©2013, college for financial planning, all rights reserved. module 6 403(b) plans & other plan...

©2013, College for Financial Planning, all rights reserved.

Module 6403(b) Plans & Other Plan Issues

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMRetirement Planning & Employee Benefits

Learning Objectives

6–1 Explain the basic provisions of a 403(b) tax-sheltered annuity (TSA) plan.

6–2 Describe the investment options and catch-up provisions available in 403(b) TSA plans.

6–3 Explain the similarities and differences between 403(b) and 401(k) plans..

6–4 Identify basic characteristics of retirement plan trust regulatory issues, including plan installation, fiduciary requirements, and reporting and disclosure.

6–5 Describe the multiple plan rules for retirement plans.

6–6 Describe the controlled group and affiliated service group rules, and explain incidental benefits and unrelated business taxable income (UBTI).

6–7 Explain the basic provisions of a Section 457 plan.

6-2

Questions to Get Us Warmed Up

6-3

Learning Objectives



6–3 Explain the similarities and differences between 403(b) and 401(k) plans.





6-4

Qualified Employer & General Plan Features

Qualified employers • Public educational systems• 501(c)(3) organizations• Ministers performing religious services for

for-profit companies• 403(b) plans are not considered to be

qualified, were around before ERISATwo basic types of 403(b)

arrangements• Employee-deferral only• Employer contribution and employee

deferral6-5

Age and Service Requirements

Typical• Minimum age 21• One year of service• If a plan has a two-year service

requirement, 100% immediate vesting• If a plan has a minimum age 26

requirement, 100% immediate vesting and the two-year service requirement cannot be used

6-6

Salary Reduction Agreement• Multiple agreements with same employer

in a taxable year are allowed.• Agreement is legally binding and

irrevocable as to amounts already earned.

• Employee may terminate agreement at any time for amounts not yet earned.

• Employer may require $200 minimum annual deferral to meet nondiscrimination safe-harbor.

6-7

403(b) Plan Vesting Schedule

6-8

Completed Years of Service

Cliff Vesting1

% VestedGraded Vesting2

% Vested

Vesting schedulesavailable 3-Year Cliff

2- to 6-Year Graded

1

2

3

4

5

6

0%

0%

100%

100%

100%

100%

0%

20%

40%

60%

80%

100%1 Full vesting occurs after specified number of completed years of service2 Participant vests at least 20% per year over a maximum five-year period

Employer 403(b) Contributions

Nonelective Employer Contributions• Require the plan to meet coverage and

participation tests:o Ratio percentage testo Average benefits test

Matching Contributions• Require the plan to satisfy only the ACP

test

6-9

Permitted 403(b) Investments• Annuity contracts• Custodial accounts holding mutual fund

shares• Retirement income accounts (churches)

6-10

Maximum 403(b) Salary Deferrals

The lesser of the following two limits:• The annual deferral limit: $17,500 in

2013 plus the long service catch-up ($3,000 limit)

• Section 415(c) limit: lesser of 100% of compensation or $51,000 (2013) plus age 50 catch-up if eligible

6-11

Learning Objectives








6-12

403(b) Catch-Up Contributions• Age 50 catch-up provision

• Long-service rule exception o Must have worked for the same employer for

15 years or more.o Must be a “HER” organizationo Additional annual catch-up allowed up to the

lesser of:• $3,000• $15,000, reduced by increases to the

general limit that were allowed in previous years due to 15-year rule• $5,000 times the number of years of service,

subtracted by the total elective deferrals made by employee for earlier years

6-13

403(b) Withdrawals & Loans

In-service withdrawals generally not permitted, except for• attainment of age 59½ • separation from service• death• disability

(Soc. Sec. definition)• hardship

(employee deferrals only).• loans (same terms as

401(k) loans)

6-14

Roth 403(b) Accounts

• Same income tax premise as Roth IRAo after-tax contributionso tax-free qualified withdrawals

• Contributions and distributions follow defined contribution ruleso 403(b) contribution limitso required minimum distributions

• Employer contributions must be made to a traditional 403(b) account

• Roth 403(b) accounts can be rolled directly into Roth IRAs

6-15

Learning Objectives








6-16

401(k) & 403(b) Plan Comparison

6-17

Characteristic 401(k) 403(b)

Sponsor? Nongovernmental employers

Public schools and 501(c)(3)

Private employer? Yes No

Qualified plan? Yes No

Eligibility? ERISA requirements Any employee (typically)

Salary deferral? Yes Yes

Matching allowed? Yes Yes, but seldom done

Nonelective contributions?

Yes Yes, but seldom done

Nondiscrimination tests? Yes No, if only salary deferralYes, if employer contributions

401(k) & 403(b) Plan Comparison (2)

6-18

Characteristic 401(k) 403(b)

Maximum deferral? $17,500 in 2013 (indexed)

$17,500 in 2013 (indexed)

Overall limits? The lesser of the 415(a) limit or annual deferral limit

The lesser of the 415(a) limit or annual deferral limit

Catch-up election? Yes, for those age 50 and older

Yes, two, age 50 and 15 years of service

Loans? Yes Yes

Hardship withdrawal? Yes Yes

Investment Limitations? No (all ERISA investments)

Yes, only mutual funds and annuities

ADP and ACP testing? Yes, unless safe harbor plan

Only ACP testing, safe harbors available

Learning Objectives








6-19

Plan Documents

Every qualified plan is required by law to beavailable in the form of a written document.Three common approaches to plan documents:1. Custom Plan—Drafted specifically for the

company2. Prototype Plan—Pre-approved plan document

with separate funding medium (separate trust or custodial account) for each adopting company, and the ability to designate trustees

3. Master Plan—Pre-approved plan document with standard funding medium (only one trust or custodial account) and no ability to designate trustees

6-20

Advance Determination Letter• This is a formal determination by the IRS

of whether the plan meets the requirements of the law.

• Only if all legal requirements are met will the plan be considered qualified and the employer entitled to a tax deduction for plan contributions.

6-21

FiduciariesA fiduciary is an individual who• has discretionary authority

or control over the assets/administration of a qualified plan trust, or

• provides investment advice regarding plan assets for compensation.

An individual is not considered afiduciary if services provided for the plan are limited to• legal• actuarial• consulting• accounting

6-22

Fiduciary Responsibilities

ERISA requires a fiduciary to perform plan responsibilities solely in the interest of participants and beneficiaries• for the exclusive purpose of providing benefits to

participants and defraying reasonable expenses of administering the plan

• with the care, skill, prudence, and diligence that a prudent person familiar with such matters would use under the circumstances

• by diversifying plan investments to minimize risk• in accordance with plan documents where such

documents are consistent with ERISA

6-23

Prohibited Transactions

• Self dealing by a fiduciary• Transferring plan assets to a disqualified

person, or such a person using plan assets

• Receipt of consideration by a fiduciary for his or her own account when dealing with a disqualified person

• Buying, selling, exchanging, or borrowing between a disqualified person and the plan

6-24

Disqualified Persons

A “disqualified person” is1. the fiduciary2. any person providing services to the plan3. an employer or employee organization with

employees covered by the plan4. a 50% owner5. a member of the family of (1), (2), (3), or (4)6. a corporation, partnership, trust, or estate that

is 50% or more owned by (1), (2), (3), or (4)7. an officer, director, 10%-or-more shareholder,

highly compensated employee, or 10%-or-more partner in (3) or (6)

6-25

Exemptions from Prohibited Transaction Rules

• Receipt of benefits under plan provisions• Distribution of plan assets in accordance with

allocation requirements• Loans made to plan participants and beneficiaries

that are:o available to all participants and beneficiaries on a

substantially equal basiso not available to highly compensated employees in greater

proportions than to otherso made in accordance with plan provisionso at reasonable rates of interest and adequately secured

• Loans made to ESOPs• Purchase or sale of qualifying employer securities by

an individual account plan, for adequate consideration, and without commission

• Providing office space or services for the plan for reasonable compensation

6-26

Plan Administrator Duties

The plan administrator has the primary responsibility for carrying out the operational requirements of the plan. It may be the employer or a third party (TPA).

The plan administrator is responsible for• determining annual contribution amounts• determining who is eligible for participation, who is

vested, and the accrual of benefits• communicating with participants and beneficiaries,

including counseling regarding plan choices and distribution options

• ruling on claims• ensuring that actuarial functions are

carried out• hiring attorneys and accountants• reporting, disclosing, and keeping

plan records6-27

Reporting & Disclosure Requirements

Federal Government• Filing forms 5500 and 1099-R• Plan summariesPlan participants and beneficiaries• Personal benefits statements• Summary plan descriptions (SPD)• Summary of material modifications (SMM)• Summary annual report (SAR)Other required notices include• Report of investment performances• Description of types of benefit payments and

distribution options permitted under the plan

6-28

Example of Single Employer with Two Defined Contribution Plans

6-29

The limit on ABC Corporation’s deduction for total contributions tothe plans is $250,000 (25% of $1 million covered payroll).

ABC Corporation is required tocontribute $100,000

(10% of covered payroll) to the money purchase pension plan.

ABC Corporation can contributeup to $150,000

(0% to 15% of covered payroll) to the profit sharing plan.

Money Purchase Pension Plan

Profit Sharing Plan

Bob, a participant in both plans, earns $100,000 this year. Annual additions to his two plan accounts are limited to an aggregate of $51,000 (the lesser of 100% of pay or $51,000).

Single Employer with Defined Benefit & Profit Sharing Plans

Multiple Plans of a Single Employer (DEF)—Defined Benefit (DB) Plan not subject to PBGC, Required Minimum Funding Is $300,000 (30% of a $1 million covered payroll) for this year, and Profit Sharing (PS) Plan contribution is 6% or less – overall limit does not apply.

6-30

Since the minimum finding requirement is $300,000, the limit of DEF Corporation’s deduction for total contributions to the two plans is $360,000 (DB plan funding

+ up to 6% to profit sharing plan + 401(k) elective deferrals + catch-ups).

DEF Corporation is required tocontribute $300,000 to the defined

benefit pension plan. This amounts to 30% of covered payroll.

DEF Corporation can contributeup to $60,000 (6% of covered

Payroll) + 401(k) elective deferrals + catch-ups to the PS Plan.

Defined Benefit Plan Profit Sharing Plan

Another Single Employer with Defined Benefit & Profit Sharing Plans

Multiple Plans of a Single Employer—Defined Benefit (DB) Plan subject to PBGC, Required Minimum Funding is $300,000 (30% of $1 million covered payroll) for this year, then Profit Sharing (PS) Plan is limited to 25% or less – overall limit does not apply.

6-31

Since the minimum funding requirement exceeds 30% of covered payroll, the limit of DEF Corporation’s deduction for total contributions for DB funding + 25% to PS plan is $550,000 (+ 401(k) elective deferrals + catch-up contributions).

DEF Corporation is required to contribute $300,000 to the defined

benefit pension plan. This amounts to 30% of covered payroll.

DEF Corporation can contribute up to $250,0000 or 25% of covered payroll (+ 401(k) elective deferrals + catch-

ups contributions) to the PS plan.

Defined Benefit Plan Profit Sharing Plan

Employee with Multiple Plans—Unrelated Employers

An individual (John in this example) who has more than one unrelated employer generally may participate in the qualified retirement plans of each employer. The Section 415 limits will apply to the individual’s participation in each employer’s plan(s) separately.

6-32

Employee with Multiple Plans—Employee Elective Deferral Limit

An individual’s elective deferrals to different plans generally must be aggregated to comply with the limits.

For example, Ann works full time for a corporation and also teaches at a local community college. She participates in the salary deferral plans offered by each employer—a 401(k) plan and a TSA. Her compensation and other relevant factors make her eligible to defer the maximum to each plan; however, her aggregate deferrals are limited to $17,500 (2013).

6-33

Employee with Qualified Plan & 457

The salary deferral limits for participants in a Section 457 plan are separate from the salary deferral limits to qualified plans and 403(b) plans.

6-34

Learning Objectives








6-35

Parent-Subsidiary Controlled Group

A group of organizations with a common parent: Each organization is under control of one or more of the other organizations, and the common parent has direct control (at least 80% ownership) over at least one member of the group.

• For example, if Regis Industries owns 80% of Climate Controls, both companies would then need to be considered and treated as one company for retirement plan purposes.

6-36

Brother-Sister Corporation

Brother-Sister test• Five or fewer people own at least 80% of

the voting power.• The same five or fewer shareholders

own more than 50% of control, taking into account ownership only to the extent of identical ownership for each business.

6-37

Affiliated Service Group Example

First Service Group and “A” Organization

6-38

Nurse/Receptionist

Partners in Health(partnership)

Owns 100% of FSO.

Greenville Medical Services, Inc.(first Service Organization)

provides medical careto third persons.

Dr. A’s P.C. (AOrganization) owns 50% of thePartnership ...

and performs servicesfor third partiesthrough the FSO.

Dr. B’s P.C. (AOrganization)owns 50% of thePartnership ...

and performsservices for thirdparties throughthe FSO.

Billing clerk Clerical assistantNurse

Affiliated Service Group Example

First Service Group and “B” Organization

6-39

Market Shares(First Service Organization)

provides marketing services to third parties and its four partners

each own 3% of

Good Words, Inc. (B Organization)performs services for the FSO

Writer #2 Editor #1 Editor #2Writer #1

UBTI

UBTI (unrelated business taxable income) is derived when a qualified plan participates in running a business.

Income not considered to be UBTI• Passive income (interest, dividends, royalties,

rent)• Capital gains• Leveraged real estate that is held directly

Income considered to be UBTI• Income from a directly held business• Dividend income, if stock is margined• Partnership income

(general and limited)

6-40

Incidental Benefit Definition

6-41

Learning Objectives








6-42

Qualified & Nonqualified Plans

6-43

Qualified Plans Nonqualified Plans

Pension PlansProfit Sharing Plans (DC)

Tax-Advantaged Plans

Other Nonqualified Plans

Defined Benefit (DB)

Profit Sharing Traditional IRA Section 457 Plans

Cash Balance (DB) Thrift Plan Roth IRA

Stock Bonus SIMPLE IRA ISO

Money Purchase (DC)

ESOP (LESOP) SEP ESPP

Target Benefit (DC) Age-Weighted (SARSEP) NQSO

Cross-Tested (Comparability)

401(k) Plan 403(b) (TSA) Deferred Compensation Plans

SIMPLE 401(k)

Section 457 Deferred Compensation Plan

A 457 plan is a deferred compensation plan, not a

qualified plan, and therefore not subject to many of

the qualified plan rules. Two main categories of 457 plans• 457(f) (non-governmental)

o Participation limited to a select group of highly paid or management employees (“top hat” plan)

• 457(b) – “eligible” o Governmental o Nongovernmental

6-44

Eligible Employers for 457(b) Plans & Deferral Amounts

6-45

Funded & Unfunded 457(b) Plans

6-46

Catch-up Provisions of 457(b) Plans

Age 50 catch-up• Additional $5,500 for those age 50 and older not

in the final three years prior to retirement

Final three years catch-up• Available for each year of the three years

preceding normal retirement age

• Catch-up contribution up to the allowable deferral for the current year, resulting in total deferrals up to two times the allowable deferral for the current year

• From unused deferrals only

• Cannot use with age 50 catch-up

6-47

Multiple Choice Question 1

Which one of the following is not a provision of TSAs?a. The contract between the employer and

the employee must be legally binding.b. The employee can execute more than one

contract per employer per year.c. Salary reduction contributions generally

are subject to a $17,500 limit in 2013.d. The annual TSA contract is irrevocable;

the employee may not terminate the agreement during the year.

e. Loans are permitted in accordance with qualified plan rules.

6-48

Multiple Choice Question 2Which one of the following is not a provision of the special limits that are available to certain employees in a TSA plan?a. It is available to employees of health, education,

and religious organizations (HER organizations). b. It may use both catch-up provisions if qualified.c. It may typically defer at least $200 to their TSA

during the first year of service.d. With 15 or more years of service, a participant

may increase each year’s deferral limit by $3,000 (up to $15,000 of cumulative increases).

e. If prior salary reductions exceed $5,000 times years of service, no increase to the deferral amount is available to employees with more than 10 years of service.

6-49


Which one of the following is not a provision of Section 457 plans?a. Elective deferrals are subject to a $17,500

limit in 2013.b. Employees of tax-exempt organizations and

state/local governments may establish Section 457 plans.

c. An employee retiring at age 65 is not permitted to receive payments until age 70½.

d. An additional deferral catch-up of up to twice the regular deferral, less any deferral for the current year, is allowed in the three years prior to retirement.

6-50


John Billups, age 53, participated in his former employer’s 457 plan. He terminated several weeks ago and just received his distribution check. Which of the following statements is true?a. He will pay no tax and no penalty on the

distribution.b. He will pay tax and a 10% penalty on the

distribution.c. His distribution is subject to the

mandatory 20% withholding.d. He will pay tax with no penalty on the

distribution.6-51

Multiple Choice Question 5Which of the following would be considered an incidental benefit in a qualified plan?I. term life insurance that costs 37% of the cost of all

plan benefitsII. ordinary life insurance that costs 48% of the cost of all

plan benefitsIII. term life insurance that costs 24% of the cost of all

plan benefitsIV. ordinary life insurance that costs 27% of the cost of all

plan benefitsV. an insured death benefit that is 100 times the

expected monthly pension benefita. I onlyb. II and III onlyc. I, II, and V onlyd. I, III, and V onlye. II, III, IV, and V only

6-52

Multiple Choice Question 6EFG Corporation is considering establishing a qualified retirement plan for eligible employees.Which of the following groups would have to be considered in meeting the statutory coverage and participation tests?I. employees of HIJ Corporation, in which EFG owns 90% of

the stockII. employees of KLM Corporation, in which EFG owns 75%

of the stockIII. leased employees working at EFG who are covered by

their leasing organization’s profit sharing planIV. workers at EFG who are members of a union in which

retirement benefits have been the subject of good-faith bargaininga. I onlyb. I and II onlyc. I and III onlyd. II and IV onlye. I, II, and III only

6-53


Which of the following types of income generated by a qualified plan trust would result in unrelated business taxable income (UBTI)?I. dividends from margin stockII. royaltiesIII. income from an energy limited partnershipIV. real property rental income

a. I and II onlyb. I and III onlyc. II and IV onlyd. I, III, and IV onlye. II, III, and IV only

6-54


Which of the individuals listed below would be considered qualified plan fiduciaries?I. a person providing legal services to the planII. a person providing investment advice

regarding plan assets for compensationIII. a person providing accounting services to the

planIV. a person who has discretionary authority

over plan assets or administrationa. I and II onlyb. II and III onlyc. II and IV onlyd. III and IV only

6-55

Multiple Choice Question 9Rita, age 63, has worked for the local animal rescue shelter for the past 17 years. The shelter offers a 403(b) plan for all of its full-time employees. Rita is currently the Senior Accountant, and plans to retire within the next three years. Her current annual compensation is $75,000. What is the maximum amount that Rita could defer this year (2013)?a. $17,500b. $20,500c. $23,000d. $26,000e. $35,000

6-56


Which of the following statements is correct regarding 403(b) plans and Section 457 plans?a. Investment options in a 403(b) plan

include annuities and stocks.b. Section 457 plans can be rolled over

into an IRA account.c. Section 457 plans do not have required

minimum distributions (RMDs).d. 403(b) plans may be subject to ACP,

but not ADP testing.

6-57