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A version that might be a little easier to administrate that will get the sponsor to where they want to go in time would be to do something like this: Amend the plan to say any employee hired (or enters the plan) on or after 1/1/2016 can only take an in-service distribution if they are 100% vested. Within a few years the people hired before that date ought to be 100% vested (assuming most employees are full time) and you have an easy way to track people and balance that the new provisions apply. Note if this sponsor has lots of re-hires this would be a pain also.

Yes and no. You'd have to track the pre-amendment partially vested funds and allow those to be available for in-service distribution. It might be administratively unfeasible to track but you can do it without it being a cut-back.

So, I pay you $2,000 a year to do a job for me and you are going to charge me $200/hr more to explain it to me? Not a very client-friendly business model.

If an employer actually sets aside funds to cover the nonqualified deferred compensation obligation that accrues, those funds belong to the employer and the employer can do whatever it wishes with the funds, subject to any contractual (including trust agreement) terms about disposition of the funds. If you mean "can be prohibited" against its will, no. If means other than an appropriate grantor trust are employed to protect or secure the set-aside assets for the benefit of the particpant, the benefit may become taxable.

For whole life or other policies that have cash values, I agree with the auditor. Premium payments are effectively a transfer from one investment to another. Term would show up as an expense.