457f Plans

The 457f is a deferred compensation plan that allows eligible employers to contribute money on a pre-tax basis into investments that provide key executives with a retirement benefit. By doing so, these companies can help their executives defer payment of federal and state income tax on the money contributed into their accounts.

In this article we're going to focus on the Section 457(f) plans which provide a valuable benefit to those executives that companies want to retain. We're going to explain the benefits these plans provide to the employer and the employee as well as some of the rules involving contributions, distributions, rollovers, and income taxes. We're also going to talk about the single most important feature of these plans - risk of forfeiture - and why that provision exists.

Benefits of the 457f

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As mentioned, the 457(f) deferred compensation plan offers both employer and employees many benefits including:

Allowing employers to attract and retain the executives they value the most.
Providing a retirement / deferred compensation plan that is easy to establish and easy to maintain.
Flexible investing options involving the contributions made by the employer.
Offering an added benefit to an existing benefits program.
Deferring of both state and federal income taxes.
Permitting companies to provide benefits that do not affect the employee's ability to fund an IRA or 401k plan.

Overall, the 457f allows employers to offer top executives a deferred compensation arrangement that provides a future income stream to the executive; while the rules of these plans help employers retain executives via some of the "golden handcuff" provisions it contains.

457f Rules

While deferred compensation plans such as the 457f offer many benefits, these benefits do come at a cost. In exchange for offering the company's executives the opportunity to defer the payment of income taxes there are a series of rules involving:

Eligibility Requirements
Asset Ownership
Rollovers
Distributions
Risk of Forfeiture

Interestingly, there are no contribution rules for 457f plans. In fact, an employer can contribute any amount - essentially deferring as much compensation as the executive likes and the employer is willing to pay. But where certain rules do apply we're going to talk about each in more depth in the following subsections.

Eligibility Requirements of the 457f

Participation in a 457f plan is limited or restricted to a select group of highly-compensated individuals and / or a select group of management employees. The exact eligibility thresholds for each company will vary, but they are pre-determined and therefore the plan's administrator or documentation will provide guidance on eligibility.

Asset Ownership

The money contributed to a 457f plan can be invested in fixed or variably annuities, mutual funds, and even life insurance. These assets, however, remain owned by the employer until paid to the employee. It is because of this rule that 457f plans create a tax shelter for the executive. By not taking ownership of the assets, income taxes can be deferred. Unfortunately, this also means that the asset is available to creditors in the case of employer default on a loan or bankruptcy.

And because the asset belongs to the employer, the employee cannot use the money in their 457f account as collateral. It's also protected from claims against the employee until distributed.

457f Rollovers / Transfers

The rollover rules for 457f plans are pretty simple. The money is not eligible for rollover or transfer into a 457b or any other qualified retirement plan such as an IRA. Remember, the money is not an asset of the employee until distributed.

Distributions from 457f Plans

There are normally three ways that a distribution from a 457f plan takes place - a disability, the passing away of the employee, or the employee retiring from the company. On occasion, the employee and employer may agree upon a date on which distribution takes place. At this point in time, a substantial risk of forfeiture no longer exists.

Distributions are usually made on a lump-sum basis. When paid, the entire account's value is subject to FICA, federal and state income taxes.

Substantial Risk of Forfeiture

The final rule we're going to talk about involves the concept of "substantial risk of forfeiture." As just mentioned, when distributions take place this risk no longer exists, and at that time all of this deferred compensation is immediately taxable.

Remember, until money is distributed from the account, it is an asset of the employer. This is why taxes can be deferred - the money is not yet owned by the employee until a distribution occurs. To ensure the asset is not owned by the employee (and merely being held by the employer) the IRS demands that their must be a substantial risk of forfeiture. In other words, they require a mechanism by which the employee risks losing all of the money.

The most obvious example of substantial risk of forfeiture would be the executive leaving the company before reaching normal retirement age. When that happens the executive would lose their rights (forfeit) to this money. If you participate in a 457f plan, then your plan's administrator should be able to explain all of the forfeiture provisions outlined in your deferred compensation agreement.

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