When setting up a 457(b) plan makes sense:
In 2019, the government allows taxpayers to contribute up to $19,000 annually to their 401(k) or 403(b) plans ($25,000 if over age 50). However, executives at nonprofit organizations tend to max out these qualified retirement plans early and are looking for a deeper tax shelter beyond these limits. Also, receiving additional employer contributions into their 401(k) or 403(b) plan is difficult because of anti-discrimination testing restrictions.
Thus, two crucial questions arise:
- How can executives defer income beyond the limits imposed on qualified retirement plans?
- How can they receive a higher employer contribution on top of their 401(k)/403(b) plans without having to give it to the entire staff and strain the organization’s budget?
For these executives, a nonqualified 457(b) plan, also known as a top hat plan, may be a great solution for the following reasons:
- A 457(b) plan allows executives to shelter an additional $19,000 of income from federal and state taxes each year on top of the amount contributed to their 401(k) or 403(b) plans. When you factor in the 401(k) and 403(b) limits, it amounts to a huge potential tax savings—as much as $38,000 ($44,000 for those over 50) of income per year!
- Executives can also receive employer contributions in addition to the match they receive in their retirement plan without running into problems with anti-discrimination testing. Any employer contribution into a 457(b) plan is considered ordinary income to the employee; therefore, the organization and the executive must pay their share of FICA taxes on the amount contributed, however, that contribution is sheltered from federal and state income taxes.
- Execs can opt for some combination of the two. For instance, if the Board approves $10,000 in extra employer contribution, they still have $9,000 to shelter from taxes should they choose to do so.
Let’s see how such a plan might work in action:
Jane Doe is an executive at Nonprofit X. She is fifty one years old and contributes $25,000 from her paycheck to max out her 403(b) plan each year. Seeing a need to reduce her taxes, Nonprofit X establishes a 457(b) plan to bonus execs like Jane Doe up to $19,000 per year.
Jane Doe sees the following tax advantages from this strategy: Supposing she pays at a 37% federal income tax rate, with her 457(b) plan, Jane Doe will save a little over $7,000 per year in federal taxes alone ($19,000 x 0.37 = $7,030)—in addition to the savings she already sees in her 403(b) plan.
Ultimately, a 457(b) plan presents an attractive option for nonprofit organization executives who are looking to defer more of their income past the $19,000 limit on qualified (i.e., 401(k) or 403(b)) retirement plans. Therefore, setting up a 457(b) plan may help your organization strengthen recruitment and retention of top performing executives by offering a more attractive retirement benefit.
Of note, a 457(b) is not appropriate for all organizations and is subject to requirements and restrictions. Ensure a qualified tax professional is consulted.
Article contributed by: Amir B. Eyal, JD, CFP®, AIF®, Employee and Executive Benefits Specialist at the Center for Nonprofit Advancement. Amir is also the CEO of Mylestone Plans – a national leader that educates the members of the nonprofit community on how to achieve their financial goals. Mylestone provides a comprehensive range of institutional services to hundreds of non-profit organizations, as well as private financial and investment planning to their leadership and employees.