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AlbanyConsultant

Adding 20 hr/wk for deferral eligibility: OK?

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Hi.  So this 403(b) plan as been around for decades, and is now starting to grow rapidly, taking on a lot of 10- and 15-hour per week employees.  The plan currently has the "20 hr/wk" exclusion for the employer contribution, but not for the deferrals.  Is there any reason why they couldn't add it for the deferrals going forward?  I can't think of any off the top of my head.  Thanks.

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As long as the plan meets 410(b)(4), the plan can exclude employees who work fewer than 20 hours per week (or less hours provided under the plan).

 

 

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I think the last sentence of 1.403(b)-5(b)(3)(i) is a good reason to not use it for deferrals. It reads " ...  if any employee listed in paragraph (b)(4)(ii)(E) of this section has the right to have section 403(b) elective deferrals made on his or her behalf, then no employee listed in that paragraph (b)(4)(ii)(E) of this section may be excluded under this paragraph (b)(4)."  (E) has the < 20 hour per week exclusion.  Put another way, mess up on one person and you can't use the < 20 hour per week exclusion.  With it most likely to come up a year or two down the road in an audit, you will have improperly excluded the other <20 hour per week people and it can get really expensive to fix. 

We had this come up in an IRS audit of a 2007 plan year.  The IRS agent involved was the 403(b) trainer for the region.  He told me he had never seen a 403(b) plan that used the <20 hour per week exclusion correctly.

 

 

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I always advise clients against using the <20 hours a week exclusion.  There are just so many situations in which it's easy to screw up.  Substitute teachers are an obvious example.  To exclude them, you have to be able to say that they are expected to work less than 20 hours a week.  But how would you determine that?  By looking at the average substitute teacher in the district?  By looking at substitute teachers at that grade level?  In that subject area?  With that amount of experience?

A lot of people who work less than 20 hours a week aren't even going to be interested in making deferrals.  The cost of letting in those who want to is minimal.  Why would you bother to exclude them?

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Just had the same conversation today with a new client.  But if there's a lot of people in and out of the building, this may be an indispensable provision.  I too avoid it where possible, but if you have to you have to.

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This is #1 on my list of rules which clients don't follow correctly in operation.  When I ask "why do you care whether they contribute or not (since there is no ADP testing)?" they always come up with some employment intake or payroll-related reason that doesn't make sense.  And, typically, they don't follow the rule because they let certain people who should be excluded under the rule participate.      

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Let's say for example a non-profit runs a 2 week summer camp that has 45 high schoolers on the payroll.  My point is (as I said before) when you have to you have to.  If you don;t have to, then by all means, do not!

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If it's a large plan with them excluded, there may be minimal cost to include them.  If adding them makes it a large plan, the cost of the audit isn't minimal.  We have a couple of non-profit clients with a small full-time staff and a large number of < 20 hours per week people.  After some discussion, they decided a small plan 401(k) fit their needs better than a large plan 403(b).  Just because they can sponsor a 403(b) doesn't always mean 403(b) is the best option.

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I hate to see people give up a guaranteed pass on the ADP test though.  That can be a significant sacrifice, especially if budget cuts preclude safe harbor contributions.  I've always been frustrated when people say "they're doing 3% of pay, 100% vested anyway, so let's do a Safe Harbor 401k!"  That;s a great short-term plan design, looking ahead just 2 or 3 years.  But no non-profit in my opinion can project the budget out in the 10 year horizon (excluding ivy league higher ed perhaps).

And non-profits (especially the executive director) tend to have a lot of people between $120K and $150K who contribute the max and will thus never ever pass the ADP test. 

And the 403b marketplace is opening up enough where there are decent choices.

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Thanks, everyone, for the responses.

I also prefer to not have the exclusion in - it is so easy for it to go wrong.  This plan happens to already be a large plan, and part of the issue was with our per head charges; the plan sponsor was trying to limit our fees (of course).

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We do use it and it can be done in the situation described.  The "20 hour exclusion" can be selected as a "class exclusion" so such employees are not in the plan, period.  The actual language  in our document (F.T. Williams) reiterates the 1000 per year requirement.   We ask for an annual census from clients which lists all employees and hours (or use a default hours selection in the document) so that at year end,  we can review in light of the 1000 hour rule and enter any employee where required.

Austin 3515... there is no ADP test in 403(b).

We do recognize the inherent risk in using this rule but for many employers, it can be the difference between an audited plan and a plan not requiring an audit so big deal.

Finally, where the 20 hour/ 1000 hour rule is not used, two tips:  Print a "Decline Form" and insert it in the new hire package.  Tell the employer that all employees must either enroll or decline.  If executed properly, this is a safeguard against the audit question concerning whether or not the plan sponsor actually offered the plan to such employees.  Second, we either charge a minimal amount for nonparticipating employees in a 403(b) (no ADP test.... what would we be doing with these employees which would require a fee?) or no charge, depending on the plan dynamics and overall revenue.  If your TPA charges the same fee for all eligible employees regardless of these factors, I suggest looking for a TPA more experienced with 403(b) plans.

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3 hours ago, Patricia Neal Jensen said:

Austin 3515... there is no ADP test in 403(b).

I think  a more thorough reading of my messages will make it clear that I was suggesting that using a 401k for a non-profit has the disadvantage (as compared to a 403b) of requiring the ADP test.

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Let me try to confirm some follow-up thoughts on this topic.

Suppose the client (not a church plan) wants to exclude employees who normally work fewer than 20 hours per week from 403(b) plan eligibility.  This is permitted as an exception to the universal availability rule for 403(b) elective deferrals under Treas. Reg. Sections 1.410(b)-5(ii)(E) and 1.410(b)-5(iii)(B). 

Assume the plan year is the calendar year.  Suppose that A is hired on February 15 of year 1.  Suppose that, contrary to reasonable expectations, A earns 1,000 hours of service during February 15 of year 1 through February 14 of year 2.  When does A become eligible to make 403(b) elective deferrals?  I think it's January 1 of year 3 based on Treas. Reg. Sections 1.410(b)-5(iiI)(B)(2), although the last sentence of that provision (the one in parentheses) is difficult to interpret.  Furthermore, as pointed out earlier in this thread, if an exclusion to the universal availability rule is used, it must apply to all employees covered by the exclusion, so one couldn't choose to simplify the plan by letting A become eligible on July 1 of year 2 of August 15 of year 2.  Is that correct?

Next, suppose the client has a matching contribution.  For the match, A would have to become eligible as of a date earlier than January 1 of year 3 because now clearly the Section 410(a) rules apply.  The employee would have to become eligible for the match no later than August 15 of year 2 (and many of us would design the plan so that A becomes eligible on July 1 of year 2).  Of course, if there are no 403(b) deferrals until January 1 of year 3 at the earliest, than there won't be any match until then.  However, A would be included in the ACP test for year 2:  A would have compensation during the time period he/she was eligible for the match presumably.  Is that also correct?

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I thought A would become eligible to defer on either the date he completed 1000 hours in the year or on the first day of year 2.

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I badly botched the regulation citation, so let me correct that and quote it.  Treas. Reg. Section 1.403(b)-5(b)(4)(iii)(B) states:

(B) For purposes of paragraph (b)(4)(ii)(E) of this section, an employee normally works fewer than 20 hours per week if and only if—

(1) For the 12-month period beginning on the date the employee's employment commenced, the employer reasonably expects the employee to work fewer than 1,000 hours of service (as defined in section 410(a)(3)(C)) in such period; and

(2) For each plan year ending after the close of the 12-month period beginning on the date the employee's employment commenced (or, if the plan so provides, each subsequent 12-month period), the employee worked fewer than 1,000 hours of service in the preceding 12-month period. (See, however, section 202(a)(1) of the Employee Retirement Income Security Act of 1974 (ERISA) (88 Stat. 829) Public Law 93-406, and regulations under section 410(a) of the Internal Revenue Code applicable with respect to plans that are subject to Title I of ERISA.)

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