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Vesting in an ERISA 403(b)


Guest Elfman
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Guest Elfman

I believe the old rules required an employer contribution into a 403b to be 100% vested.

Have the rules changed? Can we have a vesting schedule in a 403(b) now? Is there an IRS pub or Rev Ruling that specifically covers that?

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Although employee salary reduction contributions must be immediately and fully vested, employer amounts (both matching and non-matching) may be subject to a vesting schedule. The vesting schedule must comply with ERISA's minimum vesting standards.

Though permitted, a vesting schedule can impose substantial administrative burdens on a 403(b) plan and, thus, is usually avoided. It's generally preferable to make employer contributions to a Sec. 401(a) qualified plan that parallels the 403(b) arrangement. For example, when employer matching contributions are subject to a vesting requirement, the matching contributions can be based on 403(b) salary reductions but made to a qualified plan.

Lori Friedman

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Before 2002, having a vested schedule on employer contributions would create some odd results with the maximum exclusion allowance calculation.

Those rules are gone now, but 403(b) providers historically don't have much experience administering vesting schedules on employer contributions. Sure, you can put a vesting schedule on the employer contributions, but really check with your provider(s) to make sure that they can handle it accurately.

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You're correct, MWeddell, when you say that 403(b) plan vesting concerns were simplified by the MEA's elimination. But, I was thinking in a broader context. In general, it's more beneficial for a Sec. 501©(3) employer to conduct any ERISA-covered activities in a tandem, qualified plan while retaining the non-ERISA characteristics of a 403(b) arrangment.

Lori Friedman

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First, a non-ERISA 403(b) plan is the simplest and least costly vehicle for employee elective deferrals:

1. Virtually no administrative responsibilities or costs.

2. No ADP test.

3. No top-heavy test.

4. Catch-up election for long-term employees, not subject to nondiscrimination testing.

5. The participant is deemed to have purchased the contract. Compliance problems, if any, are generally limited to individual participants and do not place the entire plan at risk.

Second, for the purpose of the Sec. 415 limit, 403(b) plan and QP contributions ordinarily aren't aggregated. A participant can usually receive employer contributions up to the Sec. 415 limit in a QP and make additional contributions, up to a separate Sec. 415 limit, in the 403(b) plan. The non-ERISA 403(b) plan retains all of the advantages discussed above, plus the higher overall contribution maximum benefits the organization's executives and other HCEs.

Third, when an organization makes employer contributions to a Sec. 403(b) plan, the plan becomes fully subject to ERISA.

1. The employer assumes all of the obligations and responsibilities of plan sponsorship and administration.

2. The plan has one Sec. 415 limit to cover both the employer contribution and the employee salary reductions. It loses the greater overall contributions permitted when a Sec. 403(b) plan and QP co-exist.

3. It's difficult (impossible?) to hire a TPA to perform the testing and compliance work for a 403(b) plan. The IRS won't provide a determination letter to give the plan a "stamp of approval" (but the plan can request a private letter ruling). QPs have a well-defined set of rules, but 403(b) plans have much less certainty in the absence of final regulations (promises, promises).

Briefly:

non-ERISA 403(b) plan = excellent arrangement

ERISA 403(b) = not so great. If an organization chooses to forgo the advantages of a 403(b) plan, it should at least enjoy the benefits of a QP.

Lori Friedman

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I must generally disagree. I have been recently converted to this way of thinking about these programs.

If the entire arrangement were a 403(b), most of what you itemize would still be true (no ADP test, etc.).

And you would have no audit and no audit fee.

And your 5500 would take 2 minutes to complete.

But you would lose the 415 double limit, I agree. But you could make up for that in a 457 if necessary.

You would lose the benefit and cost of a Favorable Determination Letter. I would consider that a plus on balance. A non-profit sponsor is not concerned about the deductibility of it's contributions we must remember.

The rules would be a bit muddier, no question.

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I agree, Andy, that Sec. 457 is another piece to the jigsaw puzzle. I'll always qualify any 457 discussion, however, with a few comments.

First, a 457 arrangement, whether eligible or ineligible, is riskier for the employee. Unlike a 403(b) plan or QP, Sec. 457 deferrals are general assets of the employer and a contractual agreement to pay. An organization might be financially solvent and responsibly governed now, but there's always an inherent insecurity about betting on an unknown future.

Second, it's preferable to supplement a 403(b) plan or QP with a 457(b) eligible arrangement, to avoid the pitfalls of substantial risk of forfeiture. For 2004, 457(b) contributions are generally limited to $13,000, an amount that's comparable to 402(g) but falls far short of the 415 limit. An ineligible 457(f) benefit, although unlimited, can be a Pandora's Box of problems for the employee. When SROF expires, usually because the individual leaves the employing organization, deferred amounts are immediately taxable.

Third, there are extremely limited rollover opportunities for 457 assets. An employee can transfer benefits between organizations -- in essence, moving the general assets of one employer into those of another employer -- but that's about it.

Lori Friedman

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By the way, this is an interesting discussion, don't you think?

Lori Friedman

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Yes, and your 457 points are valid, so I would grant you that condideration should be given to matching a non-ERISA 403(b) with a qualified plan if 415 is an issue.

Otherwise, I think the reduced 5500 and lack or an an audit requirement are strong considerations.

At least until the no-MEA sunset provision re-awakens in 5 years or so. Then, nighmares.......

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Administratively a 403(b) is more desireable for employer contributions because there is no need to obtain a determination letter, the IRS does not require that the plan be administered in accordance with its terms (only has to comply with the IRC), the only qualfication requirement applicable to the plan is discrimination under 401(a)(4) which applies to each year's contributions on a discrete basis and there is no expense for terminating the plan. The nondiscriminaton rules are the same as the rules for a qualified plan. The only reason to maintain a qualified plan is if the er contributions will exceed $28,000 for HCEs in which case the er can set up a 403(b) or 457 plan for salary reductions.

mjb

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Guest Joel Lee

First, a 457 arrangement, whether eligible or ineligible, is riskier for the employee. Unlike a 403(b) plan or QP, Sec. 457 deferrals are general assets of the employer and a contractual agreement to pay. An organization might be financially solvent and responsibly governed now, but there's always an inherent insecurity about betting on an unknown future.

=====================================================

This is true if the 457 is a plan of a tax exempt other than a governmental entity. If it is a governmental entity the 457 assets are held in trust for the participant.

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I think that people often don't think carefully enough about the inherent risks involved in an exempt organization's nonqualified deferred compensation arrangements.

Personally, I've worked for 2 exempt organizations. Both groups are long gone. One organization, a 501© charity, couldn't cover its bills and went belly-up a few years ago. The other group, a 501©(6) trade association, closed down after some changes in federal law made its mission obsolete and moot.

When those organizations were in full swing, Sec. 457 seemed to be an attractive and viable option. Today, however, can you imagine how glad I am to have been covered by a 403(b) plan and a QP?

Lori Friedman

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Guest Joel Lee

The same trust requirement should be extended to 501©3 organizations. It is unthinkable that a former ee must sue a a bankrupt employer in order to recover deferred wages.

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I disagree with some of the points raised:

1) Whether the 403(b) plan is subject to ERISA or not is irrelevant when applying Code Section 415. In general, you'll have two 415 limits (one for any qualified plans, one for 403(b) plans) regardless of whether the 403(b) is subject to ERISA. Of course if all contributions are placed in the 403(b), then there's not any arithmetic advantage to having a separate 415 limit for qualified plans that isn't being used, but I thought we should clarify this a bit.

2) I wouldn't call a non-ERISA 403(b) plan an excellent arrangement except for a small employer who REALLY wants to have no role in administering retirement benefits. They often are quite expensive. To keep it non-ERISA most of us probably agree that it must have multiple providers much means one is setting up competition for assets at the participant, instead of at the plan sponsor, level. An employer is setting loose multiple insurance agents and then must be extremely passive about what it communicates about the various providers. The result is lower participation than necessary and (due to expenses) lower investment returns than necessary. Also, because the assets are held in non-ERISA contracts, the employer cannot very effectively take advantage of any economy of scale and start to use the plan assets to retain the best provider for the sake of all participants.

The above doesn't always mean that ERISA 403(b) plans or 401(k) plans are better than non-ERISA 403(b) plans, but it's a perspective that hadn't been raised in this discussion.

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Joel: public 457 plan assets are exempt from employer's creditors because the 457 plan is open to all emplyees and is the regular retirement plan for many small govt employers. NP 457 plans are available only to top hat employees so there is no reason to provide 457 assets with greater protection that assets of profit making Non q plans. Proposed legislation on non qual plans will apply to NP 457 plans but not govt plans.

MW : there is no requirement that a non ERISA 403(b) plan must offer investments from more than one provider and many small plans use one provider to avoid admin burden on employer. I have clients who use a single provider such a vanguard or T/C for all plan assets to achieve economies of scale. The salary reducton funds are kept in a non ERISA plan to avoid spousal consent for loans and lump sum distributions.

mjb

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mbozek --

I find it difficult (others including you may disagree) to have just one 403(b) provider given the language of DOL Reg 2510.3-2(f)(3)(vii). This is especially true if one considers that the worst situation is to have a plan sponsor treat an arrangement as not subject to ERISA but that later is determined to have been subject to ERISA.

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(vii) does not require that multiple contractors be permitted- it only requires reasonable choice in light of all relevant circumstances, including number of employees affected, the variety of available products, the administrative burdens and cost to the employer and possible interference with employee performance resulting from direct solication by contractors. There is no requirement that an employer allow direct solication of employees by salesman in an exempt 403b plan. Other factors can include reputation of the provider and low cost of funds. I dont know who would bring a claim against the plan in federal court on such a facts and circumstances basis. I am not aware of any employer who has been found to have mantained an ERISA plan because it limited a 403b program to the funds of one provider.

mjb

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I am not aware of any employer who has been found to have mantained an ERISA plan because it limited a 403b program to the funds of one provider.

On the other hand, I'm not aware of any employer who has successfully defended that their 403(b) plan with a single provider is not subject to ERISA. It's an open issue.

Obviously DOL Reg 2510.3-2(f)(3)(vii) does not expressly require that more than one provider be offered to participants in a non-ERISA 403(b) plan but in my opinion it'd be difficult based on the factors the regulation lists as relevant to justify hiring only one provider. If you are narrowing the field to just one provider, then you're acting like an employer and a fiduciary, you aren't merely facilitating an arrangement between the provider(s) and the employees where you are limiting providers because participants already have a reasonable choice and offering more creates an unnecessary administrative burden on the employer.

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Why? a small employer can easily justify limiting investment options to one family on the grounds of administrative burdens, costs to employer of using multiple vendors, use of reputable low cost provider, small number of employees who partricpate, etc. If an advisor doesnt have the confidence to make such a judgment call then the employer can adopt a SR plan subject to ERISA and limit investments to one fund family as a settlor decision.

mjb

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