R. David Fritz, Jr., CLU- Managing Partner
Many of you either sit on the board of a non-profit or have been asked to assist in determining compensation matters for key individuals within a non-profit organization. Planning for non-profit organizations is challenging compared to planning for executives within a for-profit organization. Let’s explore the key differences.
The IRS allows the use of non-qualified deferred compensation plans governed by Section 409A. Due to the timing of the taxation doctrine, the IRS is in favor of these plans as corporations do not get to deduct any contributions or deferrals into a non-qualified plan until payments are received. Consequently, the IRS is getting their pound of taxes from the companies while they are withholding employee or employer contributions into a non-qualified plan. When benefits are paid, the executive is also income taxed at that time. In the non-profit world, when contributions are made into non-qualified plans, the IRS does not get to tax neither the corporation nor the executive causing the IRS strife. Consequently, a new set of rules applies to non-profits.
Non-qualified plans for non-profits fall into the Section 457 deferred compensation arena. The first plan is the 457(b) “eligible” plan, and this plan allows for annual contributions up to $17,500 in 2014. This plan is exempt from the 409A deferred compensation rules.
Section 457(f) “ineligible” plans are the more generous but also more cumbersome plans. There are no limitations on the amount that can be set aside in an “ineligible” plan other than the overall reasonable compensation limitation. Employees are taxed on the entire value of the plan as soon as there is no longer a substantial risk of forfeiture.
The “substantial risk of forfeiture” requirement is generally defined as the participant’s right to the compensation conditioned upon the continued and future performance of services at the organization. If the participant terminates employment prior to the specified vesting or payout date provided for in the agreement, the participant forfeits the entire account value. For this reason, participants have not chosen to make elective deferrals into Section 457(f) “ineligible” plans as most voluntary deferral plans are 100% immediately vested.
Based on these cumbersome vesting and taxation rules on Section 457(f) plans, many non-profit organizations are looking for alternatives.
Executive Benefits Network has much experience in designing plans that are viable alternatives to Section 457(f) plans. EBN provides plans with the following benefits:
- Off balance sheet liability
- Reduction or elimination of substantial risk of forfeiture on the employee
- Vesting options
- Tax advantaged investment alternatives and distributions
- Clarity on taxation of contributions in the plan
- More friendly optics on Form 990.