Deferred Compensation for Nonprofits and Associations: 457(b) and 457(f) Plans
Deferred compensation decisions are specific to each organization, executive, and retention objective. We serve as a resource for nonprofits and associations evaluating their options, considering new arrangements, or revisiting an existing 457(b) or 457(f) plan.
Managing 457(b) and 457(f) Plans for Nonprofits and Associations
Nonprofit deferred compensation retirement plans, including 457(b) and 457(f) arrangements, allow employees to postpone receiving a portion of their income. These plans are separate from qualified retirement plans (such as 401(k) or 403(b) plans) and operate in a different manner. 457(b) plans function as supplemental retirement plans for a select group of highly compensated employees, while 457(f) arrangements are typically used for executive retention and long-term incentives, with compensation tied to a vesting schedule.
Our team partners with nonprofits and associations to evaluate, structure, and oversee deferred compensation arrangements in a way that aligns with organizational goals and individual outcomes. Additionally, due to Raffa’s 20-year history of serving nonprofits with their investment management needs, we understand how these arrangements intersect with general governance and fiduciary oversight responsibilities.
How We Help with Nonprofit Deferred Compensation
We work with nonprofit and association plan sponsors across plan design, tax impact, and investment strategy, and coordinate with legal and tax advisers to the plan throughout the process. Our team is able to help design new deferred compensation plans as well as review and evaluate existing plans. The areas below describe how we often support nonprofits and associations with deferred compensation arrangements.
Plan Design and Structuring
Investment Approach
Oversight and Coordination
Plan Review and Evaluation
Key Considerations in Nonprofit Deferred Compensation Plan Design
When evaluating or structuring a deferred compensation arrangement, several considerations come into play. The factors below shape how a 457(b) or 457(f) plan should be designed and overseen and help inform our recommendations.
Timing and Taxation
Timing and taxation are key considerations in any nonprofit deferred compensation plan, especially for 457(f) arrangements, because the rules for when compensation becomes taxable differ.
- 457(b) plans: Deferrals are taxed at distribution, similar to a 401(k) or 403(b). The taxable event occurs when funds are paid out to the executive/professional.
- 457(f) arrangements: Compensation is typically taxed when it vests, not when it is paid. If an executive earns a vested 457(f) benefit in a given year, the full amount is treated as income that year, even if the funds have not actually been distributed. That timing rule is what makes vesting schedules, payment timing, and any renewal provisions so important to design carefully.
We work alongside the organization’s tax adviser on these timing-sensitive decisions and help align the investment strategy with the tax strategy.
Disclosure: Raffa Investment Advisers does not provide legal or tax advice. Tax treatment depends on individual circumstances. Organizations and executives should consult their tax advisers regarding specific implications.
Investment Approach
The investment approach for a nonprofit deferred compensation plan should align with how and when the funds will be paid out. Because 457(b) and 457(f) plans have different payout structures, they typically call for different investment strategies.
- 457(b) plans: Funds are typically paid out when the executive leaves the organization or reaches a scheduled payout. This means that the investment approach is usually longer-term, similar to a 401(k) or 403(b).
- 457(f) arrangements: Funds are paid out around a known vesting date, so the investment approach typically shifts toward more accessible, lower-risk options as that date approaches.
It is important to consider that in both plan types, the assets remain part of the organization until they are paid out. We help plan sponsors structure the investment approach for these assets, whether they are held in a rabbi trust or in the organization’s general accounts.
Retention Objectives
Nonprofit deferred compensation plans serve different organizational purposes, and the plan structure should reflect the role each one is designed to play.
- 457(b) plans: Function as supplemental retirement savings for highly compensated employees. Deferrals are owed back to the participant on separation, so 457(b) plans are typically not used as a primary retention tool.
- 457(f) arrangements: Function as executive retention tools, with vesting schedules, performance conditions, and renewal provisions tying the deferred amount to the executive’s continued service. If retention objectives change over time, 457(f) provisions may need to be revisited within the legal framework that allows the substantial risk of forfeiture to remain valid. The board, executive leadership, and outside legal counsel typically all play a role.
We help nonprofits understand how each deferred compensation plan or arrangement aligns with their objectives and how they may support retention efforts.
Coordination with Other Benefits
Nonprofit deferred compensation should be evaluated alongside the organization’s qualified retirement plans and broader compensation and benefits structure.
- 457(b) plans: Typically operate alongside a 403(b) or 401(k), allowing eligible executives to defer compensation beyond the qualified plan limits. The ‘top hat’ eligibility restriction caps participation at a select group of management or highly compensated employees (typically 10 to 15 percent of the workforce), and a separate top hat filing with the Department of Labor is required within 120 days of plan adoption.
- 457(f) arrangements: Typically operate separately, tied to a specific retention objective rather than ongoing salary deferrals. Eligibility is generally limited to specific executives whose retention is central to the organization’s strategy.
We help nonprofit leaders evaluate how deferred compensation fits within their full benefit structure to weigh the pros and cons of the different arrangements in order to determine what will work best for their organization.
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Sample Investment Policy Statement
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Frequently Asked Questions About Nonprofit Deferred Compensation
What is the difference between a 457(b) and a 457(f) plan for nonprofits?
457(b) plans serve as supplemental retirement savings for highly compensated executives, while 457(f) plans are executive retention tools with compensation tied to a vesting schedule.
- 457(b) plan: a non-qualified deferred compensation arrangement that allows eligible executives at a nonprofit or association to defer additional compensation on a tax-advantaged basis, often alongside a 403(b) or 401(k).
- 457(f) arrangement: this arrangement is structured around a vesting schedule and a substantial risk of forfeiture, which means compensation becomes taxable to the executive when it vests, not when it is distributed. This is often designed for retention purposes and may include performance conditions or renewal conditions tied to the length of service.
When is compensation in a 457(f) plan taxed?
Typically, compensation in a 457(f) plan is taxed when it vests, not when it is paid out. The moment the executive earns the right to the deferred amount (typically by completing a service period or hitting a performance milestone), the full amount is treated as income for tax purposes that year, even if the executive has not received a single dollar yet. This timing rule is what makes 457(f) plans different from a 401(k) or 403(b), where taxes are owed at withdrawal, and it is the central design consideration when structuring a 457(f) plan at a nonprofit or association. Because timing is critical, these arrangements should be structured carefully to avoid unintended tax consequences.
Are assets in a nonprofit 457(b) or 457(f) plan protected?
Assets associated with 457(b) and 457(f) plans at a nonprofit or association remain part of the employer’s general assets and are subject to the claims of the organization’s creditors. Many plans use a rabbi trust to set assets aside informally, but those assets are still reachable in the event of insolvency. This is an important distinction from qualified retirement plan assets, which are held in trust for participants.
How should assets in a deferred compensation plan be invested?
The investment approach should reflect the timing and purpose of the arrangement. For example, a 457(f) plan with a defined vesting date may call for an investment strategy aligned with that timeline, with attention to liquidity as the date approaches. A 457(b) plan, which functions more like a qualified retirement plan, may be invested with a longer-term orientation similar to a 401(k) or 403(b). Aligning the investment approach with the structure of the plan and expected use of the funds helps keep the portfolio positioned consistent with its risk and liquidity profile.
Who is typically eligible for a 457(b) or 457(f) plan at a nonprofit?
Both 457(b) and 457(f) plans at a nonprofit or association are typically limited to a select group of highly compensated or key employees (management, executives, etc.). For 457(b) plans, this restriction is what allows the plan to remain a ‘top hat’ arrangement and remain exempt from most ERISA requirements. For 457(f) plans, eligibility is typically tied to specific executives whose retention is central to the organization’s strategy, rather than offered as a broad-based benefit.
How does deferred compensation fit alongside a 403(b) or 401(k) plan?
A 457(b) plan can operate alongside a 403(b) or 401(k) as an additional savings vehicle, allowing eligible executives at a nonprofit or association to defer compensation beyond the limits of the qualified plan (a 401(k), 403(b), etc.). When used together, these plans can provide greater flexibility in retirement planning, particularly for senior staff. A 457(f) arrangement typically operates separately, tied to a specific retention objective rather than to ongoing salary deferrals.
What key risks should a nonprofit board consider before adopting a 457(f) plan?
What key risks should a nonprofit board consider before adopting a 457(f) plan?
A nonprofit board considering a 457(f) plan should evaluate the key risks that come with this type of arrangement, including:
- Taxation at vesting: The executive may owe income tax on the deferred amount when it vests, even if no payment has been made yet, which can create a cash-flow burden if not planned for.
- Asset protection: Plan assets remain part of the organization’s general assets and could be reached by creditors if the organization runs into financial trouble.
- Forfeiture exposure: The executive can lose the deferred amount if vesting conditions are not met.
- IRS compliance: The substantial risk of forfeiture must be clearly documented and consistently enforced, or the IRS may treat the compensation as taxable earlier than intended.
Because 457(f) arrangements introduce real tax, legal, and investment considerations, plan design typically involves coordination among the board, executive leadership, legal counsel, tax advisers, and the investment adviser.
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Disclosures:
The information provided on this page is for general informational and educational purposes only and does not constitute individualized investment, legal, or tax advice. Raffa Investment Advisers (“Raffa”) is a registered investment adviser. Registration does not imply a certain level of skill or training.
Advisory services are provided only to clients pursuant to a written investment advisory agreement. The discussion of nonprofit deferred compensation plans, including 457(b) and 457(f) arrangements, is intended to provide general context and does not address the specific circumstances of any organization or individual.
Tax rules and legal requirements applicable to deferred compensation arrangements are complex and subject to change. Organizations and executives should consult with their legal and tax advisers regarding plan design, taxation, eligibility, and compliance considerations.
Any references to experience or services reflect the firm’s advisory capabilities and do not guarantee future results. Investment strategies involve risk, including the potential loss of principal.
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