What Is IRC 403(c) and How Does It Impact Retirement Plans?

Retirement planning involves navigating tax codes that dictate how funds are contributed, managed, and distributed. One lesser-known provision, IRC 403(c), differs from the more common 403(b) plans used by public school employees and nonprofit workers. Understanding its rules can help individuals and employers make informed financial decisions.

Plan Eligibility Under IRC 403(c)

Unlike 403(b) plans, which are limited to employees of public schools, churches, and certain tax-exempt organizations, IRC 403(c) applies more broadly to entities and individuals. It covers retirement arrangements that do not meet 403(b) requirements but still involve tax-deferred contributions. These plans are often used when an employer does not qualify for a 403(b) but wants to offer retirement benefits outside standard qualified plans.

A key distinction is that 403(c) arrangements are nonqualified, meaning they do not receive the same tax advantages as ERISA-qualified plans. Contributions are typically made with after-tax dollars, while investment earnings grow tax-deferred. This makes them similar to other nonqualified deferred compensation plans, where taxation is postponed until withdrawal.

Eligibility is determined by the employer rather than statutory requirements, allowing organizations that do not meet 403(b) criteria to provide retirement benefits to employees, executives, or other designated individuals. However, these plans are subject to different reporting and compliance obligations than qualified plans.

Employer Sponsorship Requirements

Organizations offering a 403(c) plan must structure it to comply with tax and labor laws. Unlike qualified plans, which must follow nondiscrimination rules, 403(c) plans allow employers to select participants, making them useful for providing benefits to executives or key personnel. However, they do not offer the same ERISA protections as most employer-sponsored plans.

To maintain tax-deferred status, employers must document plan terms, including eligibility, contribution limits, and distribution conditions. The IRS may review these plans to determine if they function as deferred compensation arrangements, which could impact taxation. Proper record-keeping and adherence to reporting requirements help mitigate compliance risks.

Funding varies. Some employers make direct contributions, while others structure plans as unfunded promises to pay future benefits. In unfunded arrangements, assets remain part of the employer’s general assets, meaning participants are exposed to the company’s financial health. Employees should assess the financial stability of their employer before relying on these benefits for retirement.

Contribution Structures

Contributions depend on the employer’s financial strategy and the plan’s objectives. Unlike qualified plans with IRS-imposed limits, 403(c) contributions are dictated by the plan agreement. Employers may make lump-sum contributions or tie them to compensation or performance benchmarks.

Because 403(c) plans are not subject to contribution caps like 401(k) or 403(b) plans, they can provide additional retirement benefits beyond traditional limits. For example, in 2024, the elective deferral limit for a 403(b) plan is $23,000, with a $7,500 catch-up contribution for those 50 and older. A 403(c) plan can supplement these limits, allowing high earners to save more for retirement.

The tax treatment of contributions depends on the plan’s structure. If funded directly by the employer, contributions are generally not tax-deductible until distributed to participants. Similarly, participants do not recognize contributions as taxable income until they receive distributions. However, if employees defer a portion of their salary into the plan, payroll tax and withholding requirements may apply.

Distribution Rules

Withdrawals follow the terms outlined in the plan agreement. Unlike qualified plans, which have statutory distribution rules, 403(c) plans allow employers to define when and how participants can access funds. Some plans specify distributions at a certain age, while others tie payments to events such as termination of employment, disability, or a vesting schedule.

These plans are not subject to required minimum distributions (RMDs) under IRC 401(a)(9), meaning participants are not required to begin withdrawals at age 73, as they would with a traditional IRA or 403(b) plan. This can be beneficial for those who want to defer income recognition. However, delaying withdrawals could create liquidity risks if financial needs change unexpectedly.

Tax Consequences

Since 403(c) plans are nonqualified deferred compensation arrangements, they do not receive the same tax benefits as qualified retirement plans, affecting both employers and participants.

For employees, taxation occurs at the time of distribution. Withdrawals are taxed as ordinary income, subject to federal and state income taxes at the participant’s marginal rate. Unlike qualified plans, which may allow for favorable capital gains treatment in certain cases, 403(c) distributions do not benefit from preferential tax rates. Additionally, early withdrawals are not subject to the 10% penalty that applies to 401(k) and 403(b) plans before age 59½. However, if the plan is structured as an unfunded deferred compensation arrangement, participants may face tax liability under IRC 409A if distributions do not comply with deferral elections and timing rules.

Employers also face tax considerations. Contributions are typically not deductible until benefits are paid to employees, unlike qualified plans where employer contributions are deductible in the year they are made. If the plan is informally funded—meaning assets remain under the employer’s control—earnings on those assets may be subject to corporate income tax. Employers must also consider payroll tax implications, as deferred compensation may be subject to FICA and Medicare taxes at the time of deferral rather than distribution, depending on the plan’s structure. Proper tax planning is necessary to avoid unintended liabilities and ensure compliance with IRS regulations.

Vesting and Ownership

Vesting schedules are determined by the employer and can be structured to align with compensation and retention strategies. Unlike qualified plans, which must follow ERISA vesting rules, 403(c) plans allow employers to set their own conditions for when employees gain full ownership of deferred benefits.

Vesting can be immediate or gradual. Some plans grant full ownership upon enrollment, while others use graded or cliff vesting. In a graded schedule, employees earn ownership over time, such as 20% per year over five years. Cliff vesting requires employees to complete a set period of service—often three to five years—before gaining full rights to their benefits. If an employee leaves before meeting vesting requirements, they may forfeit some or all of their deferred compensation.