IRC 457 (f)
Deferred compensation plans are a promise by an organization to pay specific benefits (typically in a lump sum) to an executive in the future. This future obligation results in a benefit liability on the organization’s balance sheet and benefits expense recognition every year until benefits are vested. Once vested, these amounts are paid to the executive, placing them in control of the assets’ future performance and the resultant retirement cash flows.
These arrangements commonly involve vesting provisions where the executive must remain employed with the organization for a specified period and/or achieve specific performance goals. In non-profit organizations, once a substantial risk of forfeiture no longer exists (deemed to be upon vesting), the plan’s value is immediately includable in the executive’s income.
The executive enters a contractual arrangement with the organization agreeing to remain with the employer to a specified date. Once the access date is attained, the organization will pay the promised benefits. These plans can be structured as i) a defined contribution plan, where the Employer defines an annual contribution, whereby the employee’s benefit equals the annual contributions plus any stated earnings. Performance is not guaranteed, meaning, the employee bears the risk of the plan. Or ii) a defined benefit plan, where the Employer defines a stated benefit to be paid at a stated future date. The risk of the plan is the employer’s responsibility, meaning, the employer is guaranteeing the benefit amount
Pre-retirement and post-retirement rate of return assumptions are crucial to set realistic expectations;
Given the obligation to make the payment at a future date, the organization records a benefit liability reflecting the amount projected to be due at the vesting date; and
The organization recognizes expenses annually until the executive vests in the benefit.
Applicable
Regulations Sections 457(f) and 409A of the Internal Revenue Code (the “Code”) govern these arrangements. The regulatory environment tends to make these plans less flexible than other options.
