A Primer on Nonqualified Deferred Compensation Plans
Many executives of tax-exempt organizations are looking for larger saving opportunities above and beyond what is available in a typical retirement plan. 457(b) plans may be the perfect solution for them.
What is a 457(b) Plan?
A 457(b) plan is a non-qualified deferred compensation plan available to certain employees of tax-exempt organizations. In order to be exempt from ERISA requirements, the plan must limit participation to a select group of management or highly compensated employees (“top hat” employees). The benefits of contributing to a 457(b) plan:
• Reduced current taxable income
• Defer compensation until you are in a lower tax rate
• Contributions and earnings grow tax-deferred
• Ability to contribute to a 403(b) as well
How much can be contributed into a 457(b) Plan?
The employer contribution is determined by the IRS on an annual basis. It can be a percentage of pay or a flat dollar amount. Below are the limits for 2015:
How are plan investments handled?
457(b) plan assets are participant directed similar to a 403(b) plan. The plan can be administered side by side with a 403(b) plan with similar recordkeeping and investment options available.
How are plan assets held?
Unlike a 403(b) where plan assets are held in trust for the benefit of employees, 457(b) plan assets are held in the organization’s general assets and are subject to the creditors of the organization. A rabbi trust can be used to protect assets against being used for general organizational purposes.
Can 457(b) plans be offered in addition to 403(b) plans or other plans?
Yes, the employer can offer a nonqualified deferred compensation plan in conjunction with a qualified retirement plan which provides the largest savings opportunities for employees.
What are the distribution options available upon separation of service?
The following options are available:
• Leave assets inside plan
• Taxable distribution from plan. Taxable distributions are not subject to the 10% early withdrawal penalty but are reported on a W-2 and subject to payroll taxes.
o Lump Sum
o Installment payment over certain number of years
• Transfer to another tax-exempt organization plan (if available)
Can 457(b) contributions change?
Yes, employees can change their contributions at any time.
Must everyone participate equally in the 457(b) Plan?
No. The plan must be limited to management or highly compensated employees in order to avoid ERISA requirements.
How does the cost to set up and maintain a 457(b) Plan compare with the cost of a 403(b) plan?
The cost for administering and recordkeeping a 457(b) are typically less than the fees for a traditional retirement plan including 403(b) plans. It is usually a good idea to use the same 403(b) service provider as the 403(b) in order to benefit from economies of scale.