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What’s My Limit? Contributions to both a 403(b) and a governmental 457(b) plan

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“One of my clients participates a 403(b) plan and a governmental 457(b) plan (through a state university). Her accountant is telling her that she, potentially, could contribute $41,000 of deferrals between the two plans for 2022.  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 Illinois is representative of a common inquiry related to the maximum annual limit on employee salary deferrals.

Highlights of Discussion

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 contributions rules, which are covered in the following paragraphs. Your client should rely on her tax advisor in order to determine what amounts she can contribute to her employer-sponsored retirement plans because this is an important tax question that is best answered with the help of professionals.

For 2022, 457(b) contributions (consisting of employee salary deferrals and/or employer contributions combined) cannot exceed $20,500, plus catch-up contribution amounts ($6,500) 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) or 403(b) 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 governmental 457(b) plan are not aggregated with deferrals an individual makes to other types of deferral plans.

Consequently, an individual who participates in both a governmental 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. Here’s an example.

Example

For 2022, 32-year-old Toni is on the faculty at the local state university and participates in its 457(b) and 403(b) plans. Assuming adequate levels of compensation, Toni can defer up to $20,500 in her 403(b) plan, plus another $20,500 to her 457(b) plan—for a total of $41,000.

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

 

403(b) 457(b)
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 $6,500 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 $6,500 beyond the basic 457 deferral limit of $20,500.

 

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 2022, $20,500 x 2 = $41,000),

 

Or

 

•The annual 457(b) limit, plus amounts allowed in prior years but 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.

 

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).

 

Conclusion

Sometimes individuals who are lucky enough to participate in multiple employer-sponsored retirement plan types may be puzzled by what their maximum contribution limits are. This is especially true when a person participates in a 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 or private school, hospital, home health service agency, health and welfare service agency, church, or convention or association of churches (or associated organization) and it is allowed by the terms of the plan document

[2] For 2022, the limit is 100% of compensation up to $61,000 (or $67,500 for those > age 50).

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

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Check Your Plan for ACA Notice Requirements

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“My client’s 401(k) plan has an automatic contribution arrangement (ACA) with immediate plan eligibility. How can the notice and plan entry requirements for this plan be satisfied?”

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in Wisconsin addressed a question on an ACA.

Highlights of the Discussion

The notice requirements for an ACA are that an eligible employee have an “effective opportunity” to make or change an election at least once during each plan year [see Treas. Reg. Section 1.401(k)-1(e)(2)(ii)]. Effective opportunity is based on a “facts and circumstances” test.  Consequently, determining effective opportunity when a plan has immediate eligibility can be tricky.

According to IRS Revenue Ruling 2000-8, an effective opportunity occurs if the employee receives notice of the availability of the election and the employee has a “reasonable” period before the cash is currently available to make the election.  Here again, reasonable, is based on facts and circumstances. For a plan that provides for immediate entry—the notice will still be considered timely, provided the employer gives it as soon as possible after the employee’s eligibility date, and the employee may elect to defer on any compensation earned beginning on the date he or she becomes eligible. But be aware of plan document provisions that may address notice and deferral timing and/or recordkeeping platforms that may impose a “30-90 days prior” timing requirement.

IRS Notice 2009-65 contains sample plan document language that can be used for adding automatic enrollment to plans.  The notice specifies, “At least 30 days, but not more than 90 days, before the beginning of the Plan Year, the Employer will provide each Covered Employee a comprehensive notice …”  An IRS Issue Snapshot points out that

“… if the plan document has specific language describing annual notice and election requirements, compliance in operation is required. For example, Notice 2009-65, 2009-39 I.R.B. 413, includes sample language for an ACA plan that is neither a QACA[1] nor an EACA[2]. The sample language includes a mandatory annual notice to participants that must be distributed at least 30 days but not more than 90 days before the beginning of a plan year. It is common for plans to adopt the IRS’ sample plan language.”

Further, some recordkeeping systems will not allow a new plan participant to be added until after 30 days from date of hire as that is their set internal process tied to the safe harbor for notice distribution.

Conclusion

Under an ACA, an eligible employee must receive notice of the availability of the deferral election and be given a reasonable period before the cash is currently available to make the election. A reasonable period is based on facts and circumstances, but be sure to check the plan document for specific language or recordkeeper internal processes that may affect the timing.

[1] Qualified Automatic Contribution Arrangement

[2] Eligible Automatic Contribution Arrangement

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Making a “1042” Election

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“My client has an ESOP and several employees have inquired about making a ‘1042 election.’  Can you explain what a 1042 election is and how it is made?”

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in Illinois involved questions on stock exchanges under IRC Sec. 1042.

Highlights of the Discussion

How to make a proper 1042 election is a very important tax and legal question. That is why my first response is to say that an individual contemplating such a move should work with an experienced tax or legal advisor to ensure proper filing of the 1042 election. What follows is for informational purposes only and should not be construed or relied upon as tax or legal advice.

Basically, a 1042 election allows qualifying individuals and entities to defer capital gains tax on “qualified securities” sold to an Employee Stock Ownership Plan (ESOP) if the proceeds of the sale are reinvested in “qualified replacement property” (QRP) as defined in IRC Sec. 1042(c)(4). For a general overview of qualified securities and QRP, please see an earlier Case of the Week ESOP Tax Advantaged 1042 Exchange.

Treasury Regulations Section 1.1042-1T prescribe the requirements of a proper 1042 Election. Also, see IRS Publication 550, Investment Income and Expenses  page 62 for filing details as well as Part II of IRS Form 8949, Sales and Other Dispositions of Capital Assets  and the instructions, along with Schedule D of Form 1040  and the accompanying instructions.

The IRS guidance states a taxpayer that meets the qualifications for a 1042 election, must attach three statements to his or her tax return filed with the IRS to successfully communicate his or her intent to make a 1042 election to defer capital gains tax (See Pub. 550 page 63 and PLR 200019002).

  1. Statement of Election: The filer must demonstrate his or her express written intent to elect not to recognize capital gains with respect to the sale of C corporation stock to an ESOP under IRC Sec. 1042. A very detailed description of the sale must accompany the election.
  2. Notarized Statement of Purchase: The filer must provide a signed and timely notarized statement that he or she has completed the sale of stock to the ESOP. The statement must also describe the QRP, date of purchase, the cost of the property and declare the property to be QRP for the qualified stock sold to the ESOP.
  3. Statement of Consent: The company sponsoring the ESOP must provide written consent to allow the filer to defer taxes on the sale. It must also consent to the application of certain IRS penalties under IRC Secs. 4978 and 4979A if the company sells shares purchased by the ESOP within three years or allocates them to the selling shareholder(s) and/or their families.

According to Publication 550, the filer must also attach to his or her tax filing an appropriately completed IRS Form 8949.

Conclusion

As this general description alludes, making a 1042 election to defer capital gains tax on a sale of qualified securities to an ESOP is highly nuanced. Anyone contemplating such a transaction should work with an experienced tax or legal advisor to ensure proper execution.

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