403(b) compliance trends and tips
Tax Facts | National Underwriter Company
The IRS has updated its list of compliance trends and tips for 403(b) plans. Some of the problem areas that arise most frequently during plan audits are as follows:
Failure to properly apply universal availability to participants: "Universal availability" requires that participants who are not among one of the permissively excludable groups must have the right to make elective deferrals. Universal availability has many factors, and as the Service notes, applies to each common-law entity separately, rather than grouping controlled groups together.
According to the Service, a prominent issue in the conduct of exams is confirming that all employees who technically have the right to make elective deferrals (a) are actually offered that right in practice, and (b) are given a meaningful notice of that right and the timing requirements for making and changing elections.
A central issue in examining the universal availability requirement is confirming that all individuals who are common-law employees, and not members of a permissively excludable group, are eligible to make elective deferrals. Employees who can be excluded without violating the universal availability requirement include: (a) employees eligible under other deferral plans (e.g., 401(k) plans or 457(b) governmental eligible plans that also provides for salary deferrals); (b) nonresident aliens; and (c) employees who ordinarily work less than 20 hours per week.
The Service cautions that among the permissive exclusions, the most problems arise from (a) determining when employees ordinarily work less than 20 hours per week, and (b) ensuring that the written plan spells out the details of this exclusion (e.g., how are hours tracked and monitored?). Exams by the Service have discovered 403(b) plans that have improperly excluded groups (e.g., collectively bargained employees, visiting professors, employees who have taken vows of poverty, employees who make a one-time election to participate in a governmental non-403(b) plan), and specified categories of employees (e.g., substitute teachers, janitors, cafeteria workers and nurses). The Service reiterates that such groups are not permissive exclusions.
Failure to properly track and limit 15-year contributions; ordering of catch-up contributions: The Service notes that employee elective deferrals can have different classifications depending on the circumstances of a particular participant. One such classification is permissive 15-year rule contributions, where each employee of certain public schools, hospitals, health services, churches and similar organizations who has 15 years of service with that same employer must have his or her previous elective deferrals and catch up contributions for all prior years tracked and used in the applicable calculation to determine the employee's level of permitted catch-up contribution. Elective deferrals, including catch-ups, for such individuals are limited to the lesser of: (a) $3,000; (b) $15,000 less previously excluded special 15-year rule catch-ups, and designated Roth contributions for prior tax years; and (c) $5,000 multiplied by years of service minus previously excluded elective deferrals throughout the employment period.
According to the Service, the failure to track and properly limit contributions made under the 15-year rule is a common error and usually occurs either because (a) weak internal controls prevent the plan sponsor from maintaining records of the employee's elective deferrals in all prior years throughout the employment period, or (b) the employee is not employed by an eligible employer.
The Service points out that the ordering of catch-up contributions is another aspect that causes errors. A 403(b) plan may permit participants who are age 50 or over by the end of the calendar year to make additional salary deferral contributions that are classified as catch-up contributions. These catch-up contributions receive favorable treatment because they are not subject to the general limits that apply to 403(b) contributions; however, properly identifying and classifying these contributions is a frequent compliance issue. The Service cautions that contributions can be considered age 50 catch-up contributions only after (a) the employee elective deferral limits, and (b) the 15-year rule amounts (explained above) are met for the tax year. Therefore, the Service states, properly designating employee elective deferrals as age 50 catch-up contributions requires precision in classifying and limiting the overall employee elective deferral, and the 15-year rule contribution limits as well.
Failure to limit contributions under IRC Section 415: In general, the sum of elective deferrals and employer contributions made on behalf of any participant cannot exceed the lesser of $49,000 (for 2009) or 100 percent of includible compensation for the participant's most recent year of service, plus any age 50 catch-up contributions. The Service cautions that errors made (a) in determining includible compensation, (b) the most recent year of service, (c) whether contributions from other plans are included, and (d) how the Section 415 limit applies to contributions after retirement can cause 403(b) plans to fail to comply with the required limitations under Section 415.
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