10/17/2016
The Good, the Bad and the Ugly of 401(a),
457(b) and 403(b) Governmental Plans
Sue Diehl
President PenServ Plan Services, Inc.
[email protected]
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10/17/2016
Agenda – Workshop #47
• Overview and Review of Governmental
Employers and Plan types
• Interaction of contribution limits in multiple plans
and the benefits
• Unique Rules
• Layering on the Benefits
• IRS Audits
• New Pre-approved Plan documents on their way!
Types of 403(b) plans
• 403(b)(1) - Annuity Contracts
–
investments through Insurance Annuities
• 403(b)(7) - Custodial Accounts
–
investments through mutual funds
• 403(b)(9) - Church Plans (RICAs)
•
– investments limited in Plan agreement
– not necessarily limited to annuities and mutual funds
– Trustee(s) may be Church official(s)
– Retirement distributions available for housing allowance
– 6% penalty for excesses does not apply
Previously referred to as ‘Wrap’ 403(b)(1)/(b)(7) Document
• combined annuity/mutual fund investments in a single document
• Today this is merely a 403(b) Plan (no longer needs reference to (b)(1) or
(b)(7)
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403(b) Plan Documents
• Beginning in tax year 2009, IRS regulations required a “plan” to be
established by the employer. The definition is the same as applies
under the Qualified Plan rules.
• All Employers (except for certain church organizations) were
required to have a plan document signed no later than 12/31/2009!
• RICAs must be maintained pursuant to a Plan as well. The plan
document must state the intent to constitute a retirement income
account.
• A RICA that is treated as a annuity contract is NOT a custodial
account even if the investments are solely in mutual funds. This
allows for the more liberal distribution rules under a RICA.
4 types of Qualified Employers
403(b) Programs may be offered by:
1. Tax exempt organizations under §501(c)(3) IRC
"organized and operated exclusively for religious,
charitable, scientific, public safety testing, literary,
educational purposes to encourage national or
international amateur sport competition, or for the
prevention of cruelty to children or animals.“
Examples – hospitals, nonprofits, Universities/Colleges
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10/17/2016
4 types of Qualified Employers
2. Public Educational Institutions – Focus today!
Includes primary, secondary, preparatory, or high
schools, colleges and universities, and federal
state and other public supported schools.
Examples – public schools, charter schools
treated as public schools, State
Colleges/Universities
3. Self-Employed Ministers (must have a 403(b)(9))!
4 types of Qualified Employers
4.Church/Church Related Organizations - “With”
and “Without” a Steeple
 With a Steeple – A church, place of worship
 Without a Steeple:
• QCCO (Qualified Church Controlled Org)
• For example, a Church School
• Non QCCO (Non-Qualified Church Controlled Org) For
example, a Nursing Home run by the Church. More
than 25% of income comes from non church resources.
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403(b) Plan Features
• Plan may include optional features:
– Employer contributions
– Roth contributions
– Hardship withdrawals
– Loans
– Acceptance of rollovers
– In service withdrawals
– “Exchanges” to 403(b) products approved within
the plan (for contributions or just exchanges)
– Plan to plan transfers (in or out)
Compliance
•
•
•
•
•
•
•
Exchange Agreements
Post-Employment Employer Contributions
Universal Availability for Elective Deferrals
Financial Hardship Distributions
Frozen and Terminated Plans
Timely Contribution Remittance/Deposit
Catch-up Ordering Rule
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Example
The Private Big Diehl
School
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TPA
5
“Deselected Vendor”
Signs an “ISA”
Vendors
1 2 3 4
“Accumulated Benefit”
Unique Features
• Post-employment Employer contributions
• Universal Availability
– Does not apply to steeple churches or QCCOs
• ERISA VS NonERISA – Governmental Plans
are always exempt from ERISA!
• Adding a 457 Plan
– 457(b)
– 457(f)
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Post-employment Employer Contributions
Non-elective employer contributions to retirees’
accounts after death are limited to lesser of:
– Monthly compensation to be determined based on 1/12 of final
contract salary times number of months elapsed in the year of
death
– Total contributions that would have been made on retiree’s behalf
if s/he had survived to end of 5-year period
– 415 limit for relevant year (final 12 months of compensation
before severance)
– What happens if the Employee dies while working?
Universal Availability
– Effectively requires schools to count actual hours of
service for all employees if they want to exclude
employees with fewer than 20 hrs/week (or less
than1000 hours per year)
– Most TPAs encourage employers not to exclude any
employees, especially if they can’t/don’t count hours.
– Failing Universal Availability can cause plan
disqualification!
– New Annual 415 notice for years after pre-approved
plans approval
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Universal Availability
• Requires “meaningful” written notice to employees of
eligibility to participate at least annually
• Employees must have “reasonable opportunity” to
make deferral elections
• IRS will want to see UA notices that are sent to
employees and the method by which they are provided
• Most Employers use multiple avenues to provide these
notices/information on universal availability
Non-ERISA 403(b) Coverage and
Nondiscrimination
Nondiscrimination Rule For Elective Deferrals - the Universal
Availability Rule - An “effective opportunity" to make elective
deferrals of more than $200 is "made available" to all employees.
Permitted to Exclude the following Employees –
1. Employee participating in 457(b)**, 401(k), or another 403(b) of
the employer.
2. Nonresident aliens with no US income.
3. Certain students (generally on work study programs).
4. Employees who normally work less than 20 hours per week.
**Not limited to governmental.
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Non-ERISA 403(b)
• NEVER SUBJECT TO ERISA
GOVERNMENTAL EMPLOYERS, INCLUDING:
– PUBLIC SCHOOLS
– STATE COLLEGES/UNIVERSITIES
CHURCHES (WITH AND WITHOUT A STEEPLE!)
– CAN ELECT TO BE COVERED BY ERISA
– WITHOUT STEEPLE INCLUDES QCCOs AND NONQCCOs
402(g) Limit
Taxpayer limit for 2016 $18,000
• 401(k)
• 403(b)
• SARSEP
• SIMPLE-IRA (limit = $12,500)
Limited on calendar year basis.
457(b) not subject to 402(g) limit
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10/17/2016
403(b) Catch up Rules
• One “Catch-up” limit for all 403(b), 401(k),
SARSEP ($6,000) & SIMPLE-IRAs ($3,000)
• Separate “Catch-up” for 457(b) governmental
• No Age 50 “Catch-up” permitted for tax exempt
457(b)
• Both Age 50 “Catch-up” and 15-year rule
available in the same year for 403(b)s.
• Catch-ups first treated as the 15-year catch-up
and then age 50 catch-ups
403(b) allowable distributions -But Check the plan!
Provision
Elective Def
ER-Annuity
ER- Custodial
Attainment of 59 1/2
Severance from employment
Death
Disability under 72(m)(7)
Unless
contract has
different
definition
Disability other than 72(m)(7)
Plan Termination
If annuity & group
custodial
agreements only
If annuity &
group custodial
agreements only
Financial Hardship
Attainment of stated age
Stated event or # of yrs.
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403(b) Allowable Distributions
Hardship (must follow 401(k) rules)
- Hardship distributions may only include
principal amount of elective deferrals, not
including earnings thereon.
IMPORTANT TO RECEIVE THIS INFORMATION WITH
TRANSFERS/EXCHANGES/TAKEOVERS!
- Exception for pre-1989 monies, excluding
earnings.
- Employer must have written hardship policy
or custodial agreement/annuity has language
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What is a Tax-Exempt Organization?
• Section 501(c) of the IRC contains 29 different
nonprofit organizations
For example:
• 501(c)(6) includes Business leagues, chambers of
commerce, real-estate boards, boards of trade, or
professional football leagues.
• 501(c)(3) includes certain hospitals, educational
organizations, etc.
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501(c)(3) Organizations are Unique!
• Only tax-exempt that can establish a 403(b) Plan.
• 501(c)(3) are –
“Corporations, and any community chest, fund, or foundation, organized and
operated exclusively for religious, charitable, scientific, testing for public
safety, literary, or educational purposes, or to foster national or international
amateur sports competition (but only if no part of its activities involve the
provision of athletic facilities or equipment), or for the prevention of cruelty
to children or animals, no part of the net earnings of which inures to the
benefit of any private shareholder or individual, no substantial part of the
activities of which is carrying on propaganda, or otherwise attempting, to
influence legislation (except as otherwise provided in subsection (h)), and
which does not participate in, or intervene in (including the publishing or
distributing of statements), any political campaign on behalf of (or in
opposition to) any candidate for public office.”
What is a Governmental Employer?
• Waiting on Proposed Regulations
• Announcement that proposed regs were being
worked on came on November 7, 2011 (ANPRM –
Advanced Notice of Proposed Rulemaking)
• Would describe the multiple factors under
consideration for determining whether an entity us
an agency or instrumentality of the US or of a State
or political subdivision
• Would propose a ‘facts and circumstance’ test
• On the Guidance Priority Plan for 2016-2017
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What Types of Plans can they Establish?
• 401(k) – Grandfathered only – adopted by a
governmental unit before May 6, 1986!
• Profit-sharing/Money Purchase – 401(a)
• 403(b)
• 457(b)
• 457(f)
• SEPs
• SIMPLE-IRAs
• MEPs – Multiple Employer Plans
A word about Charter Schools…
• Also unique in that they typically have “dual
taxuality”
• They are both a governmental entity and a taxexempt organization under 501(c)(3)
• State law will determine how they are treated for
State law purposes and what plans they may
adopt
• Many are required or permitted to participate in
the State Teachers Retirement plan, which means
that they are deemed to be governmental entity
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10/17/2016
A word about Charter Schools…
• For Example in Pennsylvania
– Charter Schools are treated as a
governmental employer
– Employers are required to either cover
them under the State Retirement System or
cover them with a comparable 403(b) plan.
A word about Charter Schools…
In Michigan
• if there is a management company that is
used, the plan is typically set up as a Multiple
Employer Plan
• Plan typically adopted by the Plan Sponsor
(management org) and the Charter schools
participate in that plan.
• In Michigan these are usually set up as
401(a) plans
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What does being subject to ERISA mean?
• Protection of Employee Benefits, rights
and Features
• Additional Reporting and Disclosures:
– SPDs
– SMMs
– Form 5500 filings (includes audits)
– SARs
– Benefit Statements
– Fee disclosures
Why would an Employer adopt a 401(k) in lieu
of a 403(b) Plan?
• Lack of understanding
• Eligibility of 1 or 2 years would reduce eligible
employees and may not subject the Plan to an
audit
• Employer should compare Universal
Availability rule to the ADP test to see which
one may work better.
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457(b) vs. 457(f)
FEATURES OF…
Tax-Exempt 457(b)
Gov./Tax-exempt 457(f)
Participation
Select/Top Hat Group
Select/Top Hat Group
Contribution Limit
$18,000 for 2015
No Limit
Types of Permitted
Deferrals
Age 50 Catch-up
Pre-Tax only, No Roth deferrals
N/A
Not applicable
Not applicable
Special 3-year catch-up
Up to 2 X the normal deferral limit
Not applicable
Responsibility for
Withholding
Rollovers to other Plans
Tax-exempt Entity
Employer
No
No
Transfers
Yes. To another tax-exempt 457(b)
No
Transfer to State Plan to
purchase service credits
No
No
457(b) vs. 457(f)
FEATURES OF…
Tax-Exempt 457(b)
Tax-exempt 457(f)
Distributable Events
Based on document and employee elections
Generally lump sum or over 5 years;
based on document
Loans Permitted
No
No
RMD Rules
Yes. Later of 4/1 after 70 ½ or retirement
Not applicable
Vesting
Permitted for Employer Contributions
Not applicable
FICA Tax
Yes. Applies later of: when services are
performed or when no longer substantial risk
of forfeiture
Yes. Applies later of: when services
are performed or when no longer
substantial risk of forfeiture
FUTA Tax
Yes, except 501(c)(3) Organizations
Yes, except 501(c)(3) Orgs
Reporting Contributions
N/A
N/A
Reporting Distributions
Form W-2, except decedents
Form W-2, except decedents
Form 5500
One-Time “Top-Hat” Declaration” 120 days
after establishment
One-Time “Top-Hat” Declaration”
120 days after establishment
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457(b) vs. 457(f)
FEATURES OF…
Tax-Exempt 457(b)
Tax-exempt 457(f)
Curing Excess Deferrals
Similar to 401(k)
N/A
Curing other Excesses
Waiting for EPCRS update
Waiting for EPCRS update
Investments
Depends on document; “hypothetical”
investment direction
Depends on document;
“hypothetical” investment direction
Deemed IRAs
Not permitted
Not permitted
Savers tax credit available No
No
10% premature tax
No
No
QDRO rules
Applies
No
Subject to 15 day Plan
asset rule
Trust required
No
No
Not permitted unless a Rabbi or secular trust
is established
Not permitted unless a Rabbi or
secular trust is established
Special Control Group Rules for
501(c)(3) Orgs
• New rules applied beginning for years after
12/31/08 with respect to “controlled groups of
businesses”
• If there is commonality in directors, trustees,
or individuals on boards of directors in
multiple organizations, such organizations
may need to be treated as one employer.
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PTO contributions
Revenue Rulings 2009-31 and 2009-32 permitted
deposits of unused sick and vacation leave to only
401(k) Plans.
Many 403(b) plans are written to offer this option
IRS indicated that this may be added for 403(b) and
457 plans, but as of this date has not had official
guidance! Although IRS permitting in pre-approved
plans.
Adjunct Professors
Adjunct Professors –
• Challenging endeavor for years
• Affects all retirement plans not just 403(b)
plans
• Can affect eligibility and vesting
• A “part-time” professor hired on a contractual
basis
• FACT – They are employees of the school!
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Adjunct Professors
Adjunct Professors (cont’d) –
• Cannot exclude by class
• Violation of Universal Availability Rule
• Affordable Care Act and ACA regulations and
preamble
• Counting hours can be any ‘reasonable’
method
• May not be added to Plan Document
Adjunct Professors
One reasonable method that is acceptable under
IRS audit is – an employer would credit hours as
follows:
• 2.25 hours per week for each hour of teaching or
classroom time
PLUS
• 1 hour of service per week for each additional
hour of service outside the classroom performing
required duties (e.g., office hours, department
meetings).
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Adjunct Professors-Example
The University maintains a 403(b) Plan that excludes
employees that normally do not work 20 hours per week.
Adjunct Professor has 8 hours per week of scheduled
classroom time. He is also is required to be in his office at
least 5 hours per week
Under this method he would have 17.6 hours for the week (8
x 2.25 = 17.60) PLUS 5 or a total of 22.6 hours per week.
Therefore this particular adjunct professor would be eligible
for the 403(b) Plan.
Now lets look at Plan Design
Governmental Employers
 403(b)
 457(b)
 457(f)
 401(a) Profit-Sharing, Money Purchase
 401(k) – Grandfathered Plans (5/6/1986)
 SEP/SIMPLE-IRA (but not with Model 5305SEP)
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Special Employee/Employer Contributions
 FICA Replacement Plans
 7.5 % required between Employer and Employee
 Depends on Government Employer’s State, type of Employee, etc.
 I.e., “Part time” individuals in PA can participate in a FICA replacement
Plan
 PTO Contributions
 Mandatory Employee Contribution vs. Auto Enrollment
 Mandatory Employee Contribution –
 Treated as a Non Elective Employer Contribution
 Is Subject to FICA tax
Structure of Multiple Plans (2016)
Now let’s look at a few plan designs to maximum benefits.
John, age 40 is the Superintendent of a public school and
earns $75,000. He anticipates retiring in 20 years. His
contract also requires the Employer to contribute to a
457(f) for John in the amount of $15,000 per year.
403(b) Defers the maximum
457(b) Defers the maximum
457(f) Employer Contribution
ESTIMATED TOTAL FOR YEAR 2016
$18,000*
$18,000*
$15,000
$48,000
* These amounts reduce the annual compensation
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Structure of Multiple Plans (2017)
Jane, age 60 is the superintendent of a public school and
earns $100,000. She is retiring next year (2017) and will
be receiving a post-employment amount of $10,000
beginning in 2017 for 5 years. Her contract also has
required the Employer to contribute to a 401(a) plan for
Jane in the amount of $20,000 per year since 2012.
403(b) Defers the maximum
403(b) Employer Contribution
457(b) Defers the maximum
401(a) Employer Contributes
ESTIMATED TOTAL FOR YEAR
$24,000
$10,000
$24,000
$20,000
$78,000
(For 2017-2021)
Structure of Multiple Plans (2016)
Why are we layering these types of plans?
Remember that one plan – 403(b) or 401(a) cannot accept
more than $53,000 (for 2016).
By establishing multiple plans the employees can
maximize their contributions and not run afoul of the
limitations.
By law, 401(a) plans and 403(b) plans are not aggregated
when looking at the $53,000 (415) cap.
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10/17/2016
Pre-approved 403(b) Plan Update
•
•
•
•
•
•
Submission day – April 30, 2015…came and went
IRS indicates that they received approximately 80 BPDs. That means that
approximately 50 entities submitted 403(b) documents. Compare this to
the 1000s of submitters for qualified plans.
Estimate of final approvals probably sometime late in 2016 with 2 years
for the employers to restate back to 2010.***
Approval emails will first go out to mass submitters so they can format
their plans.
All approval letters will be mailed out from the IRS on the same day!
Administrative Appendix part of all pre-approved plans
***Important reminder – this is also the deadline to have contracts and
custodial account agreements updated to be coordinated with the new
Plans.
What is a Pre-approved 403(b) Plan?
• A pre-approved plan is a plan that receives IRS approval
and receives an approval letter that provides the
Employer adopting the plan with reliance on the form of
Plan.
• As of today all 403(b) plans are customized and have
limited reliance for the Employer.
• K-14 plans have limited reliance if their plan adopted the
sample language that the IRS provided in 2007.**
** This sample language contained errors that have never
been corrected by the IRS so be careful!
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What is a Pre-approved 403(b) Plan?
• There are 2 types of Pre-Approved 403(b) Plans
– Prototype Plans
• Receives an Opinion Letter
• Basic Plan Document (BPD) with Adoption Agreements
– Volume Submitter Plans
• Receives an Advisory Letter
• Specimen Plan** Document with Adoption Agreements
** These are not the ‘specimen plans’ that some companies offered in
past years.
• Prototypes – no changes after approval not even typos
• Volume Submitter – changes can be made that are minor
What is a Pre-approved 403(b) Plan?
• Both versions will have as an attachment called an
Administrative Appendix
– will not technically be a part of the plan document.
– This will contain the vendor attachment information
– Will not need to be resigned if there is a vendor change
anymore – since it is not a part of the document!
– Will be shared with all parties under the plan to indicate to
the Employer what responsibilities under the plan are
handled by the vendors, TPA, or other entity and what
remains is the responsibility of the Employer.
– See Sample in separate handout!
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10/17/2016
Outstanding LRM Issues
Win and Loss record
• Definition of Disability now refers to sec 72(m)(7) for
all but employer contributions
• Charter Schools are not included in the definition of
Public Schools, if they are treated as a public school
under the State
• NonQCCOs can not be included in a 403(b)(9)
• QCCOs can BUT not in a pre-approved plan
• Severance from Employment only with the employer
not all entities under the State
Outstanding LRM Issues
Win and Loss record
• We have entry dates for 403(b) Plans! But we need
guidance for those employers that have always used
90 days not the new 60 day rule
• Annual 415 aggregation notice; not a statutory or
regulatory requirement; still in the LRMs and IRS
requiring this notice beginning with the January 1st
• 20 hour rule for elective deferrals
– ANSWERED – ONCE YOU ARE IN THE PLAN – YOU ARE
ALWAYS IN THE PLAN
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Outstanding LRM Issues
Win and Loss record
• Allow exclusion for 457(b) only for a governmental
457(b)
• Separate Accounting for vesting
Miscellaneous Issues
• Paperclip Rule for Document Failures
– Preamble to the final regs indicates rule;
– Gather all documents including annuity
contracts, mutual fund company custodial
agreements;
– All policies and procedures (loan and/or hardship
policies)
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Miscellaneous Issues
Once paper clipped…
• Create a document that reflects all of the items
that were treated as a part of the plan;
• Correct any operational errors ASAP (this should
have been corrected by the end of 2009.
• Check all policies and procedures (loan and/or
hardship policies)
Miscellaneous Issues
• ACT Report – 403(b) Plans
–Focused on four areas
Universal Availability
Orphan Contracts
Terminating a 403(b) Plan
EPCRS
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10/17/2016
Miscellaneous Issues
• Exam – Document Request Consistency
– ACT requested IRS look at their IDRs
(Information Document Requests)
- 403(b) Compliance Planning Group project
- Still seeing some that are incorrect
- For example, W-2 corrections for excess
deferrals
Miscellaneous Issues
Recent EPCU Project Findings
–Universal availability still an issue
–The larger the plan, the fewer issues
–Top issues in small & medium plans include



Communications to begin/change deferrals
Conditioned eligibility
Exclusion of part-time employees
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Audit Process









Initial phone call
Follow-up letter
Information Document Request (IDR)
Interviews
IRS reviews IDR responses
Possible request for more information
Discuss issues
Closing conference
Closing letter
Audit Process
Review of Internal Controls
• Key in the IRS deciding whether to expand audit
• If weak then IRS must do more due diligence to validate
operations matches the plan
• Key Internal control areas:
•
•
•
•
•
Eligibility/discrimination testing
Contributions/limitations
Vesting
Distributions
Vendor reconciliation and monitoring documents
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Audit Process
Common Failures
• Failure to follow written plan (Notice 2009-3)
• Churches and QCCOs do not need plan unless
403(b)(9)
• Payroll/HR system does not match document
• Plan amended and no longer matches operations
• Misunderstanding of document provisions
Audit Process
Common Failures
• Universal Availability Failures
• Must provide annual notice to ALL eligible
• Failure to perform non discrimination testing or
errors in test data
• Wrong definition of compensation used
• Excess deferrals
• Improper 15 year catch-up
• 415 excesses – treatment of excesses
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Audit Process
Common Failures
• 5-year post employment contributions
–
–
–
–
•
•
•
•
Must not be elective
Treatment of sick and vacation
What happens if employee dies
Watch 415 limits
Plan loans – plan vs. contract policy
Hardship distributions
Transfers/Exchanges
125 Plans cannot contain a 403(b) as an option
And in Passing…
New proposed regulations for 457(b) and 457(f); and
409A
– Will require some form of amendments for at least the
457(f)
– Can rely on these until final
– Will become effective for the calendar year following the
issuance of final regulations
Remember your new allocation rules when rolling from
a 403(b) to an IRA or another employer Plan
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Questions
Copyright 2016 PenServ Plan Services, Inc.
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