Posts

Print Friendly Version Print Friendly Version

A tale of two 457(b) plans

“Are there differences between 457(b) plans for tax-exempt entities and governmental entities and, if so, what are the differences?”

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 a financial advisor from Wisconsin is representative of a common inquiry related to 457 plans.

Highlights of the Discussion

A plan established under IRC §457(b) allows employees of eligible sponsoring employers to set aside a portion of their income on a tax-deferred basis for receipt and taxation at a later date (similar to a 401(k) or 403(b) plan). You may sometimes hear them referred to as “eligible deferred compensation plans” because they follow the rules of subsection (b) under IRC §457 as opposed to “ineligible” plans as defined under IRC §457(f).

Two types of employers can establish 457(b) plans:  1) state or local governmental entities; or 2) tax-exempt organizations pursuant to IRC §501. While there are some similarities between a governmental 457(b) plan and a tax-exempt 457(b) plan, there are some very important differences, including, but not limited to, funded status, plan loans, catch-up contributions, when amounts are taxable, and eligibility for roll over to another plan.

The IRS has compiled this handy comparison chart (recreated below) to help those who work with or participate in 457(b) plans understand in more detail the similarities and differences between plan operations for the two types of employers that sponsor them.

  Tax-Exempt 457(b) plan Governmental 457(b) plan
Eligible employer IRC §501 tax-exempt employer that isn’t a state or local government (or political subdivision, instrumentality, agency) State or local government or political subdivision or instrumentality or agency
Written plan document required? Yes Yes
Eligible participants Limited to select group of management or highly compensated employees Employees or independent contractors who perform services for the employer may participate
Coverage; nondiscrimination testing No No
Salary reduction contributions (employee elective deferrals) permitted? Yes Yes
Ability to designate all or portion of salary reduction contribution as a Roth contribution No Yes
Employer contributions permitted? Yes Yes
Salary reduction contribution limit, in general Lesser of applicable dollar limit ($19,000 in 2019) or 100% of participant’s includible compensation Lesser of applicable dollar limit ($19,000 in 2019) or 100% of participant’s includible compensation
Increased salary reduction limit for final 3 years before attaining normal retirement age Lesser of:

  • 2 x applicable dollar limit ($38,000 in 2019) or
  • applicable dollar limit plus sum of unused deferrals in prior years (only if deferrals made were less than the applicable deferral limits (Note: age 50 catch up contributions not allowed; no coordination needed))
Lesser of:

  • 2 x applicable dollar limit ($38,000 in 2019) or
  • applicable dollar limit plus sum of unused deferrals in prior years (to the extent that deferrals made were less than the applicable limits on deferrals; age 50 catch up contributions aren’t counted for this purpose)

Note: Can’t use the increased limit if using age 50 catch up contributions. Therefore, in years when an employee is eligible to take advantage of both, the employee can use the higher of the two increases to the limit.

Salary reduction contribution limits- Age 50 catch-up contributions (for individuals who are age 50 or over at the end of the taxable year) Not permitted Salary reduction dollar limit increased by $6,000 (up to a total of $25,000 in 2019)

Note: See above. Can’t use in years that a participant is taking advantage of the increased limit during the final 3 years before attaining normal retirement age.

Timing of election to make salary reduction contribution Before the first day of the month in which the compensation is paid or made available Before the first day of the month in which the compensation is paid or made available
Total contribution limits (both salary reduction and employer contributions) Same as limit for salary reduction contributions. So, any employer contribution limits the amount of salary reduction contribution an employee can make (and vice versa) Same as limit for salary reduction contributions. So, any employer contribution limits the amount of salary reduction contribution an employee can make (and vice versa)
Correcting excess elective deferrals Distribute excess (plus allocable income) by April 15 following the close of the taxable year of excess deferral Distribute excess (plus allocable income) as soon as administratively practicable after the plan determines that the amount is an excess deferral
Contributions to trust? No Yes
Participant loans permitted? No Yes
Hardship distributions permitted? Yes, if both:
1. the distribution is required as a result of an unforeseeable emergency, for example, illness, accident, natural disaster, other extraordinary and unforeseeable circumstances arising from events beyond the participant’s (or beneficiary’s) control
2. the participant exhausted other sources of financing and the amount distributed is necessary to satisfy the emergency need  (and tax liability arising from distribution)
Yes, if both:
1. the distribution is required as a result of an unforeseeable emergency, for example, illness, accident, natural disaster, other extraordinary and unforeseeable circumstances arising from events beyond the participant’s (or beneficiary’s) control and
2. the participant exhausted other sources of financing and the amount distributed is necessary to satisfy the emergency need (and tax liability arising from distribution)
Automatic Enrollment permitted? No Yes
Taxation Earlier of when made available or distribution Distribution
Distributable events
  • Attainment of age 70 ½
  • Severance from employment
  • Unforeseeable emergency (see above)
  • Plan termination
  • Qualified domestic relations order
  • Small account distribution (not to exceed $5,000)
  • Attainment of age 70 ½
  • Severance from employment
  • Unforeseeable emergency (see above)
  • Plan termination
  • Qualified domestic relations order
  • Small account distribution  ($5,000 or less)
  • Permissible Eligible Automatic Contribution Arrangement (EACA) withdrawals
Required minimum distributions under Internal Revenue Code Section 401(a)(9) Yes Yes
Rollovers to other eligible retirement plans (401(k), 403(b), governmental 457(b), IRAs) No Yes
Availability of statutory period to correct plan for failure to meet applicable requirements No Yes, until 1st day of the plan year beginning more than 180 days after notification by the IRS
Availability of IRS correction programs including the Employee Plans Compliance Resolution System (EPCRS) under Revenue Procedure 2019-19 Generally, not available to correct failures for an unfunded plan benefiting selected management or highly compensated employees. May consider closing agreement proposals when nonhighly compensated are erroneously impacted. Can apply for a closing agreement with a proposal to correct failures. Proposal is evaluated according to EPCRS standards.

 

Conclusion

While there are some similarities between governmental 457(b) plans and a tax-exempt 457(b) plans, there are some very important differences of which to be aware.

© Copyright 2019 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Correcting governmental 457(b) plans

“Does the IRS have a correction program that covers 457(b) plans for governmental employers under the Employee Plans Compliance Resolution System (EPCRS)?”

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 Ohio is representative of a common inquiry related to correcting 457(b) plan errors.

Highlights of the Discussion

Effectively, yes. The two avenues of correction for governmental 457(b) plans are 1) self correction (without a submission); and 2) voluntary compliance (VC) with a formal submission. The IRS accepts VC submissions for governmental plans on a provisional basis under standards that are similar to EPCRS, but that are, technically, outside of the correction system. Qualifying governmental entities are listed in Internal Revenue Code (IRC) § 457(e)(1)(A), and include a

  • State;
  • Political subdivision of a state (e.g., a county, city, town, township, village or school district); and
  • Any agency or instrumentality of a state or political subdivision of a state.

Sponsors of governmental 457(b) plans may self-correct their plans without a formal IRS submission if they did not comply with the Internal Revenue Code (IRC) or regulations in some way. A sponsor has until the first day of the plan year that begins more than 180 days after the IRS notifies it of the failure (IRC Section 457(b)(6) and Treasury Regulation Section 1.457-9(a)). Considering the amount of time governmental entities have to self-correct plan errors, they may not need to make voluntary submissions to the IRS under the following procedures.

The IRS will accept VC submissions for some errors related to 457(b) plans for governmental employers (see Section 4.09 of Revenue Procedure 2016-51 through 2018 and Section 4.09 of Revenue Procedures 2018-52 effective January 1, 2019.) Note, however, the IRS, generally, will not address any issues 1) related to the form of a written 457(b) plan document; nor 2) problems associated with top-hat[1] plans of tax-exempt entities. However, the IRS may consider a submission where, for example, the top hat plan was erroneously established to benefit the entity’s nonhighly compensated employees and the plan has been operated in a manner that is similar to a qualified plan.

The IRS’s VC unit retains complete discretion to accept or

or reject any requests for correction approval. If accepted, VC will issue a special closing agreement.

The steps to voluntary correction are

  1. Complete IRS Form 8950, Application for Voluntary Correction Program (VCP).
  2. Compose a cover letter that describes the problem and includes a proposed solution.
  3. Mail both the form and cover letter to the address listed in the instructions to Form 8950.

Sponsors will receive IRS Letter 5265 acknowledging the submission along with a control number for reference.

Conclusion

The IRS has two avenues of correction for governmental 457(b) plans: self correction without a submission; and voluntary compliance with a submission. Sponsors can refer to IRS Form 8950 and its instructions, along with Revenue Procedure 2016-51 through 2018, and 2018-52 beginning in 2019 for complete details.

 

[1] Nongovernmental 457(b) “Top Hat” plans must limit participation to groups of highly compensated employees or groups of executives, managers, directors or officers. The plan may not cover rank-and-file employees.

© Copyright 2019 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Retirement Savings Tax Credit

“What contributions are eligible for the retirement savings tax credit?”

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 an advisor in Oklahoma is representative of a common inquiry regarding available tax credits for retirement contributions.

Highlights of Discussion

IRA owners and retirement plan participants (including self-employed individuals) may qualify for a retirement savings contribution tax credit. Details of the credit appear in IRS Publication 590-A and here Saver’s Credit.

The credit

  • Equals an amount up to 50%, 20% or 10% of the taxpayer’s retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on adjusted gross income (as reported on Form 1040, 1040A or 1040NR);
  • Relates to contributions taxpayers make to their traditional and/or Roth IRAs, or elective deferrals to a 401(k) or similar workplace retirement plan; and
  • Is claimed by a taxpayer on Form 8880, Credit for Qualified Retirement Savings Contributions.

Contributors can claim the Saver’s Credit for personal contributions (including voluntary after-tax contributions) made to

  • A traditional or Roth IRA;
  • 401(k),
  • Savings Incentive Match Plan for Employees (SIMPLE) IRA,
  • Salary Reduction Simplified Employee Pension (SARSEP) IRA,
  • 403(b) or
  • Governmental 457(b) plan.

In general, the contribution tax credit is available to individuals who

1) Are age 18 or older;

2) Not a full-time student;

3) Not claimed as a dependent on another person’s return; and

4) Have income below a certain level.

2018 Saver’s Credit Income Levels

Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution AGI not more than $38,000 AGI not more than $28,500 AGI not more than $19,000
20% of your contribution $38,001 – $41,000 $28,501 – $30,750 $19,001 – $20,500
10% of your contribution $41,001 – $63,000 $30,751 – $47,250 $20,501 – $31,500

*Single, married filing separately, or qualifying widow(er)

The IRS has a handy on-line “interview” that taxpayers may use to determine whether they are eligible for the credit.

Conclusion

Every deduction and tax credit counts these days. Many IRA owners and plan participants may be unaware of the retirement plan related tax credits for which they may qualify.

© Copyright 2019 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

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

© Copyright 2019 Retirement Learning Center, all rights reserved