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Universal Availability Rule

“Can you explain the universal availability rule and does that apply to 401(k) 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 Illinois is representative of a common inquiry related to 403(b) plans.

Highlights of the Discussion

The universal availability requirement is a rule that relates to eligibility to make elective deferrals in 403(b) plans—not 401(k) plans. It is the nondiscrimination test for 403(b) elective deferrals. Universal availability requires that if the sponsor of a 403(b) plan allows any employee to make elective deferrals to the plan, it must permit all employees to make elective deferrals as well [Treas. Reg. Sec. 1.403(b)-5(b)]. There are a few limited exceptions explained next.

The IRS allows a 403(b) plan sponsor to disregarding the following excludable employees when applying the universal availability test to their plans:

  • Nonresident aliens with no U.S. source income;
  • Employees who normally work fewer than 20 hours per week (or a lower number if specified in the plan document);
  • Student workers performing services as described in Treas. Reg. Sec. 31.3121(b)(10)–2 (note that medical residents are not considered to be students for this purpose);
  • Employees whose maximum elective deferrals under the plan are less than $200; and
  • Employees eligible to participate and make elective deferrals under another 401(k), 403(b) or 457(b) plan sponsored by the same employer.

Under the fewer-than-20-hours-per-week and student worker exclusions listed above, if any employee who would be excluded under either exclusion is permitted to participate, then no employee may be excluded under that exclusion [ Treas. Reg. Sec. 1.403(b)-5]. Consequently, if the plan allows an employee working fewer than 20 hours per week to participate, the plan cannot exclude any employee using the fewer-than-20-hours-per-week exclusion.

A 403(b) plan may not exclude employees based on a generic classification such as the following:

  • Part-time,
  • Temporary,
  • Seasonal,
  • Substitute teacher,
  • Adjunct professor or
  • Collectively bargained employee.

However, if these employees fall under the fewer-than-20-hours criterion, then they may be excluded on that basis. For examples on the application of the exclusion, please see IRS 403(b) Universal Availability. The key to this exclusion is that a plan must determine eligibility for making 403(b) elective deferrals based on whether the employee is reasonably expected to normally work fewer than 20 hours per week and has actually never worked more than 1,000 hours in the applicable 12-month period.

And don’t forget, an employee is not considered to have had the right to make a deferral election unless he or she has had what the IRS calls an “effective opportunity” to make such an election. Effective opportunity is a facts-and-circumstances test. Essentially, at least once during a plan year, employees must receive a deferral notice and have a window of time to make or change a deferral election.

If a plan violates the universal availability rule, the effect can be loss of IRC 403(b) status. In that extreme case, contributions to the plan would become subject to income tax, employment tax and withholding. But the IRS wants to avoid that, so it provides correction remedies in its Employee Plans Compliance Resolution System (See the IRS’s 403(b) Fix-It Guide and Rev. Proc. 2019-19 for remedies.)

Conclusion

The ability to make elective deferrals in a 403(b) plan must be universally available to all eligible employees of a 403(b) plan sponsor. Be aware of the subtle nuances and follow IRS guidance on applying this important rule.

© Copyright 2019 Retirement Learning Center, all rights reserved
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Adding In-Service Distributions to a Company’s Retirement Plan

“What are the considerations around adding an in-service distribution option to a company’s qualified retirement 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, 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 New Jersey is representative of a common inquiry related to in-service distributions from qualified retirement plans.

Highlights of the Discussion

There are several important considerations surrounding adding an in-service distribution option to a company’s qualified retirement plan, including, but not limited to,

  • Type of plan,
  • The process to add,
  • The parameters for taking,
  • Potential taxes and penalties to recipients,
  • Nondiscrimination in availability, and
  • The effect on top-heavy determination.

Several types of retirement plans can offer in-service distributions, including 401(k), profit sharing, employee stock ownership and even defined benefit plans. If a plan sponsor desires an in-service distribution option, it must be formally written into the plan document, either when adopted or later through a plan amendment. The plan sponsor would need to check with its document provider for the exact adoption or amendment steps. For example, adding an in-service distribution option to a prototype 401(k) plan can be as easy as checking a box on the adoption agreement, selecting an effective date, signing the amendment and notifying participants of the change.

There are pros and cons to including an in-service distribution option in a plan. The pros include increased participant control of plan assets, and a higher level of participant satisfaction with the plan. The cons include the potential for greater administrative burdens and cost to the plan sponsor as a result of an increase in the number of distribution requests, potential taxes and penalties for the distribution recipient, and depletion of savings meant for retirement income.

Plan participants need to understand the taxation rules that apply to in-service distributions. Any pre-tax amounts that are distributed from a plan prior to age 59½ will be subject to taxation and, possibly, an early distribution penalty tax, unless an exception applies. Completing a rollover of the in-service distribution either directly or indirectly within 60 days of receipt is one way to delay any tax impact.

If a plan sponsor wants to add an in-service distribution option, it can choose to make the option very liberal or attach restrictions such as a requirement for a participant to reach a certain age, or complete a set amount of service. It is important to note that the IRS does not allow employee pre-tax elective deferrals to be distributed prior to age 59½, nor defined benefit assets to be distributed prior to age 62 under the in-service distribution rules. The plan sponsor could also limit access to a particular contribution source or sources (e.g., matching contributions, after-tax, etc.).

Distributions are part of the benefits, rights and features of a plan under Treasury Regulation §1.401(a)(4)-4. Therefore, if a plan offers in-service distributions, it must do so in a nondiscriminatory manner (i.e., not make them disproportionately more available to highly compensated employees (HCEs) than nonHCEs).

Finally, keep in mind that in-service distributions from a qualified retirement plan can affect top-heavy determination for up to five years. A plan is top-heavy if the key employees own more than 60 percent of the plan’s assets or benefits on the determination date. In-service distributions for active employees are added back to account balances if the distribution occurred within the five-year period ending on the determination date (Treasury Regulation §1.416-1, T-30)).

Conclusion

When the desire to give plan participants greater control of their plan assets exists, plan sponsors and participants may look to in-service distributions of retirement plan assets as a possible solution. But there are several important considerations surrounding such a plan feature. Financial advisors can help educate their clients on the pros and cons of adding, or changing the terms of an existing, in-service distribution option.

 

© Copyright 2019 Retirement Learning Center, all rights reserved