There may not be a party to celebrate, but January 1, 2019 marks the 10thanniversary of the regulations that remade IRC section 403(b) plans. The regulations, which pushed 403(b) plans to follow rules akin to (but not identical to) qualified plans, generally became effective on January 1, 2009. An IRS official involved in the development of the regulations said at the time that he thought it would take 10 years for all existing 403(b) plans to fully conform to all the new rules, and viewed from the vantage point of 2018 that prediction may turn out to be even a bit optimistic. But there has certainly been a significant shift in the administration of 403(b) plans and an enhanced awareness among many plan sponsors of their compliance responsibilities over the past 10 years.
In addition, 403(b) plans are currently undergoing a second plan document revolution. The first, of course, was the requirement under the 2009 regulations that 403(b) plans have documents at all. Now, many plans are rushing to adopt documents that were pre-approved by the IRS, and to meet an important deadline of March 31, 2020 in order to take full advantage of the IRS’ pre-approval program.
Despite this progress, there are a number of recurring compliance problems with 403(b) plans that remain on the IRS’ radar. At a recent meeting, IRS officials identified two familiar issues that are in the sights of auditors this year. Even though much ink has been spilled (and pixels created) on these issues in the past, given the IRS’ stated focus we want take a closer look at those issues and how they can cause compliance headaches. And we also will briefly revisit the pre-approved 403(b) document program.
The universal availability rule provides that with limited exceptions, all employees must be permitted to contribute elective deferrals to an employer’s 403(b) plan if any employee is allowed to do so. Unlike the eligibility rules that apply to employer contributions, an employer cannot exclude specific classes of employees from the right to contribute elective deferrals unless the class is one that is explicitly permitted in the statute. The two groups of employees that are most commonly excluded are employees who “normally work fewer than 20 hours per week” (“part time employees”), and employees who are students performing services described in IRC section 3121(b) (10). In addition, universal availability requires that employees must have “an effective opportunity” to participate. To meet this requirement, employees must be notified of their right to contribute and be given a reasonable opportunity to sign up or change their elections.
The regulations further define when an employee normally works fewer than 20 hours per week, providing that an employee can be excluded from contributing elective deferrals if the employer reasonably expects the employee to work fewer than 1000 hours in the 12-month period beginning on the employee’s first day of work. However, if the employee actually works more than 1000 hours in that year or subsequent years (the regulations explain how this is calculated) he or she must be allowed to contribute elective deferrals in the following year. But the IRS has put a further gloss on the rule, saying that if an employee reaches the 1000-hour threshold even once, he or she must be allowed to contribute in all subsequent years. This is the famous, “once in, always in” doctrine.
Students performing services described in IRC section3121(b) (10) primarily are students who are working for a school, college or university while the student is enrolled and regularly attending classes. The regulations under this statute (which are the regulations that govern when a student is exempt from FICA) provide considerable guidance as to when an employee qualifies as a student as opposed to being an employee who is taking classes while employed. Most notably, students who are working during the summer break may not be eligible for the student exemption unless they are also enrolled in classes and therefore become eligible to contribute elective deferrals to a plan.
Common Universal Availability Compliance Pitfalls
Eligible employees are not notified that they are eligible to contribute elective deferrals.
The plan document fails to include a provision excluding part time employees or students but they are excluded anyway.
Eligible employees are improperly excluded from participation because the employer fails to properly count hours or assumes its definition of “part time” allows the employees to be excluded.
A full-time employee reduces her hours below 1000 hours a year and is told incorrectly that she can no longer contribute elective deferrals.
A student employee who continues to work over the summer while not enrolled in classes is not offered the opportunity to contribute elective deferrals.
Contribution Limits and the 15 Year Catch-up Rule
The contribution limits that apply to 403(b) plans are fundamentally the same as those that apply to other defined contribution plans, with a few important twists. The limits on elective deferrals under section 402(g) ($19,000 in 2019), age 50 catch up limits under section 414(v) ($6000 in 2019), the overall contribution limits under section 415(c) ($56,000 in 2019), and the maximum amount of compensation that can be used to determine employer contributions under section 401(a) (17) ($280,000 in 2019) all apply to 403(b) plans. There are some special rules that govern the determination of the section 415(c)limits where an employee is covered by another retirement plan sponsored by an employer that he or she controls. But possibly the most troublesome of the rules that apply to 403(b) plan contribution limits is the 15 year catch-up rule.
As its name suggests, the 15 year catch-up rule allows certain employees whose elective deferral contributions were low in the earlier years of their career to take advantage of an increased elective deferral limit after having completed at least 15 years of service at a qualified organization. Such organizations include educational organizations, hospitals, health and welfare service agencies, and church related or controlled organizations. It is beyond the scope of this article to describe the calculation required for the 15 year rule in detail, but suffice it to say that it is a complicated one requiring very good historical information. Correctly performing the calculation for a participant requires the administrator to have detailed records of the participant’s service and the employee’s complete contribution records. In addition, the calculation must be redone each year, as there is a maximum cap of $15,000 on the total amount of catch-up contributions. Finally, the 15 year catch up must be coordinated with the age 50 catch up, and any catch up amount contributed by an employee who is eligible for both increased limits will be treated first as a 15 year catch up.
Common 15 Year Catch-up Rule Compliance Pitfalls
Ineligible organization applying the rule.
Incorrect calculation of 15 years of service for employees who worked part time.
Incorrect records used to determine prior contributions. This typically can occur in plans with multiple investment providers, where the participant has contributed to more than one investment provider.
Failure to recalculate the availability of the catch up each year, so that an employee goes over the maximum cap.
Plan Documents, Redux
Many sponsors of 403(b) plans are by now aware of the availability of pre-approved volume submitter 403(b) documents, and many plans have already adopted such documents. For the first time, the IRS has reviewed and approved 403(b) documents that can be adopted by plan sponsors. A plan using a pre-approved document would be assumed to have a compliant form of document on audit. In addition, the IRS has provided a special remedial amendment period for 403(b) plans. If a compliant document is adopted by March 30, 2020, it can have a retroactive effective date back to January 1, 2010 (or, if later, the date of the establishment of the plan). That means that the IRS will deem the plan as compliant (in form but for not for its operation) back to the retroactive effective date. (More information about pre-approved documents and the remedial amendment period can be found in the Boutwell Fay newsletters for February and March, as well as Adopting a New Pre-Approved 403b Document? It’s a Good Time for a Plan Compliance Review).
If they have not done so already, 403(b) plan sponsors will want to seriously consider adopting a pre-approved document by the end of the remedial amendment period. In addition to giving sponsors assurance that their documents are compliant, adopting a new document also puts on the document provider the responsibility for updates required because of changes in the law.
Most large investment providers are offering documents, and Boutwell Fay can provide sponsors with one as well. But keep in mind: while March 31, 2020 may seem like it is still well in the future, things move slowly in the retirement plan world. Sponsors who are interested in switching to a pre-approved document before the end of the remedial amendment period should not wait too much longer to get the process going.
Please contact our Firm if you would like to discuss any of the foregoing information in greater detail. We would welcome the opportunity to consult with you.
© Boutwell Fay LLP 2018, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of November30, 2018.