NQDC Church Plan - Eligibility and Vesting

[Plan Doc]

Can/must a church having a 501(c)(3) determination and offering a nonqualified deferred compensation plan limit eligibility to a "top-hat" group?  Also, as I understand 457(f) doesn't apply in the case of a church employer, can plan accounts avoid current taxation upon vesting, as usually occurs with other tax-exempt organization nonqualified plans?

[Peter Gulia]

An unfunded deferred compensation plan is designed in ways that do not meet part 2 (participation and vesting), part 3 (funding), and part 4 (fiduciary responsibility) of subtitle B of title I of the Employee Retirement Income Security Act of 1974.

For each of those parts, an exception excuses “a plan which is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees[.]” To meet that exception, a nongovernmental ERISA-governed plan limits participation to such a “select group”.

But a church plan (see below), which is not ERISA-governed unless it elects to be so governed, does not need the select-group exception if ERISA title I does not apply.

A church plan is a plan that a church, a convention or association of churches, or an organization controlled by a church (or a convention or association of churches) establishes or maintains for a church’s employees. A church plan does not include a plan for employees of an unrelated trade or business. A church plan might include a plan established or maintained by an organization that is sufficiently controlled by, or associated with, a church.

Before assuming a plan is a church plan, get an expert lawyer’s advice about whether the plan is sufficiently established and managed by the church, not merely a church-related organization. Also, a plan should obey the internal law of the church.

Even if there is no ERISA title I need to limit participation, there are tax law, wage-payment law, contract law, and other reasons to limit participation under an unfunded deferred compensation plan.

For more information on these points, see 457 Answer Book and ERISA: A Comprehensive Guide, both published by Wolters Kluwer in convenient internet formats.

This is not accounting, tax, or legal advice to anyone.

[Plan Doc]

Thank you, Peter Gulia.

Any thoughts on whether vesting under a 501(c)(3) church NQDC plan is a taxable event as it is for tax-exempt NQDC plans under Code Section 457(f)?

[Peter Gulia]

If a church seeks to design an unfunded deferred compensation plan that is not a § 457(b) eligible plan, the church should get its expert lawyers’ advice about whether a condition for the participant’s “future performance of substantial services”:

is legally enforceable under each state law that would or could govern the employment,

is proper under the internal law of the church, and

provides enough risk that the condition might not be met, and enough confidence that the church or the church-related charitable organization would enforce the condition, so that the condition is a substantial risk of forfeiture within the meaning of § 457(f)(3)(B).

Some conditions designed to protect interests of a profit-seeking business, or even of a nonchurch charitable organization, might be inapt regarding a church’s wider purposes (or might be contrary to a church’s beliefs about human dignity).

[Tom Veal]

If I may add a couple of points --

• An unfunded church plan that doesn't meet the criteria for a section 457(b) eligible deferred compensation plan is subject to IRC §457(f).  Deferred compensation is then included in taxable income when the right to the compensation is no longer subject to a substantial risk of forfeiture.  Earnings credited after vesting are taxable when actually or constructively received.
• Church plans are not exempt from IRC §409A, which imposes significant restrictions on plan design and severe penalties for violations.  It is therefore important to consult knowledgeable counsel before adopting an unfunded plan.

[Plan Doc]

Thank you Peter/Tom.  These are all great insights!

[Patricia Neal Jensen]

Why would a church plan use a 457(b)? Or (f)?  There are useful opportunities to select the group covered in a church 403(b) since these plans are exempt from Title 1.

[Peter Gulia]

Some churches allow both § 403(b) and § 457(b).

If an employee is 50 or older, eligible for both plans, and has enough compensation, this might allow elective deferrals up to $61,000 [2004].

That’s in addition to nonelective and matching contributions (if any), if those are provided under a plan other than a § 457(b) plan.

This is not accounting, tax, or legal advice to anyone.