Deferred Compensation in California: Plans, Limits, and Taxes

Deferred compensation in California covers two very different arrangements: qualified plans like 401(k), 403(b), and governmental 457(b) accounts that follow federal rules and get full California conformity, and non-qualified plans used mostly by private-sector executives that carry their own federal Section 409A rules plus an extra 5% California penalty when things go wrong. For 2026, most participants can defer up to $24,500 of salary, with larger catch-up amounts available at certain ages.¹ California also has sourcing rules that can reach former residents on some non-qualified payouts even after they leave the state.

Qualified and Non-Qualified Plans Are Fundamentally Different

The category a plan falls into determines the contribution limit, when tax is due, how well the money is protected, and what happens if the employer fails. It is the first thing to get straight.

Qualified plans include 401(k), 403(b), and governmental 457(b) arrangements. They must satisfy IRS requirements including nondiscrimination testing so the plan does not disproportionately favor highly compensated employees.² In return, contributions get favorable tax treatment and assets sit in trust, out of reach of the employer’s creditors.

Non-qualified deferred compensation (NQDC) plans are contractual arrangements between an employer and specific employees, usually executives. They allow deferrals well beyond qualified-plan limits, but the money remains part of the employer’s general assets. If the company files for bankruptcy, participants stand in line as unsecured creditors.³

Some private employers set up a rabbi trust to signal that funds will be available when payments come due. The trust preserves tax deferral only if its assets remain reachable by the employer’s general creditors in insolvency. That means a rabbi trust protects you from an employer that is solvent but slow to pay. It does not protect you from an employer that goes broke.

Plans Available to California Public Employees

Public-sector workers in California often have access to more than one deferred compensation plan at the same time. The 457(b) and 401(k) limits are separate, so employees offered both can contribute the full amount to each.

Governmental 457(b) Plans

The main deferred compensation plan across California’s public sector is the governmental 457(b). State and local government employees defer part of each paycheck on a pre-tax or Roth after-tax basis, up to $24,500 for 2026.¹ CalPERS administers the CalPERS 457 Plan for public agency and school employer employees through participating employers.⁴

The governmental 457(b) has an unusual advantage: no 10% early withdrawal penalty on distributions after you separate from service, regardless of age. Governmental 457(b) plans are not classified as qualified plans under IRC Section 4974(c) and therefore sit outside the early distribution tax under IRC Section 72(t).⁵ Leave your government job at 50 and you can draw from the account right away without the extra tax. You still owe ordinary income tax on pre-tax withdrawals.

Savings Plus and CalSTRS Pension2

State of California and California State University employees participate in the Savings Plus Program, administered by CalHR. Savings Plus offers both a 401(k) and a 457(b), pre-tax or Roth, through payroll deduction.⁶ Since the two plans have separate limits, a state employee could defer up to $49,000 in regular contributions across both in 2026.

Educators covered by CalSTRS can save through CalSTRS Pension2, which offers 403(b), Roth 403(b), and 457(b) options as a voluntary supplement to the defined-benefit pension.⁷

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

Governmental 457(b) plans offer 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 annual limit, so up to $49,000 in each of those three years for 2026. The extra amount is capped at the lesser of twice the annual limit or the sum of your unused deferrals from earlier years.⁸ You cannot use the special catch-up and the age-based catch-up in the same year; the plan applies whichever produces the larger deferral.

Non-Qualified Plans and Section 409A

California’s large private-sector economy generates heavy demand for non-qualified deferred compensation, especially Supplemental Executive Retirement Plans and other employer-specific deferral agreements. These plans exist because qualified-plan limits cap out far below what a highly compensated executive wants to set aside.

Every private-sector NQDC plan must comply with IRC Section 409A. Deferral elections generally have to be made before the start of the year the compensation will be earned. Distributions are limited to a short list of triggers: separation from service, disability, death, a fixed date set in the plan, a change in company ownership, or an unforeseeable emergency.³

A 409A failure is expensive. All vested deferred amounts become immediately taxable, plus a federal penalty equal to 20% of the taxable amount, plus interest at 1% above the IRS underpayment rate reaching back to the year of the original deferral.³ California adds its own 5% penalty on top of the federal 20%, bringing the combined penalty to 25% of the non-compliant amount before ordinary income tax and interest. A design or administration mistake can wipe out the whole benefit of deferring in the first place.

Section 457(f) Ineligible Plans

Tax-exempt organizations and government employers sometimes use 457(f) arrangements to recruit senior executives. These plans have no annual contribution limit. Deferred amounts become taxable in the year the participant’s substantial risk of forfeiture lapses, typically when a service or performance requirement is met. Tax is triggered at vesting whether or not the money has been paid out. If the plan fails to keep a genuine risk of forfeiture in place, the entire deferral can be taxed at the time of the promise.

2026 Contribution Limits and Catch-Up Rules

The IRS adjusts limits annually for inflation. For 2026, the key figures are:¹

Standard deferral limit for 401(k), 403(b), and 457(b) plans: $24,500.
Catch-up for ages 50 and over (and 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, available in the three years before normal retirement age.

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

How California Taxes Deferred Compensation

Conformity to Federal Law for Qualified Plans

California generally conforms to federal treatment of deferred compensation, so contributions to qualified plans and governmental 457(b) plans receive the same state-level deferral they get federally.⁹ Your pre-tax 401(k) or 457(b) contributions reduce both your federal and California adjusted gross income in the year of deferral. California does not conform to every federal provision, and the Franchise Tax Board publishes ongoing guidance where state and federal rules diverge.

The Extra 5% State Penalty on 409A Failures

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

The Sourcing Trap for Former Residents

One California rule catches people who leave the state after building up deferred compensation here. Federal law generally prevents states from taxing retirement income received by nonresidents. California follows that rule for qualified plans, governmental 457 plans, IRAs, and 403(b) plans. For private non-qualified deferred compensation, though, the exemption applies only if the 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.¹⁰

If your non-qualified plan pays out in a lump sum or over fewer than 10 years, California can source that income back to the state and tax it even though you no longer live here. Distribution schedule matters. An executive negotiating an NQDC arrangement should think about the payout structure with California sourcing in mind, because a five-year payout after a move to a no-income-tax state can still generate a California tax bill on every payment.

FICA on Non-Qualified Deferrals

Social Security and Medicare taxes on non-qualified deferred compensation follow a special timing rule. FICA is due at the later of the date you perform the services or the date the deferred amount is no longer subject to a substantial risk of forfeiture. For fully vested deferrals, that means FICA hits in the year the compensation is earned, even though the payout is years away. Social Security tax applies up to the taxable wage base ($184,500 for 2026), and Medicare tax of 1.45% applies to the full amount with no cap.¹¹

Once an amount has been subject to FICA under the special timing rule, neither the principal nor the earnings on it are taxed again for FICA when distributed. For a highly compensated executive, paying FICA at the time of deferral often means the compensation has already exceeded the Social Security wage base, so only the 1.45% Medicare tax actually applies. Getting the timing wrong can result in FICA being assessed on both the deferral and the distribution.

Dividing Deferred Compensation in Divorce

California is a community property state, so deferred compensation earned during a marriage is generally community property subject to equal division. That creates a practical problem because the money has not been paid out yet. The court cannot split cash that does not exist.

For qualified plans like a 401(k) or 403(b), division requires a Qualified Domestic Relations Order directing the plan administrator to pay a specified amount or percentage to the former spouse. The QDRO must identify both the participant and the alternate payee by name and specify the amount or percentage transferred. It cannot award benefits the plan does not offer.¹² The former spouse who receives QDRO payments reports them as their own income and can roll the distribution into their own retirement account.

Non-qualified plans are harder. Because NQDC arrangements are contractual and typically not subject to ERISA’s QDRO framework, courts use 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 that the plan may or may not honor depending on its terms. A poorly drafted order can trigger unintended 409A consequences for both parties, so this is not the place to save on legal help.

Beneficiaries and Death Benefits

A beneficiary designation on a retirement plan overrides a will. If your named beneficiary is an ex-spouse and you never updated the form, the ex-spouse gets the money regardless of what your will says. This is worth an afternoon.

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

A surviving spouse who receives a distribution from a qualified plan as a named beneficiary or through a QDRO can roll it into their own IRA or retirement account, preserving the tax deferral.¹² 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 SECURE Act 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
Franchise Tax Board. California Conformity to Federal Law
10
Franchise Tax Board. FTB Publication 1005 – Pension and Annuity Guidelines
11
Social Security Administration. Contribution and Benefit Base
12
Internal Revenue Service. Retirement Topics – QDRO: Qualified Domestic Relations Order