(b)lines Ask the Experts – 457(f) Plans and Proposed Regulations

“What is a 457(f) plan? Is it something we should consider sponsoring? I work in the benefits office of a large 501(c)(3) health care organization.” 

Michael A. Webb, vice president, Cammack Retirement Group, answered: 

All good questions! A 457(f) plan is an unfunded, nonqualified deferred compensation (as opposed to a funded, qualified retirement) plan.  Except in the case of governmental or some church employers, it can only be used to provide a tax-deferred benefit to a “select group of management and highly compensated employees.” That is not a term that has a bright line test, but generally, C-Suite and other senior executives of 501(c)(3) and other nonprofit organizations are included.                       

The Department of Labor (DOL) in an early opinion referred to the group as “individuals, [who] by reason of their position or compensation level, have the ability to affect or substantially influence, through negotiation or otherwise, the design and operation of their deferred compensation plan, taking into consideration any risks attendant thereto, and, therefore, would not need the substantive rights and protections of Title I [of ERISA].” It is important that plans subject to this limitation avoid letting in employees who do not qualify, as the plan may is likely then to violate numerous provisions of the Employee Retirement Income Security Act (ERISA), and there have been a number of cases in which the courts have ruled on various facts over the years.

Unlike a 457(b) plan, which is subject to contribution limits, 457(f) plans allow for unlimited compensation deferrals, not taxed so long as the amounts remain subject to a “substantial risk of forfeiture” (generally, that the employee must continue to perform substantial services for a period of time and will forfeit the amount if they do not do so to the end of the period).

However, as with all good things there is a catch—or, in this case, many catches. There are a number of restrictions that such plans must follow, including having to worry about compliance with two major sections of the Code (409A and 457). In fact, since the enactment of Code Section 409A in 2005, there had been a marked decline in the number of active 457(f) plans due to regulatory concerns.

However it is possible that the proposed 457 regulations that were recently released, as well as related 409A regulations, may stem the decline in the number of such plans. The reason for this is that, at first glance, the proposed 457 regulations provided much-needed clarity in the design of 457(f) plans, including allowing for extensions of the date deferred compensation becomes taxable under certain circumstances (the so-called “rolling risk of forfeiture”) as well as identifying specific provisions under which taxation of compensation can be deferred (what constitutes what is known as a “substantial risk of forfeiture” that would trigger current taxation if such a risk did not otherwise exist).

Though 457(f) plans still contain significant disadvantages (because unfunded, assets are subject to creditor claims in the event the plan sponsor becomes insolvent, for example), if the proposed regulations are finalized in their present form, such plans may become more attractive as a tool to attract and retain senior executives. Thus, you may wish to track the progress of the proposed regulations and consult with counsel well-versed in such plans should there be a need to provide such executive compensation within your organization.

Thank you for your questions!

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.