Nonprofit supplemental pension plans after 1993.

• Author: Mann, Michael C.

Providing retirement benefits to key employees of nonprofit organizations has become more difficult after 1993. Effective planning for deferred compensation requires timely analysis and action to avoid missing opportunities that remain available to for-profit entities. This article will discuss the issues involved in determining the appropriate plan, and analyze the benefit levels and coverage available in a variety of supplemental pension plans.

Sec. 457 Plan Rules

Nonprofit organizations that have a qualified Sec. 401 (k) or an elective deferral simplified employee pension (SEP) plan must have established such plan before July 2, 1986. After that date, nonprofit organizations cannot establish a Sec. 401(k) or similar plan.(1)

Sec. 457 provides for a nonqualified deferred compensation plan for nonprofit organizations that defers annual compensation up to the lesser of $7,500 or one-third of includible compensation per employee.(2) Establishing a Sec. 457 plan requires very little planning or administration. For small nonprofit organizations without a grandfathered Sec. 401(k) plan, Sec. 457 can be a useful tool in providing deferred compensation to executives.

However, for larger nonprofit organizations, with long-term highly compensated employees (HCEs), Sec. 457 has draconian implications. Any nonqualified deferred compensation plan established by an exempt organization after 1986 that has a semblance of vesting is a Sec. 457 plan. If a Sec. 457 plan participant is a participant in other eligible plans (e.g., a Sec. 401(k) plan) for the same year, the maximum annual Sec. 457 contribution is limited to $7,500, and the contributions to such other plans are counted in applying this limit.(3) Any combined deferral in excess of $7,500 is taxable income to the participant or beneficiary. The presence of funding is irrelevant; the vested promise to pay will trigger income recognition.

"Grandfathered" nonqualified deferred compensation plans escape Sec. 457 treatment only if they were established and written before Aug. 17, 1986, and the benefit formula does not change after that date.(4) Ideally, the nonprofit organization should have established before 1986 a Sec. 401(k) plan and a nonqualified deferred compensation plan to provide pension benefits to key employees in excess of the limits established by Secs. 415 and 401 (a) (17).

Effective Jan. 1, 1994, the annual wage base that can be used for benefits was reduced from $235,840 to $150,000.(5) This reduced wage base affects an employee who is a defined benefit pension plan participant earning over $150,000, and/or a participant with an average wage base for benefits as of Dec. 31, 1993 exceeding $150,000.

The combined effect of the Secs. 401(a)(17), 415 and 457 limits makes it almost impossible for a nonprofit employer to provide a defined benefit pension based on the "unrestricted basic pension formula" (years of service multiplied by the wage base multiplied by an accrual percentage). Whether a nonprofit organization is affected by these issues depends on its level of commitment to providing an "unrestricted basic benefit," which its employees may have been expecting ever since they were hired.

Supplemental Plan Design Issues

A supplemental defined benefit plan is essential for large nonprofit organizations with long-term employees and HCEs earning in excess of $150,000 per year. Factors to consider in determining whether to develop supplemental plans include whether the HCEs are officers or highlevel managers, and the existence of multiple employer and control group issues for organizations with related affiliates or interlocking boards.

The exact benefit payable under a supplemental plan is based on a specific calculation for each participant. The results of the benefit calculation can vary widely, depending on the facts. The following issues need to be considered before a nonprofit organization can design an effective supplemental pension plan:

1. Does the employer sponsor a qualified defined benefit plan with a formula to determine the basic unrestricted benefit?

2. By using a nonqualified supplemental pension plan, does the employer intend to provide a pension...