Comparing 457(b), 457(f), and Split-Dollar Plans for Nonprofits

Nonprofit organizations often look for ways to attract and retain key executives through deferred compensation arrangements. Three common approaches are the 457(b) plan, 457(f) plan, and split-dollar life insurance plan. Each can supplement retirement benefits, but they differ in eligibility, funding, and tax treatment.

457(b) Plans – Eligible Deferred Compensation

Purpose: A 457(b) plan is a tax-deferred retirement plan available to employees of 501(c) tax-exempt organizations and state and local governments.

Key Features of a 457(b) plan of a tax-exempt organization: 

• Eligibility: Limited to select management or highly compensated employees.

• Deferrals/Employer Contributions: Overall dollar limit applies, e.g., participants may defer (or employers may contribute) the lesser of $23,500 (for 2025) or 100% of compensation (IRC §457(b)(2)).  These amounts are adjusted annually for inflation. 

• Vesting: Contributions are generally vested when made.

• Catch-Up Options: Employees within 3 years of normal retirement age may defer up to twice the annual limit.

• Tax Treatment: Deferrals and earnings are not taxable until paid or made available (IRC §457(a)). Required minimum distribution rules apply. 

• Funding: Must be unfunded (a bookkeeping account or rabbi trust) to avoid current taxation. Assets must remain subject to the employer’s general creditors.

• Advantages: Familiar to employees, operating similarly to a 401(k) or 403(b), distributions can be deferred until minimum distributions required.

457(f) Plans – Ineligible Deferred Compensation

Purpose: A 457(f) plan provides supplemental deferred compensation for key executives, allowing larger deferrals than under 457(b), but with stricter tax rules.

Key Features of a 457(f) plan of a tax-exempt organization: 

• Eligibility: Limited to select management or highly compensated employees.

• Vesting Rule: Amounts are taxable when no longer subject to a substantial risk of forfeiture (IRC §457(f)(1)(A)). Can be structured with performance-based or time-based vesting.

• Deferral Limits: No statutory dollar limit. 

• Funding: Must be unfunded (a bookkeeping account or rabbi trust) to avoid current taxation.

• Tax Implications: - Once vested, the entire present value of the deferred amount is taxable as ordinary income.

Split-Dollar Life Insurance Arrangements

Purpose: A split-dollar plan is a life insurance funding arrangement often used to provide executives with a death benefit and potential supplemental retirement income.

Optional Structures: 

• Endorsement Method: Employer owns the policy and “endorses” a portion of the death benefit to the employee.

• Collateral Assignment Method: Employee owns the policy and assigns a portion of the cash value or death benefit to the employer as collateral for a loan to pay policy premiums.

Tax Treatment: 

• Economic Benefit Regime (Treas. Reg. §1.61-22(b)): Employee taxed on the value of life insurance protection each year.

• Loan Regime (Treas. Reg. §1.7872-15): If employer’s premium payments are treated as a loan, interest may be imputed under IRC §7872 if the loan is below market. 

• Cautions: Complex documentation and annual valuation required.- Must be carefully structured to avoid IRC §409A treatment or imputed income issues.

Summary Comparison

Feature	457(b) for a Tax-Exempt Employer	457(f) for a Tax-Exempt Employer	Split-Dollar
Eligible Employers	501(c)	501(c)	Any employer
Who Can Participate	Select management or highly compensated employees	Select management or highly compensated employees	Typically, used only for executives
Deferral Limit (2025)	$23,500 + catch-up during 3 years prior to normal retirement age	No dollar limit	N/A
Tax Timing	When paid/made available	At vesting	Annually or at loan interest
Funding Type	Unfunded	Unfunded	Life insurance policy
Primary Goal	Retirement savings	Executive retention	Life insurance / wealth transfer

457(b) Plans: Citations: IRC §§457(a), (b); Treas. Reg. §1.457-4.

457(f) Plans Citations: §457(f); Treas. Reg. §1.457-11; IRS Notice 2007-62; IRC §409A.

Split Dollar Plan Citations: Treas. Reg. §1.61-22; Notice 2002-8, 2002-1 C.B. 398; IRC §§7872, 409A.

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