403(b) Questions, Answered.
Summary paragraph: Calculating 403(b) catch-ups; contributing to church plans; state-sponsored plans
Q: We have many individuals who utilize the 15-year catch-up election in our 403(b) plan, and, for that and other reasons, it would not be practical to eliminate it immediately. Until such point that we can get rid of this provision, how can we maximize our chances that the calculations will be performed correctly?
A: Although the 15-year catch-up calculation is extremely difficult to perform, there are steps you can take in working with the third party making the calculation-e.g., the recordkeeper or adviser-to maximize the chances it will calculate correctly. These are as follows:
* Make sure all relevant data is obtained. This data will be different for each employee, as it needs to cover all elective deferrals from all recordkeepers throughout each person's working career.Do you currently use more than one recordkeeper? All such vendors must supply you with records of deferrals for each employee for every year. Aggregation is required if an employee used more than one recordkeeper in a calendar year. This includes switching from one recordkeeper to another or utilizing two recordkeepers simultaneously. Did you have a different recordkeeper 10 years ago? Twenty years ago? Presuming you have employees with more than 10/20 years of service, you will need detailed annual deferral data for any who used those earlier vendors, as well.
* Make certain that the use of the age-50 and 15-year catch-up elections in prior years are thoroughly documented. For the 15-year catch-up election, documentation must be done for all years of employment with you, beginning with year 15. For the age-50 catch-up, it begins with the calendar year in which the employee turned 50, but only as of 2002 and later.
Why do we mention 2002? That is the year an added level of complexity was integrated into the 15-year catch-up election calculation. Beginning that year, as a participant could apply either the age-50 or 15-year catch-up election, deferrals have been subject to a special ordering rule. Thereby, deferrals in excess of the basic 402(g) limit for any year in question are considered to be 15-year catch-up contributions until that limit is exhausted and then age-50 limit deferrals after that. This creates situations where a participant thinks he had been using the age-50 catch-up election and he actually was using the 15-year. When, in later years, he attempts to use the 15-year catch-up election, he makes excess deferrals, as, unbeknownst to him-and often to the recordkeeper/adviser/plan sponsor as well-the 15-year election has already been exhausted. Often, this issue is not discovered until the plan is audited, leading to substantial correction costs for the plan sponsor.
Some professionals are aware of the intricacies of these calculations and indeed can perform them correctly. If you wish to retain the 15-year catch-up election, it is imperative that you engage those who are subject matter experts in this regard.
Contributing to Church Plans
Q: Are there still rules that allow church employees to contribute more than they might normally be able to under the existing contribution limits?
A: Yes, such rules apply to all church plans, including plans of churches and qualified church-controlled organizations (QCCOs) under 3121(w) as well as to non-QCCO religious organizations such as church hospitals. These unique church plan rules are as follows:
* There is an election, subject to a $40,000 lifetime maximum, under which church employees may exceed their Internal Revenue Code (IRC) Section 415 percentage limit-generally, 100% of compensation-up to an annual maximum of $10,000. This election can be useful to, for example, individuals who have taken a vow of poverty and
thus receive little or no compensation from the church. Even if such a person receives zero compensation, $10,000 may be contributed to a 403(b) on his behalf for a period of four years-i.e., $10,000 x 4 = $40,000 lifetime limitThere is an election under which foreign missionaries may contribute the greater of $3,000 or their includible compensation under Section 403(b)(3).
* Besides these two church plan elections, there is a special way that service is counted for church employees for purposes of the 15-year catch-up election. All years of an individual's church service, regardless of whether he performed it for the current church plan sponsor, are aggregated to determine whether he has completed the number necessary to qualify for the catch-up.
Keep in mind that certain ministers or chaplains who are self-employed can make elective contributions of their own funds to a church 403(b)(9) plan up to the usual elective contribution limits and deduct them from their individual income taxes as an above-the-line deduction. That appears in the deduction rules of IRC Section 404(a)(10). Of course, the plan must permit such contributions.
Q: I realize that a state may sponsor a 457(b) plan, and such plans appear to be quite common. But what about 403(b) and 401(k) plans? I see what appear to be state-sponsored 403(b) and 401(k) plans, but I thought states were not permitted to sponsor such plans.
A: We agree that the 457(b) plan is by far the most common sponsored-plan model we see by which public-sector employees can make elective deferrals. Some states have also moved to sponsoring defined contribution (DC) 401(a) plans as an alternative to the traditional defined benefit (DB) pension plan that many state retirement systems offer.
Though certain states sponsor 401(k) plans, these are less common. The reason is that the Tax Reform Act of 1986 (TRA 86) eliminated the adoption of new 401(k) plans by states. However, under Treasury Regulation 1.401(k)-1(e)(4)(ii), plans that were in existence prior to May 7, 1986, were grandfathered, meaning that such plans could be maintained and new employees enrolled.
As for 403(b) plans, the situation is a bit more complex. A state may sponsor a 403(b) plan but only for its public school employees. When sponsoring such a plan, a state may do so directly; more typically, however, it will sponsor its 403(b) plans through a state agency-these are also permitted to sponsor 403(b) plans-that deals with educational matters, such as a state board of regents or a state department of education.
Contributors David Levine and David Powell, both principals with Groom Law Group, Chartered, and Michael Webb, vice president, retirement plan services, Cammack Retirement Group, will field selected questions concerning 403(b) plans and regulations, for use in this column. This article is meant to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
Do you have a 403(b) question? Send it to firstname.lastname@example.org (email@example.com) with the subject line: Ask the Experts. Questions must be of a general nature and of interest to a majority of plan sponsors.