403(b) PLAN QUESTIONS
What is a 403(b) plan? A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, 501(c)(3) tax-exempt organizations and churches. Individual accounts in a 403(b) plan can consist of an annuity contract, which is provided through an insurance company, or a custodial account, which is invested in mutual funds. PlanMember offers both types of investments through its consolidated PlanMember Model Plan.
What are the advantages of Traditional and Roth contributions to a 403(b) plan? A 403(b) plan usually has two options: Traditional and Roth contributions. With a Traditional account, a participant’s gross salary is reduced by the amount of the pre-tax contributions, deferring federal (and, in most states, state) income taxes. Earnings will not be taxed until withdrawal. With a Roth Account, participant contributions are subject to federal and, where applicable, state income taxes before they go into the plan but participants will not pay taxes on the earnings when they make a qualified withdrawal. Roth accounts are ideal for employees who expect to be in a higher tax bracket in retirement, and prefer to be taxed now in their lower bracket.
Which employees must be included in the employer's 403(b) plan? In terms of employee salary reductions (the voluntary contributions made by the employee to their account), employers must generally include all employees, with no waiting period or age requirement, who normally work 20 or more hours per week and who plan to contribute more than $200 per year to their account. Churches and qualified church controlled organizations are not subject to these requirements.
For employer contributions made in ERISA plans, generally all employees must be included after one year of service and attainment of age 21(nonprofits), or age 26 (education employers) if there is no vesting schedule. "One year of service" is generally defined as a year in which the employee worked 1,000 hours or more. If employer contributions are totally vested from the first deposit, inclusion can be delayed to two years of service or upon attainment of age 21.
Note: Leased employees are not eligible to participate in an employer’s 403(b) plan. Also, unique to public schools is the role of members of the governing board. In some locations, school board members are compensated with W-2 reported income. This might lead to the conclusion that those school board members are eligible to participate in the 403(b) plan, but this is not the case because elected officials are not eligible unless the office held requires a background in education, such as the superintendent of public instruction.
What are the contribution limits for a 403(b) plan? The combination of employer contributions and employee salary reduction contributions cannot exceed the lesser of 100% of includible compensation or $50,000 in 2012. Employee salary reduction contributions are limited to $17,000 in 2012 (plus $5,500 for age 50+ employees). The age 50+ catch up contribution made by the employee does NOT count against the $50,000 limit. Employees with 15+ years of service with the same employer may be eligible to contribute an additional $3,000, if the employer is an educational organization, hospital, religious organization, health and welfare agency, or home health service agency.
Are loans from the 403(b) plan allowed? Loans can be allowed at the employer’s discretion. Participants can borrow (subject to the loan terms under the account held) the greater of one-half of the vested account values or $10,000 in non-ERISA plans. In an ERISA plan, the limitation is 50% of the vested values capped at $50,000, minus the difference between the highest outstanding loan balance in all plans of the employer in the previous 12 months, and the amount still outstanding when a new loan is taken.
How can I select the eligibility, contribution and loan features of my organization's 403(b) plan? This can be addressed through your plan document and PlanMember can help.
What is “Universal Availability”? The universal availability rule means that if an employer permits one employee to defer salary into a 403(b) plan, the employer must extend this offer to all employees of the organization. However, certain employees may be excluded from the plan, including:
*Caution is urged in the use of this exclusion since the IRS has reported frequent violations when employees are excluded based on hours worked because, if one employee working less than 1,000 hours in prior years is permitted to participate, then all employees working less than 1,000 hours must have been permitted to do so. A mistake in this area may lead to the entire 403(b) plan losing its tax deferred status.
What is ERISA, and what types of organizations can be subject to ERISA with regard to their 403(b) plans? The Employee Retirement Income Security Act of 1974 (ERISA) protects the retirement assets of Americans by implementing rules that qualified plans and 403(b) plans must follow to protect the benefits of participants and beneficiaries.
Public school districts, governmental organizations, churches, church-controlled organizations or 414(e) religious organizations, are not subject to ERISA. (Note that churches and other religious organizations can make an election to be an ERISA 403(b) plan, however such elections are rare). They are also exempt from the nondiscrimination rules for non-elective contributions to their 403(b) plans. All other 501(c)(3) nonprofit employers are subject to ERISA when employer contributions are made to the plan.
If you are a non-governmental nonprofit who is concerned about ERISA, see our section entitled All About ERISA.
What is a fiduciary, and when do fiduciary responsibilities apply? In plans covered under Title I of ERISA, the plans sponsor, including members of the Board of Directors, is always a fiduciary. So are:
For public education institutions, since ERISA does not apply, and fiduciary responsibilities can only be applied through state statute. In general, state statutes tend to apply fiduciary responsibilities under state trust law which generally does not apply to 403(b) assets (because those assets are not required to be held in trust). Public education employers should consult legal counsel to become familiar with statutes in their won state, and potentially guard against taking actions that might cause the employer to assume a fiduciary role. The IRS 403(b) regulations, generally effective on January 1, 2009, did not impose any fiduciary responsibilities, only compliance responsibilities.
For 501(c)(3) nonprofit employers sponsoring voluntary (elective) 403(b) plans that qualify for the DOL Safe Harbor exemption from ERISA, the fiduciary responsibilities imposed by ERISA would not apply. However, if the nonprofit sponsors an ERISA 403(b) plan or a 401(k) plan in addition to their 403(b), they are subject to ERISA and will automatically be fiduciaries and will need to understand those responsibilities.
Many charter schools hold a 501(c)(3) designation but are also a part of the public school district (with oversight from a state governmental agency such as the Department of Education). Is this type of charter school subject to ERISA coverage? When charter schools are part of the public education system, they too are exempt from ERISA for their retirement plans. As is true of all public education employers, these charter schools are also exempt from nondiscrimination rules. The only nondiscrimination requirement applicable to them is the universal availability requirement applicable only to employee elective deferrals. However, charter schools should take care to firmly establish whether the school is, in fact, a part of the public education system of that state.
For ERISA 403(b) plans, new 5500 reporting requirements in 2009 require plan asset data to be reported, much like for 401(k) plans. How much data do I need to include? Field Assistance Bulletin 2009-2 has provided relief by permitting ERISA plan sponsors to disregard reporting assets, for the purposes of Form 5500 reporting only, in all annuity contracts or 403(b)(7) custodial accounts issued prior to January 1, 2009, if no contributions were made to those accounts on and after January 1, 2009 as long as those account values are fully vested, and are funded in individual annuity contracts or custodial accounts where the employees have control. For detailed information on these accounts, employers should obtain a copy of FAB 2009-2. Employers sponsoring ERISA 403(b) plans should require that their product vendors provide plan level reporting to avoid issues in gathering data to meet the w reporting requirements going forward.
457(b) PLAN QUESTIONS
What is a Section 457(b) deferred compensation plan? A Section 457(b) plan is a deferred compensation plan offered by state or local governmental employers and other tax-exempt employers. A 457(b) plan allows employees to make contributions on a pre-tax basis through salary reduction.
Can the employer make contributions to the 457(b) plan? While employers can make contributions, all contributions to the plan are treated as salary reduction contributions, and FICA and other payroll taxes would apply. Generally, employers will choose to make employer contributions to other retirement plan types where such taxes do not apply.
What types of organizations may establish a Section 457(b) deferred compensation plan?
Note: Churches and qualified church controlled organizations are not governed under the rules of 457 plans.
Why should my organization consider a 457(b) plan? You and your employees will be able to better meet goals for the accumulation of pre-tax savings with the addition of a 457(b) plan. For certain employees who already make maximum contributions to a 403(b) or 401(k) plan, additional pre-tax contributions can be directed to a 457(b) plan. This can be especially important in the final years of service when employees may be receiving extra compensation. Distributions from the 457(b) plan are not subject to the IRS 10% penalty tax on an early withdrawal – a benefit that does not apply in a 403(b), 401(k) or other qualified retirement plans.
If you are a non-governmental, tax-exempt nonprofit, you might be interested in sponsoring a 457(b) plan to benefit key employees since it may be prohibited in your regular retirement plan, due to nondiscrimination rules in those retirement plans.
In a governmental plan, rank and file employees are permitted to participate; however, plans sponsored by 501(c) tax-exempt employers must limit eligibility only to a select group of key employees to avoid being covered under ERISA. This opens the door to providing a benefit for those key employees that is not available (without violation of nondiscrimination rules) in regular retirement plans.
How do I establish a 457(b) plan for my organization? You must adopt a plan document, appoint a Plan Administrator, select the investment options you will include in your plan, establish plan administration procedures (or delegate plan administration to the vendor providing investments) and arrange for enrollment of your employees. Depending on state statutes in your specific state, you may be required to provide education to your employees (which is a responsibility that also can be assumed by your selected vendor). It is highly recommended that the investment options you select provide diverse choices to your employees regardless of whether or not the statutes in your state specifically require investment diversity in your plan. Before establishing your own 457(b) plan, you should be aware of any state statute that might prohibit the establishment of a plan of your own. While rare, there may be a statute that limits your choice to only the state-sponsored 457(b) plan.
Can employees contribute to more than one plan? Yes. Contributions to the 457(b) plan do not affect contributions to any other type of plan. For example, if you sponsor a 401(k) retirement plan or a 403(b) plan, you and your employees can contribute the maximum amounts to both plans.
What kinds of investments are allowed in a Section 457(b) plan? It depends on the options that you choose for your plan, keeping in mind that the options should provide diversity for your employees. That might include fixed annuities, variable annuities, mutual funds, savings accounts, CDs or money market accounts. PlanMember also offers programs that provide professional investment management and model portfolios.
Who is allowed to participate in the plan? In a public school plan, any employee who performs services for the employer (even an independent contractor) may participate. Because there are no nondiscrimination rules, employers can also limit participation to select groups of employees.
Employers that are nonprofit organizations under IRC 501(c) must establish the plan only for a select group of management or highly compensated staff - the "top hat" group. The limitation to a “top hat” group is necessary to receive ERISA exemption, which is vital to a 457(b) plan under a non-governmental nonprofit. This also permits employers to reward only key employees without concern about violating the nondiscrimination rules that do apply to their 403(b), 401(k) or other qualified plans.
Who owns the assets in the 457(b) plan? The governmental plan sponsor will own the asset for the benefit of each employee until the employee leaves your employment and elects to take distributions (or rollover or transfer that asset). The 501(c) employer is required to own the asset until the employee leaves employment, at which time an election must be selected for the manner of distributions. Those assets may NOT be rolled over. Each employee names his or her own beneficiaries who will receive the asset upon the employee’s death.
Are 457(b) assets protected from my general creditors? This differs based on the type of employer. If you are a public school, your plan is a governmental plan, and the assets are required to be “set aside” in a trust, an annuity contract or a custodial account. General creditors of the employer have no access to them. In selecting the investment options, you will want to be sure that the vendor(s) meet the requirements of the “set aside” rule.
For Non-governmental 501(c) nonprofits, the assets are subject to the employer’s general creditors, and the employer is listed as the owner of each account (with the employee listed as the annuitant).
Are loans available to employees? Section 457(b) plan loans are available in governmental plans only, and only if you choose to include that feature in your plan. Many employers do not permit loans because the failure to monitor loan limits and loan defaults can create problems for the entire plan. However, if your vendor agrees to administer loans for you, you might consider including that feature in your plan.
How much can be contributed to the 457(b) plan? Employees can contribute 100% of includible compensation up to the salary reduction contribution limit for that year. In 2012, that limit is $17,000. Employees who are age 50 or older can contribute an additional catch-up of $5,500 in 2012. Additionally, if you permit it in your plan, employees may be eligible to use a catch-up for three years prior to normal retirement age. Note that both catch up options cannot be used in the same tax year.
For more information about PlanMember’s support for employers, how to select a consultant or TPA, or other issues important to plan sponsors, please contact Chris Guanciale at (800) 874-6910 extension 2329, or send an email to email@example.com.Share
Tom Nugent, PlanMember CIO since 1994, talks about his investment strategy.