457(f) Executive Deferred Compensation

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1 SAVING : INVESTING : PLANNING 457(f) Executive Deferred Compensation 457(f) Executive Deferred Compensation plan for private, tax-exempt employers Looking for a compensation plan that will help you attract or retain highly skilled executive talent? An Executive Deferred Compensation (EDC) plan could be your answer. EDC plans enable an employee to defer an additional amount of current income until a specified future date. This provides a current tax advantage for both employee and employer. Two types of EDC plans can be offered under Section 457: eligible deferred compensation plans under Section 457(b) and ineligible deferred compensation plans under Section 457(f). This brochure highlights the features of Section 457(f) plans. Attract and reward key employees EDC plans are employer-sponsored nonqualified plans that augment tax-qualified retirement plans, and are tailored to benefit key or highly compensated employees. An EDC plan is exempt from the participation, vesting, funding and fiduciary requirements of the Employee Retirement Income Security Act of 1974 (ERISA), as long as participation in the plan is limited to a top-hat group. The employer must file a one-time registration statement (top-hat statement) with the Department of Labor (DOL) within 120 days of the effective date of the plan (or the adoption date, if that is later) in order to exempt the plan. EDC plans for not-for-profit organizations Any private, not-for-profit employer can establish an EDC arrangement for a select group of its management or highly compensated employees (top-hat group). Please note that certain church organizations are not eligible to sponsor a 457(f) plan. The plan must adhere to the rules outlined in Internal Revenue Code Sections 457(f) and 409A. EDC plans of private, tax-exempt employers are tailored to benefit a select group of management or highly compensated employees by helping participants postpone taxation on current income in addition to standard IRS contribution limits. For Plan Sponsor Use Only. Not for Public Distribution. 1 of 6

2 Advantages, risks and protection strategies EDC plans offer several advantages and pose certain potential risks to employers and employees. The primary attraction, from an employee s perspective, is the ability to postpone current taxation of income. The primary advantage for the employer is that it enhances the ability to attract and retain highly skilled executive personnel. All funds deferred under EDC plans remain the property of the employer and are subject to the risk of employer bankruptcy. Since the assets remain the employer s property until paid to the employee, many organizations establish a rabbi trust. The rabbi trust is designed to prevent the employer from using the funds for purposes other than payment of benefits under the EDC plan, except in the case of insolvency. Eligibility to participate EDC plans are designed to benefit certain key individuals. Employees who constitute a select group of management or highly compensated employees may participate in EDC plans; however, there is no formal guidance defining this select group. The selection of the individuals in the top-hat group is determined by looking at the facts and circumstances for each employer. That s why it is important for employers to review this issue very carefully with legal counsel before establishing a top-hat group. Potential candidates Organizations may want to offer a 457(f) EDC plan when contributions to the organization s qualified plan are limited because: The employee s compensation exceeds the maximum tax-qualified plan limitation of $275,000 in 2018 Other contribution limitations exist resulting from failed nondiscrimination tests such as the Actual Contribution Percentage (ACP) test Other annual additions exceed the individual 415 limit of 100% of compensation or $55,000 in 2018 Organizations that offer signing bonuses can contribute to an EDC plan rather than provide a cash bonus if the individual is part of the eligible top-hat group. 2 of 6

3 Section 457(f) eligible plan attributes Available to private, tax-exempt organizations. Exclusions: IRC Section 3121(w)(3) churches and qualified church-controlled organizations (QCCO) are not eligible to sponsor a 457(f) plan. However, certain church-related organizations such as church hospitals, nursing homes, colleges and universities may be eligible to establish 457(f) plans Only available to employees who are among a select group of management or highly compensated employees, except for church-related organizations that have not elected to be ERISA-covered Assets are always owned by the employer (or the trustee of a rabbi trust) and are, therefore, subject to the claims of the employer s general creditors There are no contribution limits on a 457(f) arrangement. However, the compensation that is deferred under this type of plan is generally not regarded as includible compensation and could reduce the retirement benefits under other plans of the employer Plan accumulations must be subject to what is termed a substantial risk of forfeiture Substantial risk of forfeiture defined Section 457(f) provides that the compensation deferred under a 457(f) plan will be included in the gross income of the participant in the first taxable year in which the employee has a legally binding right to the compensation, or the first year in which the substantial risk of forfeiture lapses. For Section 457(f) purposes, a substantial risk of forfeiture is as follows: Deferred compensation is subject to a substantial risk of forfeiture only if a participant s rights to such compensation are conditioned upon the future performance of substantial services Generally, the plan participant is required to continue service with the employer until a stipulated date, or forfeit what has accumulated in the plan up to that time if he or she voluntarily terminates employment for reasons other than those specified in the plan Generally, a minimum of a two-year period of service, measured from the year in which the compensation is deferred, is necessary to meet the substantial risk of forfeiture requirement. This service requirement may be waived if the employee dies or becomes disabled 3 of 6

4 If a Section 457(f) plan is also subject to 409A, the plan must comply with both sets of rules. If a plan violates Section 409A, deferred amounts will become taxable at the earliest date they are no longer subject to a substantial risk of forfeiture. For Section 409A purposes, a substantial risk of forfeiture exists if deferred compensation is conditioned upon the performance of substantial future services or the occurrence of a condition related to the purpose of the compensation, and the risk of forfeiture is substantial. Rolling deferral election Some 457(f) plans might provide for a rolling deferral election. Under the rolling deferral election, a participant can elect to extend his or her service completion date to allow an additional period of tax deferral. Under 409A, such elections must be made at least 12 months before the year in which the participant s interest would otherwise become nonforfeitable under the plan and must defer the service completion date for at least five years from the current service completion date. Distributions and taxation Provided that there is not a violation of Section 409A that would require earlier taxation, the entire amount of deferred compensation, including earnings in a 457(f) plan, is taxable as ordinary income to the participant in the calendar year in which the substantial risk of forfeiture no longer exists (the stipulated period of service has been completed). Taxation cannot be deferred by transferring the accumulations to any other investment or plan once there is no longer a substantial risk of forfeiture. Earnings credited after the lapse of the substantial risk of forfeiture are taxed when they are paid or made available to the participant. Deferrals are subject to FICA and FUTA taxes on the later of the date the services were performed or the date on which the substantial risk of forfeiture ceases to exist. Funding The 457(f) plan is technically unfunded; however, it can be informally funded through contributions made to any legitimate funding vehicle, as long as the employer (or the trustee of a rabbi trust) is the owner of the investment. 4 of 6

5 Miscellaneous rules Distributions from 457(f) plans may not be rolled over to any other employer plan or IRA. 457(f) plans are not included in the definition of retirement plans for determining active participation for IRA contribution deduction purposes. Capital gains treatment and five-year income averaging are not permitted. Loans are not permitted. Plan-to-plan transfers are not permitted to any plan. In order for 457(f) plans to be exempt from most ERISA requirements, the employer must register its plan with the DOL (top-hat election). Plan comparison: 401(k) 403(b) Non-Governmental 457(b) Top Hat 457(f) Top Hat Contribution limits $18,500 employee deferral in 2018, then indexed Offset by 403(b) deferrals Total employee plus employer: lesser of 100% of compensation or $55,000 in 2018 $18,500 employee deferral in 2018, then indexed Offset by any 401(k) deferrals Total employee plus employer: lesser of 100% of compensation or $55,000 in 2018 $18,500 deferrals in 2018, then indexed Offset by other 457(b) plan contributions Total employee plus employer: lesser of 100% of includible compensation or $18,500 in 2018 None Catch-up provisions Age-based for 50 and older of $6,000 in 2018, then indexed Service-based catch-up (cap expansion) up to $3,000 each year (indexed) up to a total lifetime limit of $15,000 for 15 years of service with an eligible employer Age-based catch-up for those 50 and older is $6,000 in 2018 Up to twice the annual limit within the three taxable years ending the year before reaching normal retirement age under the plan. Limited to aggregate of participants unused contribution limits from prior years N/A Portability Yes, to any other qualified plan, 403(b), governmental 457(b) or IRA Yes, to any other qualified plan, 403(b), governmental 457(b) or IRA Plan-to-plan transfers are only permitted to another top-hat plan for a tax-exempt employer if both plans permit. Such a transfer should be handled cautiously as it could result in funds being taxable but not distributable Rollovers are never permitted None Loans Yes (if plan allows) Yes (if plan allows) No No In-service withdrawals Yes (if plan allows) Yes (if plan allows) Yes, for unforeseeable emergency or after reaching age 70½ (if plan allows) Based on irrevocable election before deferral Taxation At distribution At distribution When made available At lapse of substantial risk of forfeiture At risk to employer s creditors No No Yes Yes 5 of 6

6 VALIC is the right partner for your organization. Our group retirement plans offer a flexible mix of services, technology and support, allowing us to easily customize plans for groups both large and small. With more than half a century of experience, we help Americans plan for and enjoy a secure retirement. Serving more than 23,000 group plans, VALIC is a leading plan provider* for healthcare, government, higher education, K-12 and other not-for-profit institutions. We are committed to the same unchanging standard of one-on-one service we have delivered since our founding. Our goal is to help your employees live retirement on their terms. * Source: LIMRA SRI Not-for-Profit Retirement Market Survey 09/30/2017. Based on total assets in a survey of 25 major companies. Real strategies Let us put real retirement solutions to work for your organization and your employees CALL CLICK VALIC.com Securities and investment advisory services offered through VALIC Financial Advisors, Inc. ( VFA ), member FINRA, SIPC and an SEC-registered investment advisor. VFA registered representatives offer securities and other products under retirement plans and IRAs, and to clients outside of such arrangements. Annuities issued by The Variable Annuity Life Insurance Company ( VALIC ). Variable annuities distributed by its affiliate, AIG Capital Services, Inc. ( ACS ), member FINRA. VALIC, VFA and ACS are members of American International Group, Inc. ( AIG ). American International Group, Inc. (AIG) is a leading global insurance organization. Founded in 1919, today AIG member companies provide a wide range of property casualty insurance, life insurance, retirement products and other financial services to customers in more than 80 countries and jurisdictions. Copyright The Variable Annuity Life Insurance Company. All rights reserved. VC (02/2018) J33101 ER For Plan Sponsor Use Only. Not for Public Distribution. 6 of 6