403(b) and 457(b) plans - beyond the fundamentals

403(b) and 457(b) Plans: Beyond the Fundamentals

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Learning Objectives

• Discuss common issues and plan features affecting 403(b) and 457(b) plans

• Learn about recent 403(b) plan eligibility and plan termination rule clarifications

• Know special 403(b) rules for church plans

• Review 457(b) plan special catch-up rule

• Understand 457(b) funding and employee eligibility issues

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403(b) Plans

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Background

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403(b) “Once In, Always In” Rule (IRS Notice 2018-95)

Employees who normally work less than 20 hours per

week may be excluded

“Part-Time Exclusion”

All employees generally must be permitted to make deferrals

Universal Availability

Generally effective after 12/31/08

Final Regulations

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Requirements of Part-Time Exclusion

Meet these3 conditions

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“First Year” ExclusionReasonably expect

employee to work less than 1,000 hours during first year of

employment

“Preceding Year” Exclusion

After first year of employment, employee

must have actually worked less than

1,000 hours in preceding year

“OIAI” ExclusionOnce employee

doesn’t meet conditions for exclusion,

they may never be excluded again

“Once In, Always In”

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“Fresh Start”403(b) plans will not fail as long as the OIAI rule is applied properly as if it first became effective January 1, 2018.

On or after January 1, 2019• 403(b) plans that contain the part-time

worker exclusion must apply the OIAI exclusion condition properly in both form and operation.

• May disregard pre-2018 work history.

“Fresh Start”

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Deferrals for Long-Term, Part-Time Employees The new qualified plan “long-term, part-time employee” rule, created by the SECURE Act, is effective for 2021 plan years. This rule does notapply to 403(b) and 457(b) plans.

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Employer Contributions After Separation from Service

Plan permitting, employer contributions may continue for up to 5 years after a participant has separated from service.

1Salary deferral contributions may not continue.2

Employer contributions must cease by the end of the 5th year following the year of the participant’s severance from employment.3

For plans, other than governmental or church plans, such contributions are subject to IRC Sec. 401(a)(4) nondiscrimination testing.4

Such contributions are subject to the IRC Sec. 415 limit for theapplicable year.5

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Helpful Hint: This rule is used primarily in the public educational organization arena. Employer nonelective contributions on behalf of a participant who has severed employment may be paid to the 403(b) arrangement as an early retirement incentive.

NOTE: The final regulations clarify that no contributions can be made beginning with the month following the month of the participant’s death.

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Employer Contributions After Separation from Service

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IRC Sec. 415 Limit• The individual employee limit

on total contributions received for the plan or limitation year.

• This limit applies to all categories of contributions allocated to an employee’s account during the year.

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IRC Sec. 415 Limit

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Lesser of

$58,000 for 2021 (indexed)

100% of an employee’s

compensation

Limit generally applies separately to each 403(b) plan.

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Participation in a Qualified Retirement Plan and a 403(b) Plan

The individual has more than a 50% controlling interest in separate corporations, partnerships, or is a sole proprietor.The individual must combine all contributions for purposes of applying a single IRC Sec. 415 limit.

A 403(b) plan participant also participates in a qualified retirement plan or a SEP plan.The annual additions limit is generally applied separately to each plan regardless of whether one or more related employers are involved.

When a participant “controls” the qualified plan

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EXAMPLE

Dr. X is employed by Community Hospital, which maintains a 403(b) plan.

Dr. X also maintains her own solo medical practice where she maintains a qualified retirement plan.

Because Dr. X “controls” her solo practice where the qualified plan is maintained, her IRC Sec. 415 limit between the two plans is aggregated.

In other words, for 2021 she receives only one $58,000 IRC Sec. 415 limitation, even though she is covered under two plans—the 403(b) plan at the hospital and the qualified plan at her solo medical practice.

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Participation in a Qualified Retirement Planand a 403(b) Plan

Minister’s Housing Allowance

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IRC Sec. 107Nontaxable housing allowance amounts may not be counted as includible compensation for the purposes of calculating contributions to a retirement plan.

OwnedAmount excluded from income is the lesser of• the amount used to

provide a home; • the fair amount

officially designated as rental allowance;

• the home’s fair rental value.

Publication 517A minister can exclude from income an amount officially designated as a rental allowance.

RentedAmount excluded cannot be more than the home’s fair market rental value.

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A retired minister can exclude from gross income the home’s rental value (plus utilities, etc.) provided to the minister by the church as part of her pay for past services, or the part of her pension that was designated as a rental allowance.

Minister’s Housing AllowanceRetired Minister

This exclusion from income applies to federal taxes and self-employment taxes.

This exclusion does not apply to the minister’s surviving spouse.

The exclusion may apply to distributions from church defined contribution plans, including qualified plans and 403(b) plans, but not from IRAs.

The church must formally designate the amount that is designated as the housing allowance. The designation may be done “under the plan” or outside of the plan, generally by a church board resolution.

403(b) Plan Terminations

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The plan sponsor must adopt a binding resolution to

403(b)

authorize the distribution of all benefits as soon as administratively practicable after the termination date

cease plan contributions

fully vest all plan participants on the termination date

establish a plan termination date

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The plan sponsor must take the following actions.

Notify all participants and beneficiaries about the

plan’s termination.

Provide a 402(f) rollover notice to participants and

beneficiaries.

Generally distribute all plan assets within 12 months of the plan’s

termination date.

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Similar to a 401(k) plan termination, the 403(b) plan sponsor may not establish a new 403(b) plan for a period of 12 months.

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Many 403(b) annuity contracts and custodial accounts are “controlled” by the individual plan participant.

The employer is typically not a party to the contract or account and often cannot authorize a distribution when attempting to terminate the plan.

403(b) Plan TerminationsDistributions of annuity contracts and in-kind distributions from custodial accounts

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Distributions of annuity contracts or certificates to participants and beneficiaries

Plan termination allows for a

distribution of the individual annuity

contract or certificate (under a group

annuity contract)

Employer should notify the participant that the account is no longer part of

the plan

Assets must remain subject to the 403(b)

rules in order to remain tax deferred

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Employer should notify the participant that the account is no longer part of the plan

Assets must remain subject to the 403(b) rules in order to remain tax deferred

Plan termination allows for an in-kind distribution of the custodial account for individual and group contracts

In-kind distributions of custodial accounts to participants or beneficiaries

NOTE: The Revenue Rulings allowing in-kind distributions of annuity contracts and custodial accounts do not address the implications of accounts that may be subject to the QJ&S Annuity Rules.

457(b) Plans

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Two Types of Eligible Employers –457(b)

Governmental employers (state or political subdivision of a state)• City/municipal agencies• State/county agencies• Public utility companies• Elementary/secondary schools• Public universities and colleges• City, county, state hospitals• Indian tribal governments (with plans for

employees who perform noncommercial, essential government work)

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Two Types of Eligible Employers –457(b)

Nongovernmental tax-exempt employers• Charitable organizations• Business leagues or boards of trade• Fraternal orders• Labor unions or employee organizations• Rural electrical cooperatives

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Two Types of Eligible 457(b) PlansGovernmental 457(b) Plans

Funded plan

Exempt from Title I of ERISA

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Nongovernmental tax-exempt 457(b) plans (top-hat plans)

• Unfunded plan that covers select group of management or HCEs

• May not cover rank and file employees

• “Top-Hat” plans must file a one-time statement with the DOL within 120 days of establishment

• Generally exempt from Title I of ERISA

• Employee deferrals are often placed in “rabbi trusts”

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Two Types of Eligible 457(b) Plans

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Rabbi TrustsNongovernmental tax-exempt 457(b) plans(top-hat plans)

• Even though assets may be placed in the trust for the future benefit of the participants, the assets remain available to employers’ general creditors

• A rabbi trust is not required to file a federal tax return

• 100% of includible compensation, not to exceed the applicable dollar limit ($19,500 for 2021)

• The $19,500 limit is an overall employee contribution limit under IRC Sec. 457(b)(2), not IRC Sec. 402(g)

• Any employer contributions reduce the maximum $19,500 per year annual contribution limit

• No offset for deferrals to other salary reduction plans– For example, an individual could potentially defer up to $19,500 under a 457(b) plan

and up to $19,500 under a 403(b) or 401(k) plan in 2021– Public educational organizations may maintain a 457(b) plan in conjunction with a 403(b) plan

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Annual Deferral Limit

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• Age 50 catch-up rule and the special 457(b) plan catch-up rule may not be used in the same year– May use whatever rule gives the

better result– Age 50 catch-up contribution is not

aggregated with 403(b) or 401(k) plans

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Age 50 Catch-Up Rule and Special 457(b) Catch-Up Rule

Governmental 457(b) PlansCatch-up Contribution Limit

Tax YearCatch-Up Contribution for

Participants Age 50 and Older

2021 $6,500

EXAMPLE

Participants in a governmental 457(b) plan who also participate in a 403(b) plan can use the age 50 catch-up provisions in both the governmental 457(b) plan and the 403(b) plan.

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Age 50 Catch-Up Rule and Special 457(b) Catch-Up Rule

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Special 457 Plan Catch-Up Provision• Governmental and nongovernmental

tax-exempt 457(b) plans

• Participants within 3 years of normal retirement age may defer the lesser of– Twice the “applicable limit” ($39,000 for

2021), or– The applicable limit for the current year,

plus the amount (if any) the participant under-contributed in prior years under the applicable limit and the “special catch-up rule”

Paula will attain normal retirement age in 2021. She was eligible to use the special catch-up rule in 2018, 2019, and 2020. Her contribution history is shown below. What was her maximum allowable deferral amount for 2020?

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Special 457 Plan Catch-Up Provision Example

Year Gross Comp

Deferral Amount

Deferral Limit

CumulativeUnder-Contributed

Amounts

2016 $50,000 $5,000 $18,000 $13,000

2017 $55,000 $5,500 $18,000 $25,500

2018 $58,000 $6,000 $18,500 $38,000

2019 $60,000 $7,000 $19,000 $50,000

2020 $63,000 ? $19,500 N/A

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Answer: $39,000• She may defer the lesser of

– Twice the applicable 2020 deferral limit (2 x $19,500), or– The 2020 deferral limit, plus all past under-contributed deferral amounts

($19,500 + $50,000 = $69,500).

Special 457 Plan Catch-Up Provision Example

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Normal Retirement Age • May be any age on or after the earlier of

– Age 65, Or

– NRA under the employer’s DB plan (if no DB plan, may use NRA under the employer’s MPP)

• NRA may not be greater than age 70½

• NRA for police and firefighters may be earlier, but not earlier than age 40

• A 457(b) plan may also allow participants to select their own NRA that is within the allowable ranges

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Matching and Employer Contributions• Employers may make

matching and nonelective contributions.

• Matching and other employer contributions reduce a participant’s salary deferral limit for the year (different from 401(k) and 403(b) plan rules).

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Eligible EmployeesIndividuals who perform services for an eligible employer, including• Employees, and• Independent contractors

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457(b) Plan Distribution Triggering Events (Governmental Plans)

Unforseeable emergency

Attainment of age 59½

Death Small account balance

QDRO distributionsBirth or adoption Plan termination

Severance from employment

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457(b) Plan Distribution Triggering Events(Tax Exempt Plans)

Small account balance

QDRO distributions Plan termination

Unforseeable emergency

Attainment of age 70½

DeathSeverance from employment

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Employee Severance From Employment

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Unforeseeable Emergency

Severe financial hardship resulting from

• An illness or accident of the participant or beneficiary, or of the participant’s or beneficiary’s spouse or dependent;

• Loss of the participant’s or beneficiary’s property because of unforeseeable circumstances beyond the participant’s or beneficiary’s control.

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Unforeseeable EmergencyExamples• Imminent foreclosure of or eviction from the

participant’s or beneficiary’s primary residence• Medical expenses (including nonrefundable

deductibles and prescription drug expenses)• Family member’s funeral expenses • Distribution should not be taken if the hardship

could be reasonably relieved through other means– Insurance– Cessation of deferrals– Liquidation of other assets

• Purchase of a home or college tuition generally not unforeseeable emergencies

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Small Account DistributionsMay distribute vested amounts of $5,000 or less (excluding rollover amounts), if

• No employee deferrals or employer contributions for 2-year period ending on date of distribution; and

• No prior distributions to employee under this rule.

Less than $5,000

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Governmental 457(b) Plan Distributions• Amounts are not included in income

until distributed.

• Previously elected irrevocable elections may be modified, plan permitting.

• Most distributions may be rolled into an eligible retirement plan or IRA.

Taxation of 457(b) Plan Distributions

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Governmental 457(b) Plans• Taxed as ordinary income

in the year distributed from the plan

Nongovernmental 457(b) Plans• Distributions are taxed

when distributed or “made available”

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Nongovernmental 457(b) Plan Distributions

Distributions are taxed when distributed or made available.

Distributions not treated as made available if irrevocable election is made to defer to future date. (Must declare both the start date and payout schedule)

Regulations require election to be made 30 days before payment date.

Participant has one additional election to defer (but not to accelerate) distributions before the distribution start date.

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No Early Distribution Penalty Tax• No 10% early distribution

penalty tax on 457(b) plan assets.

• Amounts rolled over from IRAs, QRPs, or 403(b) plans must be separately accounted for and are subject to the 10% early distribution penalty tax.

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Misc. 457(b) Plan Considerations

Roth deferrals may be allowed in governmental plans, but not in tax-exempt plans.

Corrections of excess deferrals• Governmental Plans:

distribute excess plus NIA as soon as practicable after the plan determines an excess has occurred.

• Tax-Exempt Plans: distribute the excess by April 15th following the close of the year the that the excess was made.

Automatic enrollment is allowed in governmental plans, but not in tax-exempt plans.

Questions?

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403(b) and 457(b) plans - beyond the fundamentals

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