distribution from a qualified plan through a QDRO or as a named beneficiary can roll the amount into their own IRA or retirement account and preserve the tax deferral.¹³ Non-spouse beneficiaries generally do not have that rollover option for most plan types and must take distributions within 10 years of the participant’s death under the SECURE Act’s rules.

1
Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs
2
eCFR. 26 CFR 1.401(a)(4)-1 – Nondiscrimination Requirements of Section 401(a)(4)
3
Office of the Law Revision Counsel. 26 U.S. Code 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans
4
CalPERS. CalPERS 457 Plan
5
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
6
CalPERS. Deferred Compensation
7
CalSTRS. Pension2
8
Internal Revenue Service. Issue Snapshot – Section 457(b) Plan Catch-Up Contributions
9
Internal Revenue Service. IRC 457(b) Deferred Compensation Plans
10
Social Security Administration. Contribution and Benefit Base
11
Franchise Tax Board. California Conformity to Federal Law
12
Franchise Tax Board. FTB Publication 1005 – Pension and Annuity Guidelines
13
Internal Revenue Service. Retirement Topics – QDRO: Qualified Domestic Relations Order