Category Archives: Section 457(b) Plans

IRS Announces New Benefit Limits for 2017

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On October 28, 2017 the IRS announced 2017 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.   Salary deferral limits to 401(k) and 403(b) plans remained unchanged for the second year in a row, but other dollar limit adjustments were made. Citations below are to the Internal Revenue Code.

Limits That Remain the Same for 2017 Are As Follows:

–The annual Salary Deferral Limit for 401(k), 403(b), and most 457 plans, currently $18,000, stays the same.

–The age 50 and up catch-up deferral limit, currently $6,000, also remains the same. For 2017 as in this year, the maximum salary deferral an individual age 50 or older may make is $24,000.

–The compensation threshold for determining a “highly compensated employee” remains unchanged at $120,000.

–Traditional and Roth IRA contributions and catch-up amounts remain unchanged at $5,500 and $1,000, respectively.

–The compensation threshold for SEP participation remained the same at $600.

–The SIMPLE 401(k) and IRA contribution limit remained the same at $12,500.

Limits That Changed for 2017 Are As Follows:

–The maximum total annual contribution to a 401(k) or other “defined contribution” plan under 415(c) increased from $53,000 ($59,000 for employees aged 50 and older) to $54,000 ($60,000 for employees aged 50 and olded).

–The maximum annual benefit under a defined benefit plan increased from $210,000 to $215,000.

–The maximum amount of compensation on which contributions may be based under 401(a)(17) increased from $265,000 to $270,000.

-The compensation dollar limit used to determine key employees in a top-heavy plan increased from $170,000 to $175,000.

In a separate announcement, the Social Security Taxable Wage Base for 2017 increased from $118,500 to $127,200.  

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Filed under 401(k) Plans, 403(b) Plans, Benefit Plan Design, COLA Increases, ERISA, IRA Issues, Profit Sharing Plan, Section 457(b) Plans

Section 457(f) Gets Its Groove Back

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In June of this year the IRS issued proposed regulations under Section 457 of the Internal Revenue Code (“Code”) that primarily affect “ineligible” plans under Code § 457(f).  These are plans for employees of governmental entities and tax-exempt employers, limited in the latter instance to a select group of management or highly compensated employees (the “top-hat” group), that permit deferral of compensation in excess of the limits that apply under Code § 457(b).  Our prior post looked at some exceptions to these rules; this post focuses on when deferred amounts are subject to a substantial risk of forfeiture or “SROF.”

Amounts set aside under Section 457(f) plans must be included in the executive’s taxable compensation once the amounts are no longer subject to a “substantial risk of forfeiture,” for instance upon completion of a vesting schedule. Due to the requirement that income inclusion/taxation occur when the risk of forfeiture lapses, Section 457(f) plans generally work best when retirement is in the fairly near future (e.g., 2 to 7 years out), and where vesting occurs on or near the anticipated retirement date.

Traditionally it was not uncommon under Section 457(f) plans for organizations to push back a previously established vesting date, to allow the executive to work additional years for the organization without triggering taxation of their plan accounts. This practice of “rolling vesting” was popular for the planning flexibility it allowed.  Another popular practice under Section 457(f) plans was to use a covenant not to compete to prolong the substantial risk of forfeiture (and hence postpone taxation) for several years after an executive’s departure.

Both of these practices – “rolling” vesting, and use of covenants not to compete, came under a cloud, however, when the Congress passed legislation in 2005 that included a comprehensive set of rules governing nonqualified compensation plans. The rules, codified at Section 409A of the Code, were passed due to perceived and actual abuses of deferred compensation plans (for instance, the Enron executives triggered acceleration clauses under their plans when they foresaw the company’s demise).  Section 409A disallowed acceleration clauses and imposed a plethora of other design restrictions on nonqualified deferred compensation.  Section 409A was expressly made applicable to Section 457(f) plans, but final regulations issued in 2007 did not fully explain the intersection of Sections 409A and 457(f).  Separate guidance, in the form of Notice 2007-62, suggested that when formal guidance did issue, it would not recognize rolling vesting as a legitimate tax deferral measures.  Final Section 409A regulations expressly disallowed covenants not to compete as means of creating a substantial risk of forfeiture.  Therefore, for nine years, risk-averse sponsors of Section 457(f) plans have avoided rolling vesting and covenants not to compete, and have accustomed themselves to the stricter, post-Enron plan design rules.

As explained in the chart below, the proposed 457 regulations have resurrected rolling vesting, and also permit a covenant not to compete to create a substantial risk of forfeiture, subject in both instances to some tricky prerequisites.  This added design flexibility for 457(f) plans is good news for non-profit organizations, which increasingly must compete for talent with for-profit organizations.

457(f) SROF Chart

Also welcome is an updated definition of “substantial risk of forfeiture” which harmonizes with the Section 409A definition. Specifically, compensation is subject to a substantial risk of forfeiture under 457(f) when entitlement to it is conditioned upon:

  • the performance of substantial services (generally at least 2 years, unless earlier terminated by death, disability, or involuntary termination, including for “good reason”), or
  • the occurrence of a condition that is related to the purpose of the compensation, (such as a performance goal for the employee, or to the employer’s tax-exempt or governmental activities (such as completion of a funding campaign).

As under 409A, there is no SROF if the facts and circumstances suggest that the employer is unlikely to enforce the forfeiture condition.   Relevant facts and circumstances include the employer’s past practices in enforcing (or not enforcing) forfeitures, the level of the benefitted executive’s control of or influence over the organization, and the likelihood that the conditions would be enforceable under applicable law.

The proposed 457 regulations may be relied upon until the effective date (the “applicability date”) of the final regulations, which will follow their publication in the Federal Register. Transition relief applies only to certain union and governmental plans, such that risk-averse plan sponsors should consider taking steps to voluntarily comply with the proposed regulations in advance of the applicability date.

Finally, compensation for the non-profit executive must meet reasonableness standards or it will potentially trigger excise taxes under Code Section 4958.  This standard applies to deferred compensation amounts, and increases in those amounts, including, arguably, the minimum increase necessary under the new rolling risk of forfeiture rules.

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Filed under Benefit Plan Design, Nonqualified Deferred Compensation, Section 409A, Section 457(b) Plans, Section 457(f) Plans

Chart of Section 457(f) Carve-Outs Under New Proposed Regulations

The IRS recently announced proposed regulations under Internal Revenue Code (“Code”) Section 457 that update prior, final regulations issued in 2003 and other subsequent guidance from IRS.  Section 457 governs deferred compensation rules for government employees, and for executives of private, tax-exempt organizations it permits deferrals from compensation over and above limits set forth in Code § 403(b).  The proposed Section 457 regulations impact “ineligible” deferred compensation plans under Code § 457(f) more substantially than “eligible” deferred compensation plans under Code § 457(b) which were more comprehensively covered in the 2003 final regulations.

By contrast to eligible Section 457(b) plans, which limit annual contributions to $18,000, as adjusted for inflation (and without the age 50 catch-up for private non-profit executives), there is no dollar limit on annual contributions to a Section 457(f) plan (although as explained below other laws do set reasonableness limits upon nonprofit executive compensation in general).   However, amounts set aside under Section 457(f) plans must be included in the executive’s taxable compensation once the amounts are no longer subject to a substantial risk of forfeiture, for instance upon completion of a vesting schedule, even if amounts are not physically paid out from the plan.  Due to the requirement that income inclusion/taxation occur when the substantial risk of forfeiture lapses, Section 457(f) plans generally work best when retirement is in the fairly near future (e.g., 5 to 7 years out), and where vesting occurs on or near the anticipated retirement date.

As summarized in the chart, below, the proposed regulations clarify how certain pay arrangements are carved out from Section 457(f) compliance, either because the arrangement is not deemed to provide for a deferral of compensation, or because it defers compensation but not in a manner that does not fall under Code § 457(f). Where no deferral of compensation occurs, the pay arrangement generally is also exempt from the “Enron rules” applicable to for-profit deferred compensation plans under Code § 409A, and related regulations.  (Final regulations under Code § 409A were published in 2007; the second of two sets of proposed regulations were published the same day as the proposed Section 457 regulations).  The proposed Section 457 regulations clarify that Section 457(f) arrangements generally are also subject to Code § 409A, although there are some important distinctions between the two sets of rules which I will address in a future post.

457(f) Chart

 

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Filed under 403(b) Plans, COLA Increases, Fringe Benefits, Nonqualified Deferred Compensation, Section 409A, Section 457(b) Plans, Section 457(f) Plans