Deferred Compensation for Nonprofits

Unlike for-profit organizations, employees of nonprofit organizations have the inability to receive stock based compensation and prosper with the growth and value of the organization. Nonprofits do not have “owners” and private inurement of the benefits of a nonprofit to an individual could be subject to the return of the benefit and additional penalties.

Employees could potentially receive some deferred compensation from their nonprofit. This could also provide some tax and retirement benefits to a nonprofit executive.

Nonprofits can have a qualified retirement plan such as a 401(K), 403 (B), or certain simple plans which can have an organization contribution feature to help with retirement accumulation. Additionally, the nonprofit can establish a nonqualified deferred compensation plan for a select group of upper management or highly compensated employees. These plans are governed by IRS Code section 457, and the simplest plan is a so-called 457 (b) plan.

A 457 (b) plan allows an employee to defer compensation from their regular salary payments, or additional amounts provided by the employer, to the lesser of $18,000 (for 2017) or 100% of the participant’s includable compensation. The amounts deferred can be in addition to those deferred in a qualified plan.

While there is no over 50 catch-up provision in a nonprofit 457 (b), there is a catch-up opportunity to contribute more during the last three years of normal retirement age. Any withdrawals and related taxation would begin after severance from employment and after the age 70 ½. As with any plan, there are a variety of other rules related to rollover restrictions and a unique feature of 457 plans – the subject to the claims of creditor’s criteria. Unlike qualified plans, the deferral of taxation to the individual also rests on the amounts deferred being subject to the claims of creditors. The money cannot be set aside in a separate trust.​

Top executives who prefer to defer larger amounts than the 457(b) limits allow should consider a 457 (f) plan. While there is no specific limit on the amount that can be contributed to a 457 (f) plan, the amounts are subject to a substantial risk of forfeiture and the claims of the creditors. For example, an agreement might state that the CEO is eligible for the deferred 457 (f) amounts provided they are still employed on December 31, 2020. The risk is substantial, because if they are terminated prior to that date they would not be entitled to the money. Additionally, the future date cannot be “rolling” merely for the purpose of deferring taxation longer. Once December 31, 2020 arrives, they cannot change the date to 2023 just because the CEO has signed another three year contract.

The amounts are taxable to the executive immediately upon the lapse of the substantial risk regardless of when the amounts are paid out, so “vesting” and payment usually occur at the same time.

Both 457 (b) and 457 (f) plans can be a very powerful retirement planning tools if executed properly. Complications could occur, so organizations should be mindful when implementing one of these arrangements. The 457 (f) plan in particular presents some significant planning opportunities for nonprofit organizations, but does has pitfalls.

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