IRA rollovers to buy DB service credit

[Guest Dan Gould]

In the summaries of HR1836 I have not seen mention of the ability to use IRA funds to purchase service credit in governmental DB Plans. I was under the impression that was part of the legislation. Is it? Is the IRS working on rules on how it is to handled?

[Carol V. Calhoun]

No, this is not included in the legislation. Section 647 of the legislation includes provisions for the direct trustee-to-trustee transfer of amounts from a 403(B) or 457 plan to a defined benefit plan to purchase service credit, but it does not mention IRAs. Of course, in some instances you might be able to do a rollover from an IRA to a plan, and then a transfer from that plan to purchase service credit in a defined benefit plan, but the normal statutory requirements for IRA rollovers would apply.

[Guest Dan Gould]

I am confused.

The Title of Section 642 of H.R. 1107-1836 is

"ROLLOVERS OF IRAS UNTO WORKPLACE RETIREMENT PLANS."

What does that section allow, if not the ability to take IRA money and directly rollover the account to purchase retirement plan benefits such as additional service credit?

I really need some clarification here. Is there someone in the government that can tell me authoritatively what that section is doing and not doing?

Thanks

Dan Gould

303-894-2700

[Carol V. Calhoun]

Sorry, Dan, you are right. The special provision which permits in-service transfers from 403(B) or 457 plans to defined benefit plans to purchase service credit does not apply to IRAs. However, since most IRAs permit distributions at any time, you could use an IRA rollover to purchase service credit.

I was actually thinking of this in terms of an IRA set up by an employer (which is now possible not only as a free-standing plan, but as part of certain other types of plans), in which case you might not (depending on the plan's terms) have a right to a distribution under the plan prior to termination of employment. Until you can get a distribution, you cannot have a rollover. This contrasts with the new rules for 403(B) and 457 plans, which can provide for in-service transfers to purchase service credit, even if an employee is not entitled to a distribution.

However, to the extent that the IRA allows for distributions, you could use a rollover from the IRA to purchase service credit.

[jlf]

Under what circumstances would using 403b/457 amounts to purchase prior service credits not be in the best interests of the purchaser?

Best wishes,

Joel L. Frank

[Carol V. Calhoun]

The real issue is what the cost is of purchasing service credit--it's a financial decision, not a tax one. The cost to purchase service credit will vary, but in some instances will be the full actuarial cost of the additional credit given. In that instance, a participant has to figure out whether the additional benefit under the db plan is greater than the benefit that would have been produced, had the money been left in the 403(B) or 457 plan.

Also, remember that 403(B) and 457 plans are permitted, but not required, to provide for transfers. Moreover, many 403(B) and 457 plans are invested in products that have stiff penalties for early withdrawals, and/or may not provide for in-service withdrawals at all. Thus, even if the plan provides for transfers, such transfers may be impractical or impossible, given the investments currently held.

[jlf]

Some other questions need to be addressed:

Does the cost include the employer's share?

Recognizing that DB governmental plans mandate lifetime annuitizing, does the purchaser desire an additional lifetime benefit in return for transferring the title to the money (cost of the purchase) to the Plan. The purchaser will be giving up the wealth building aspect derived from the 457/403(B) arrangement.

Moreover, the transaction can never be reversed. No refunds allowed. I am of the opinion that it would be prudent to keep the money in the DC plan. Upon retirement one can shop for an immediate annuity if one desires at that point in life to annutize.

Best wishes,

Joel L. Frank

[Everett Moreland]

Carol: You say that "403(B) and 457 plans . . . can provide for in-service transfers to purchase service credit, even if an employee is not entitled to a distribution." What's your level of confidence in that statement? The statute can be read to mean that a trustee-to-trustee transfer at a time when the account is distributable is not includible in gross income.

[Carol V. Calhoun]

The original question asked about HR 1836. The provision allowing for direct transfers of money from 403(B) or 457 plans (even without a distributable event) is in Section 647 of HR 1836, which reads as follows:

SEC. 647. PURCHASE OF SERVICE CREDIT IN  GOVERNMENTAL DEFINED BENEFIT PLANS.

(a) SECTION 403(B) PLANS.—Subsection (B) of section 403 is amended by adding at the end the following new paragraph:

‘‘(13) TRUSTEE-TO-TRUSTEE TRANSFERS TO PURCHASE PERMISSIVE SERVICE CREDIT.—No amount shall be includible in gross income by reason of a direct trustee-to-trustee transfer to a defined benefit governmental plan (as defined in section 414(d)) if such transfer is—

‘‘(A) for the purchase of permissive service credit (as defined in section 415(n)(3)(A)) under such plan, or

‘‘(B) a repayment to which section 415 does not apply by reason of subsection (k)(3) thereof.’’.

(B) SECTION 457 PLANS.—Subsection (e) of section 457, as

amended by section 641, is amended by adding after paragraph (16) the following new paragraph:

‘‘(17) TRUSTEE-TO-TRUSTEE TRANSFERS TO PURCHASE PERMISSIVE

SERVICE CREDIT.—No amount shall be includible in gross income by reason of a direct trustee-to-trustee transfer to a defined benefit governmental plan (as defined in section 414(d)) if such transfer is—

‘‘(A) for the purchase of permissive service credit (as defined in section 415(n)(3)(A)) under such plan, or

‘‘(B) a repayment to which section 415 does not apply by reason of subsection (k)(3) thereof.’’.

© EFFECTIVE DATE.—The amendments made by this section shall apply to trustee-to-trustee transfers after December 31, 2001.

The Conference Report contains the following language with respect to this provision:

(e) Purchase of service credit under governmental pension plans (sec. 407 of the House bill, sec. 647 of the Senate amendment, and secs. 403(B) and 457 of the Code)

PRESENT LAW  

A qualified retirement plan maintained by a State or local gov-ernment employer may provide that a participant may make after-tax employee contributions in order to purchase permissive service credit, subject to certain limits (sec. 415). Permissive service credit means credit for a period of service recognized by the governmental plan only if the employee voluntarily contributes to the plan an amount (as determined by the plan) that does not exceed the amount necessary to fund the benefit attributable to the period of service and that is in addition to the regular employee contribu-tions, if any, under the plan.  In the case of any repayment of contributions and earnings to a governmental plan with respect to an amount previously refunded upon a forfeiture of service credit under the plan (or another plan maintained by a State or local government employer within the same State), any such repayment is not taken into account for purposes of the section 415 limits on contributions and benefits. Also, service credit obtained as a result of such a repayment is not considered permissive service credit for purposes of the section 415 limits.

A participant may not use a rollover or direct transfer of benefits from a tax-sheltered annuity (‘‘section 403(B) annuity’’) or an eligible deferred compensation plan of a tax-exempt organization or a State or local government (‘‘section 457 plan’’) to purchase permissive service credits or repay contributions and earnings with respect to a forfeiture of service credit.

HOUSE BILL

A participant in a State or local governmental plan is not required to include in gross income a direct trustee-to-trustee transfer to a governmental defined benefit plan from a section 403(B) annuity or a section 457 plan if the transferred amount is used (1) to purchase permissive service credits under the plan, or (2) to repay contributions and earnings with respect to an amount previously refunded under a forfeiture of service credit under the plan (or another plan maintained by a State or local government employer within the same State).

Effective date.—The House bill is effective for transfers after December 31, 2001.

SENATE AMENDMENT

The Senate amendment is the same as the House bill.

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment.

Thus, under the new law (effective for transfers after December 31, 2001), direct in-service transfers will be permissible for the limited purposes specified by HR 1836. This should be distinguished from the separate provisions in HR 1836 for rollovers from 403(B) or 457 plans to 401(a) plans (or vice versa), which do require a distributable event.

[jlf]

Could it be that section 642 refers to only DC plans which have no provision for the purchase of prior service and, therefore, it is simply a means of allowing consolidation among retirement vehicles?

Best wishes,

Joel L. Frank

[jlf]

Carol,

I am having difficulty in getting the full Conference Report (pension provisions).

Would you be gracious enough to give us the link?

Joel