the good, the bad and the ugly of 401(a), 457(b) and 403(b ...€¦ · 10/17/2016 3 403(b) plan...

10/17/2016

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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]

10/17/2016

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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 Employers403(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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4 types of Qualified Employers2. 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 Employers4.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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ExampleThe Private Big Diehl

School

TPA

Vendors

1 2 3 4

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“Accumulated Benefit”

Signs an “ISA”

“Deselected Vendor”

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 NON-QCCOs

402(g) LimitTaxpayer 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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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 & groupcustodial 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

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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

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 tax-exempt 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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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

Pre-Tax only, No Roth deferrals N/A

Age 50 Catch-up Not applicable Not applicable

Special 3-year catch-up Up to 2 X the normal deferral limit Not applicable

Responsibility for

Withholding

Tax-exempt Entity Employer

Rollovers to other Plans 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

No No

Trust required 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 ProfessorsAdjunct 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 ProfessorsOne 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-ExampleThe 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 5305-SEP)

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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 $18,000* 457(b) Defers the maximum $18,000*457(f) Employer Contribution $15,000ESTIMATED TOTAL FOR YEAR 2016 $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 $24,000

403(b) Employer Contribution $10,000 (For 2017-2021)

457(b) Defers the maximum $24,000

401(a) Employer Contributes $20,000

ESTIMATED TOTAL FOR YEAR $78,000

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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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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• 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


• 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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Outstanding LRM IssuesWin 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


• 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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• 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 IssuesOnce 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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• 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


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 ProcessReview 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 ProcessCommon 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


• 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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• 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. 63