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403(b) 15 years-of-service catch-up contribution election

“How does the special 15-year catch-up contribution rule works for 403(b) plans?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Massachusetts is representative of a common inquiry related to 403(b) salary deferrals.

Highlights of the Discussion

The IRS allows certain long-term employees to catch-up on the funding of their 403(b) plans by electing to increase their elective deferrals over the standard dollar limit. The election is available only to employees who have completed at least 15 years of service with one of the following types of employers:

With the exception of church-related organizations or organizations controlled by a church-related organization, years with different employers cannot be added together for purposes of satisfying the 15-year requirement.

Example 1

Anna is a teacher with the West County School System. She has been employed by West County for six years, but worked for the East County School System for 10 years prior to coming to West County. There is a State Teachers Retirement System that covers all of Anna’s years with both West and East Counties. However, only the years that Anna worked while a teacher for West County may be counted for purposes of eligibility for the 15-year catch-up contribution election [see Treas. Regs. 1.403(b)-4(c)(3)(ii)(B) and 1.403(b)-4(e)(3)].

Under the special 15-year catch-up election, the standard annual deferral limit (i.e., $18,500 for 2018) is increased by the lesser of the following three numbers:

  1. $3,000 or
  2. $15,000 minus any elective deferrals previously excluded under this catch-up election, plus any amount of designated Roth contributions in prior years under this catch-up, or
  3. $5,000 multiplied by the employee’s years of service minus the elective deferrals made to plans of the organization in prior taxable years.

There is a lifetime limit of $15,000 for this catch-up election. And, to complicate matters further, an individual age 50 or older may make an additional standard catch-up of $6,000. For an employee eligible to use both the 15-year catch-up and the age 50 catch-up, he or she must apply the 15-year catch-up first. Then an amount may be contributed as an age 50 catch-up to the extent the age 50 catch-up limit exceeds the 15-year catch-up limit.

Example 2

Let’s apply all this in an example.

For 2018, Dion, age 50, has taxable compensation of $70,000. He has worked for the local hospital for 15 years. Dion has made no other elective deferrals during the year, and this will be the first year he contributes to the hospital’s 403(b) plan.

The general 402(g) limit is $18,500. Dion can use up to $3,000 of the 15-year catch-up, and he qualifies for the age 50 catch up of $6,000. Therefore, the maximum amount Dion can elect to defer is $27,500 ($18,500 + $3,000 + $6,000). If Dion defers only $24,500, then $3,000 will count as his 15-year catch-up contribution (reducing future 15-year catch-up contributions because of the $15,000 lifetime limit) and $3,000 will count as his age 50 catch-up.

Example 3

Similarly, Fiona, age 50, has taxable compensation of $70,000 for 2018. She has worked for the local hospital for 20 years. Fiona has made no other elective deferrals during the year, but she has made elective deferrals in prior years to the 403(b) plan of $175,000.

The general 402(g) limit is $18,500. The 15-year catch-up is only available if prior deferrals do not exceed $5,000 x her years of service (i.e., $5,000 x 20 = $100,000). Fiona had prior deferrals of $175,000. Therefore, she has used up her 15-year catch-up. However, because she has attained age 50, she is eligible for the age 50 catch-up limit of $6,000. Consequently, the maximum Fiona can elect to defer is $24,500 ($18,500 plus $6,000 under the age 50 catch-up).

Be sure to check the terms of the 403(b) document for any additional limitations that may apply on salary deferrals.

Conclusion

Certain long-tenured 403(b) plan participants who work for eligible employers such as a public school system, hospital or church have special considerations when it comes to the maximum amount they can defer into their 403(b) plans. Plan language can also affect how much participants are eligible to contribute. The rules are complicated; therefore, 403(b) plan participants should be encouraged to discuss their contributions with a tax advisor.

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Changes to hardship distributions for 2019

“Are the rules for hardship distributions from 401(k) plans changing?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Illinois is representative of a common inquiry related to hardship distributions.

Highlights of the Discussion

Yes, changes to the hardship distribution rules for 401(k) plans as a result of the Bipartisan Budget Act of 2018 will take effect for the 2019 plan year (e.g., as of January 1, 2019, for calendar year plans). There are three primary changes to the current hardship distribution rules.

Participants will

  1. Not be required to take plan loans before a hardship distribution is granted;
  2. Not need to suspend their employee salary deferrals for six months following a hardship withdrawal; and
  3. Will be able to distribute other types of contributions beyond employee salary deferrals and grandfathered, pre-1989 earnings thereon as part of a hardship distribution, including qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), safe harbor contributions, and earnings from all eligible sources (including post 1988 earnings on elective deferrals).

Items 1. and 2. are currently part of the IRS’s requirements for a hardship distribution to meet the safe harbor definition of “necessary to satisfy an immediate and heavy financial need.” [See Treasury Regulation Section 1.401(k)-1(d)(3)].

In order to implement the new provisions, plan sponsors will need to

  • Update their hardship distribution procedures,
  • Ensure plan record keepers are making necessary administrative changes, and
  • Review plan document language for necessary amendments.

We believe it was Congress’s intent to have the same changes apply to hardship distributions from 403(b) plans, but clarifying guidance from the IRS is needed. Treasury regulations under Section 403(b) of the Internal Revenue Code state that a hardship withdrawal from a 403(b) plan has the same meaning, and is subject to the same rules and restrictions, as a hardship withdrawal under the 401(k) regulations [see Treasury Regulation Section 1.403(b)-6(d)(2)]. The Treasury Secretary has until early 2019 to modify the current 401(k) regulations to reflect the new hardship distribution rules.

Conclusion

Come 2019, plan sponsors may incorporate softer hardship distribution rules into their plans, policies and procedures as a result of changes under the Bipartisan Budget Act of 2018.

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Suspending Plan Loan Repayments

“Under what circumstances, if any, can a 401(k) plan participant with an outstanding plan loan suspend repayments?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Massachusetts is representative of a common inquiry related to plan loans.

Highlights of Discussion

There are just two scenarios under which the IRS will allow a plan to suspend loan repayments of a participant with an outstanding loan: 1) in the case of a leave of absence of up to one year or 2) for the period during which an employee is performing military service [Treasury Regulation Section 1.72(p)-1, Q&A-9(a) and (b)]. Check the terms of the plan document and loan agreement regarding a participant’s ability to suspend loan repayments.

If a plan permits loan repayments to be suspended during a leave of absence, upon return, the participant must make up the missed payments either by increasing the amount of each monthly payment or by paying a lump sum at the end, so that the term of the loan does not exceed the original five-year term.

EXAMPLE: Leave of Absence

On July 1, 2018, Adrian borrows $40,000 from her 401(k) account balance under the agreement that it will be repaid in level monthly installments of $825 over five years (by June 30, 2023). Adrian makes nine payments and then starts a one-year, nonmilitary leave of absence. When Adrian resumes active employment, she also resumes making her loan repayments. However, the amount of monthly installment is increased to $1,130 in order to repay the loan by the end of the initial five-year term. Alternatively, she could have continued making the monthly $825 installment payment, provided she repaid the full balance due at the end of the five-year term (i.e., make a balloon payment).

A plan may permit a participant to suspend loan repayments during a leave of absence for military service (as defined in Chapter 43 of Title 38, United States Code). In such cases, the participant will not violate the level payment requirement provided loan repayments resume at the end of the military service, the frequency and amount of payments is not less than what was required under the terms of the original loan, and the loan is repaid in full (including interest that accrues during the period of military service) by the end of the loan term, which is five years, plus the period of military service.  Consequently, the suspension could exceed one year and the term of the loan could exceed five years.

Of additional note on suspensions due to military service, the plan is limited on the rate of interest it may charge on the loan during the period of military service to six percent. A loan is subject to the interest rate limitation if the following are true: 1) the loan was incurred prior to the military service; and 2) the participant provides the plan with a written notice and a copy of the military orders within 180 days after the date of the participant’s release or termination from military service [Service Members Civil Relief Act of 2003 (SCRA) Pub. L. No. 108-189]. The plan must forgive any interest that exceeds six percent. For this purpose, “interest” includes service charges, renewal charges, fees, and any other charges (except bona fide insurance).

EXAMPLE: Military Service

On July 1, 2018, Joshua borrows $40,000 from his 401(k) account balance under the agreement that he will repay it in level monthly installments of $825 over five years (by June 30, 2023). Joshua makes nine payments and then starts a two-year, military leave of absence. His service ends on April 2, 2021, and he resumes active employment on April 19, 2021, after which, he resumes making loan repayments in the amount of $825. On June 30, 2025, Joshua makes a balloon payment for the full remaining balance due.

Alternatively, Joshua could have increased the monthly repayment amounts so no remaining balance was due at the end of the term (i.e., June 30, 2025).

Conclusion

Under limited circumstance, plans may suspend loan repayments for participants. Be sure to check the terms of the plan document and loan agreement for specific procedures and requirements.

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Maximum contributions to 403(b), 401(k) and 457(b) plans

“One of my clients participates in a 401(k) plan [her own “solo (k)”], plus a 403(b) plan and a 457(b) plan (through the public school system). Her accountant is telling her that she, potentially, could contribute twice the $18,500 deferral limit for 2018. How can that be so?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans, including nonqualified plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Massachusetts is representative of a common inquiry related to the maximum annual limit on employee salary deferrals.

Highlights of Discussion

First off, kudos to your client for working with you and a tax advisor in order to determine what amounts she can contribute to her employer-sponsored retirement plans as this is an important tax question based on her personal situation that is best answered with the help of professionals. Generally speaking, it may be possible for her to contribute more than one would expect given the plan types she has and based on existing plan contribution rules, which are covered in the following paragraphs.

For 2018, 457(b) contributions (consisting of employee salary deferrals and/or employer contributions combined) cannot exceed $18,500, plus catch-up contribution amounts if eligible [Treasury Regulation Section (Treas. Reg. §1.457-5)]. Since 2002, contributions to 457(b) plans no longer reduce the amount of deferrals to other salary deferral plans, such as 401(k) plans. A participant’s 457(b) contributions need only be combined with contributions to other 457(b) plans when applying the annual contribution limit. Therefore, contributions to a 457(b) plan are not aggregated with deferrals an individual makes to other types of plans.

In contrast, the application of the maximum annual deferral limit under Internal Revenue Code Section (IRC §) 402(g) (the “402(g) limit”) for an individual who participates in both a 401(k) and a 403(b) plan requires the individual to aggregate deferrals between the two plans [Treas. Reg. §1.402(g)-1(b)]. Consequently, an individual who participates in both a 457(b) plan and one or more other deferral-type plans, such as a 403(b), 401(k), salary reduction simplified employee pension plan, or savings incentive match plan for employees has two separate annual deferral limits. Let’s look at an example.

Example #1:

For 2018, 32-year-old Erika has an individual 401(k) plan for her business as a self-employed tutor. She is also on the faculty at the local state university, and participates in its 457(b) and 403(b) plans. Assuming adequate levels of compensation, Erika can defer up to $18,500 between her 401(k) plan and her 403(b) plan, plus another $18,500 to her 457(b) plan.

Also, keep in mind the various special catch-up contribution options depending on the type of plan outlined next.

Catch-Up Contribution Options by Plan Type

401(k) 403(b) 457(b)
Age 50 or Over Option

 

Employees age 50 or over can make catch-up contributions of $6,000 beyond the basic 402(g) limit of $18,500.

 

15-Years of Service with Qualifying Entity Option:[1]

402(g) limit, plus the lesser of

1) $3,000 or

2) $15,000, reduced by the amount of additional elective deferrals made in prior years because of this rule, or

3) $5,000 times the number of the employee’s years of service for the organization, minus the total elective deferrals made for earlier years.

 

Age 50 or Over Option

 

Employees age 50 or over can make catch-up contributions of $6,000 beyond the basic 402(g) limit.

 

Note: Must apply the 15-year option first

Age 50 or Over Option

Employees age 50 or over can make catch-up contributions of $6,000 beyond the basic 457 deferral limit of $18,500.

Special “Last 3-Year” Option

 

In the three years before reaching the plan’s normal retirement age employees can contribute either:

•Twice the annual 457(b) limit (in 2018, $18,500 x 2 = $37,000),

 

Or

 

•The annual 457(b) limit, plus amounts allowed in prior years not contributed.

 

Note: If a governmental 457(b) allows both the age-50 catch-up and the 3-year catch-up, one or the other—but not both—can be used.

 

415 Annual Additions Limit

Another consideration when an individual participates in more than one plan is the annual additions limit under IRC Sec. 415(c),[2] which typically limits plan contributions (employer plus employee contributions for the person) for a limitation year [3] made on behalf of an individual to all plans maintained by the same employer. However, contributions to 457(b) plans are not included in a person’s annual additions (see 1.415(c)-1(a)(2). With respect to 403(b) plans and the 415 annual additions limit, there are special plan aggregation rules that apply.

Generally, the IRS considers 403(b) participants to have exclusive control over their own 403(b) plans [Treas. Reg. Section 1.415(f)-1(f)(1)]. Therefore, in many cases, contributions to a 403(b) plan are not aggregated with contributions to any other defined contribution plan of the individual (meaning two 415 annual additions limits in some cases). An exception to this rule, however, occurs when the participant is deemed to control the employer sponsoring the defined contribution plan in which he or she participates. In such case, a participant must aggregate his or her 403(b) contributions with contributions to any other defined contribution plans that he or she may control [see  IRC § 415(k)(4)].Regarding the treatment of catch-up contributions, the “Age 50 or Over” catch-up contributions [see 1.415(c)-1(b)(2)(ii)(B)] are not included as annual additions, regardless of plan type, whereas the 403(b) “15-Years of Service” catch-up contributions are included as annual additions (IRS 403(b) Fix-It Guide.)

Example #2

Adam is a non-owner, employee of an IRC 501(c)(3) organization that contributes to a 403(b) plan on his behalf. Adam is also a participant in the organization’s defined contribution plan. Because Adam is deemed to control his own 403(b) plan, he is not required to aggregate contributions under the qualified defined contribution plan with those made under the 403(b) plan for purposes of the 415 annual additions test.

 

Example #3

The facts are the same as in Example #2, except that Adam is also a participant in a defined contribution plan of a corporation in which he is more than a 50 percent owner. The defined contribution plan of Adam’s corporation must be combined with his 403(b) plan for purposes of applying the limit under IRC 415(c) because Adam controls his corporation and is deemed to control his 403(b) plan.

Example #4

Dr. U.R. Well is employed by a nonprofit hospital that provides him with a 403(b) annuity contract. Doctor Well also maintains a private practice as a shareholder owning more than 50% of a professional corporation. Any qualified defined contribution plan of the professional corporation must be aggregated with the IRC 403(b) annuity contract for purposes of applying the 415 annual additions limit.

For more examples, please see the IRS’ Issue Snapshot – 403(b) Plan – Plan Aggregation.

Conclusion

Sometimes individuals who are lucky enough to participate in multiple employer-sponsored retirement plan types are puzzled by what their maximum contribution limits are. This is especially true when a person participates in a 401(k), 403(b) and 457(b) plan. That is why it is important to work with a financial and/or tax professional to help determine the optimal amount based on the participant’s unique situation.

[1] A public school system, hospital, home health service agency, health and welfare service agency, church, or convention or association of churches (or associated organization)

[2] For 2018, the limit is 100% of compensation up to $55,000 (or $61,000 for those > age 50).

[3] Generally, the calendar year, unless the plan specifies otherwise

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Can a plan sponsor merge 401(k) and 403(b) plans?

“I have at least one of my plan sponsor clients who has both a 401(k) plan and a 403(b) plan. Could my client merge the two plans in order to consolidate the assets?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in New York is representative of a common inquiry involving the merging of retirement plans.

Highlights of Discussion

  • Save for two exceptions, no, your client cannot merge 403(b) assets with an unlike plan (e.g., a profit sharing, 401(k), 457(b) plan, etc.) without causing the 403(b) assets to become taxable to the participants. Such a transfer could also jeopardize the tax-qualified status of the 401(k) plan.
  • 403(b) plan assets may only be transferred to another 403(b) plan. Further, the final 403(b) regulations are clear that neither a qualified plan nor a governmental 457(b) plan may transfer assets to a 403(b) plan, and a 403(b) plan may not accept such a transfer (see Treasury Regulation Section 1.403(b)-10 and Revenue Ruling 2011-07).
  • The two exceptions noted previously are plan-to-plan transfers by participants to governmental defined benefit plans in order to 1) purchase permissive service credits; or to make a repayment of a cash out.
  • This does not preclude a 403(b) or 401(k) participant with a distribution triggering event (such as plan termination) to distribute and complete a rollover to another eligible plan [e.g., a 401(k) or 403(b) plan] that accepts such amounts.

Conclusion

While there are similarities between a 401(k) plan and 403(b), the IRS treats them as unlike plans and, therefore, incompatible, for the purpose of plan-to-plan transfers or mergers. Participant rollovers, on the other hand, are potentially possible between the two.

 

 

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403b plan
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Nonprofit with 401(k) and 403(b)

Can a 403(b) plan merge with a 401(k) plan?

“I have a tax-exempt client that currently offers a 401(k) plan. The group is taking over another IRC Sec. 501(c)(3) tax-exempt entity that has a 403(b) plan.  Can the acquiring entity merge the 403(b) plan into the 401(k) plan?”  

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • No, generally the IRS does not allow mergers or transfers of assets between 403(b) and 401(k) plans [Treasury Regulation 1.403(b)-10(b)(1)(i)]. The IRS has stated in private letter rulings (PLRs) that if a 403(b) plan is merged with a plan that is qualified under IRC Sec. 401(a), the assets of the 403(b) plan will be taxable to the employees PLR 200317022.
  • One option would be to terminate the 403(b) plan, which would allow its participants to receive distributions (See the IRS’ Terminating a 403(b) Plan for more information).
  • The participants in the terminated 403(b) plan who receive eligible rollover distributions from the 403(b) plan would have the option to roll the amounts to the 401(k), provided the 401(k) plan permits rollover contributions (Revenue Ruling 2011-7 and IRS Rollover Chart.)

Conclusion

IRC Sec. 501(c)(3) tax-exempt entities have the ability to maintain both 401(k) and 403(b) plans independently. The IRS does not allow a sponsor to merge the two plan types, however.   A plan termination followed by participant rollovers may be a viable alternative to merging the plans.

 

 

 

 

 

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