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Guest bergs
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Guest bergs

A new governmental defined contribution plan has a leave conversion feature for retirees -- automatic conversion for certain employee groups and conversion through pick-up contributions for other employee groups. The plan also has ongoing contributions. The plan has been submitted to the IRS for a determination letter.

The IRS has just informed the sponsor that the DL submission will be delayed because the Service is seeking "technical advice" on whether leave conversion plans violate the tax laws.

We are aware that, in December 2004, the IRS sent out notices to volume submitter sponsors of stand-alone leave conversion plans indicating that those plans may run afoul of the "recurring and substantial" requirement under the profit sharing plans. However, it appears that the IRS is rethinking its position on individually-designed plans with leave conversion -- even if they are not "stand-alone" plans.

Does anybody know what the IRS' concerns are? Or, is anyone familiar with plans that have a leave conversion feature, and if so, is the plan sponsor taking any action in response to this new IRS initiative?

Thank you.

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Is the idea that any unused leave when the retiree retires is converted to a contribution to the defined contribution plan?

Maybe it's just a 401(k) issue - it looks like an opportunity to defer cash compensation by not taking the leave that could span a number of years - and there would be issues with a 401(k) feature like that in a governmental plan? Just a guess.

Is the "recurring and substantial requirement" the requirement to regularly contribute to a profit sharing plan? That might be an issue if these are the only contributions that are made.

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Guest bergs

Yes, unused vacation and/or sick leave is converted to a contribution to the qualified plan.

I agree with you that the IRS's "recurring and substantial" argument could cause problems for a plan that only has the leave conversion (stand-alone plans).

But now the IRS is making noises about plans with other ongoing contributions.

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It looks like a 401(k) plan issue to me. The only 401(k) plans that state governments can sponsor are grandfathered 401(k) plans. This looks like a 401(k) plan to me - the employee decides whether to be taxed currently by taking the leave; by not taking the leave the income is deferred; by not taking the leave before retirement, the income is deferred to a retirement plan. The first two steps are common, but when you add the contribution to a retirement plan, the IRS may be saying it is going over the line.

It doesn't look like a pick up plan, because the contribution is not mandatory.

Suppose you had a deal where you got 6 weeks of vacation a year, but usually took only 3 weeks - that's a lot of income subject to discretion as to the timing of payment.

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The plans I have seen that operate in this manner use money purchase pension plans. Some also allow conversion pay to go to a funded health reimbursement arrangement (welfare benefit plan). This was based on a private letter ruling from IRS in January of 2003 (I believe). Those arrangements do not appear to be in danger. It also appears to me that such contributions could go directly into a 457 plan without causing a problem.

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  • 2 weeks later...
Guest bergs

I agree that, under the proposed 415 regulations, there is more leeway to putting accumulated leave into a 457 plan. The problem is that many of this employer's retirees can only put a small portion of leave into the 457 plan because of the deferral limit. The solution (we thought) was to put the remainder (up to 415 limits) into a qualified plan either automatically (i.e., without a cash option) or through pick-up elections.

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