Ask any HR Director, and they’ll tell you there’s a talent war going on. Non-profit organizations are not exempt. In the quest to attract, recruit, and retain top-tier leadership in today’s competitive hiring landscape, a growing number of non-profit organizations are getting creative with executive compensation. That includes looking beyond the traditional retirement plan.
For many private companies, the 401(k) plays a key role in executive benefits designed to attract the best talent. But what are the options available to non-profit organizations? And which one is right for you? Understanding the slew of cryptic plans out there is no easy task. To help bring some clarity, let’s focus on the 457(b) plan and its advantages.
The 411 on 457(b)
If you’re like many non-profit organizations, this may be the first time you’re hearing about 457(b) plans. The 457(b) is an IRS-sanctioned, tax-advantaged plan that is exclusive to tax-exempt organizations as well as governmental agencies. For purposes of this article, we are focusing on 457(b) plans for tax-exempt organizations.
For starters, 457(b) plans offer their participants more flexibility and control. Because it’s a non-qualified, deferred compensation plan, 457(b) is not subject to many of the same rules and constraints that govern qualified retirement plans. Here are some of the other key advantages that make 457(b) so appealing to tax-exempt organizations and their employees.
With a 457(b) plan, contributions are taken from the participant’s paycheck on a pre-tax basis, resulting in lower taxable income. Eligible participants set aside a percentage of their salary each month — pre-tax — to be placed in a retirement account. Those funds can then compound without being taxed, until they are withdrawn. What’s more, any interest and earnings generated from the funds also avoid being taxed prior to withdrawal. Employers can make contributions to these plans as well.
Additional Savings Vehicle On Top of Other Qualified Plans
But wait: there’s more. With a 457(b) plan, participants can contribute up to 100% of their salary, as long as they don’t exceed the current $19,500 annual limit. This contribution is in addition to contributions to other plans such as 403(b) or 401(k) Plans.
In some circumstances, participants can even contribute beyond the annual limit. Participants may have the opportunity to “catch up” on missed savings opportunities depending on prior participation.
457(b) Plans for Non-Profits
With advantages like these, it’s no surprise that non-profit organizations are starting to take an interest in 457(b) plans.
Available exclusively for executives, 457(b) Plans help assure executives and founders of non-profit organizations are rewarded for their often times career-long service to the organization.
With 457(b) plans, distributions are typically triggered by a specific event such as severance from employment, reaching an age threshold, termination of the plan, or death. Funds can be distributed as a lump sum, in installments, or as an annuity option — giving participants plenty of flexibility.
For non-profits, the key attraction of 457(b) plans is that it goes beyond retirement plans for executive compensation — bolstering recruitment and retention for top leadership talent. Because 457(b) contributions are not lumped in with 403(b) or 401(k) plans, participants are able to contribute more each year. And unlike qualified plans that must meet IRS Code requirements, 457(b) plans are not subject to discrimination testing to ensure executive compensation isn’t out of balance with benefits received by non-executives. Which means organizations can compensate their executives what they’re truly worth.
The Tricky Part About 457(b) Plans
The advantages of 457(b) plans are clear. But before you start signing up your executives, there are a few considerations to keep in mind.
The “Top Hat” moniker, which these plans can be referred to, speaks to the exclusivity of these plans; they are designed for a small, select group of your top executives. Not every employee is eligible. Indeed, if you invite too many of your employees to participate in a 457(b) plan, you may also be inviting closer scrutiny from the IRS.
And while not subject to the same rules as qualified retirement plans, you will have to check off a few boxes with a 457(b) plan. To avoid 5500 filing requirements, for instance, you’ll need to disclose your 457(b) plan to the Department of Labor within 120 days of adopting it. Contributions are also subject to FICA/FUTA (Federal Insurance Contributions Act/Federal Unemployment Act) requirements, as well as distribution tax reporting requirements via a W-2 form.
While 457(b) plans give participants multiple options for distributing funds, that flexibility may come with some risk. Participants who take their distributions as an entire lump sum may find themselves in a higher tax bracket. Fortunately, if the plan is set up properly, periodic distributions are possible. Assets in a 457(b) plan can be subject to credit risk since there is no trust requirement.
Knowing Your Limits
457(b) plans are appealing in large part because they exceed contribution limits placed on qualified retirement plans — allowing participants to set aside more money each year, pre-tax. However, there are some limiting factors to keep in mind. For instance, employer-matched contributions count toward the maximum contribution limit, which in turn can limit the amount a participant can contribute to their 457(b) plan.
It’s complicated, we know. So complicated that the IRS has stated on their website that mistakes are often made because of the plan’s unique characteristics. Despite these complexities, 457(b) plans do offer a viable, cost-effective alternative for compensating (and retaining) top leadership talent. To fully capture the advantages for you and your executives, you may want to partner with a financial advisor who understands the intricacies and nuances of 457(b) plans.
Chances are, you still have questions. At StoneKimbro, we’re here to help you understand your options, provide answers, and support your goals — including attracting and compensating the leadership you need to support your mission. Contact us today.