Carol V. Calhoun

Thanks for the confirmation, PensionPro. That was my reading as well. However, given that another law firm had drafted a VCP submission that discussed only the tax issue (and didn't even mention 415(n)), I was basically looking for a sanity check.

The only operational failure I can see is that the contributions were not treated as participant contributions for purposes of 415(n), and therefore a few participants violated the five-year limit on the purchase of nonqualified service credit. My concern is whether using EPCRS for that failure (which affects only a few participants) would clean up the withholding issue as to all participants. The description of the effects of a successful VCP are that it maintains the qualification of the plan, but the applicable revenue procedure doesn't suggest it would also provide relief for any other tax issues.

Has anyone had experience with whether the IRS is willing to allow the VCP program to be used for something that is not a qualification issue? In the situation I'm looking at, employees were permitted to choose at retirement whether to have accumulated leave contributed to a defined benefit plan or to receive it in cash. The employer erroneously believed that in the case of the employees who chose the contribution, it would be a pretax contribution. The employer therefore did not withhold taxes on the contributions. Having now received legal advice that such contributions would be after-tax, it is attempting to fix the situation for past years. Reading through Rev. Proc. 2013-12, I cannot see a way that VCP can be used to remedy a provision which is not disqualifying, but which caused unanticipated adverse tax consequences. However, I entered this matter late, after another firm had already prepared a draft VCP submission. I therefore want to be very sure of my ground before I talk to the client.

What we have had our clients do is to provide in our plan document that if the maximum limits would otherwise be violated, benefits under the outside plan are to be cut back before benefits under the 403(b) plan. Then in the salary reduction agreement, we have had the employee certify that if there is an outside plan, the employee will ensure that benefits are appropriately limited so as not to cause a violation when the plans are aggregated. So far, at least, we have never had the IRS demand anything else if those precautions were followed.

Typically, you would count service with both entities for eligibility and vesting purposes, but merely allow participation in whichever plan(s) the employee's current employer maintained. So, for example, an employee who moved from the Trust Authority to the hospital would cease to participate in the 457 and 401(a) (although s/he would continue to have a deferred benefit in those plans) and begin participating in the 403(b). At retirement or other distribution event, the employee would have a benefit from all three plans.

The only difference between a 403(b) and a 403(b)(7) is that a regular 403(b) is invested in an annuity, while a 403(b)(7) is invested in a custodial account which in turn invests in a mutual fund. There are also some tax differences (e.g., penalties on excess contributions to a 403(b)(7), but not to a regular 403(b)). But otherwise, the requirements are the same.

Dave, it was authored April 30, 2012. (That date was apparently stamped at the top, not typed in, so it didn't appear when I converted the thing from PDF to HTML, but I've now added it.)

I've just gotten hold of some internal IRS guidance on the application of vesting requirements to plans governed by section 411(e)(2). While the guidance was primarily directed toward governmental plans, it indicates that it would also be applicable to church plans. For anyone who is interested, I've put a copy up at this link.

We've had some discussion here in the past regarding what vesting requirements applied to qualified governmental plans. The confusion arises because Code section 411(e)(2) says that governmental plans are required to comply with pre-ERISA section 401(a)(4) and (7), but Code section 401(a)(5)(G) says that 401(a)(4) does not apply to a governmental plan. I've now gotten a copy of an internal IRS directive on the subject, and have posted a copy of it at this link. Essentially, it is applying pre-ERISA section 401(a)(4) to the vesting standards of governmental plans, notwithstanding section 401(a)(5)(G). My analysis of the guidance can be found at this link.

If the plan is nongovernmental the whole $30,000 must be included on the W-2, and is taxed, if the $10,000 pension contribution is stated in the plan to be an employee contribution. This is true even though the employee never actually receives it and indeed has no way to receive it.

If the plan is not governmental, pick-ups are irrelevant regardless of any other factors. You need to look at Internal Revenue Code section 414(h)(2). Rule for nongovernmental employers: If the plan calls a contribution an employee contribution, it is after-tax, regardless of any other factors. Internal Revenue Code section 414(h). Rule for governmental employers: Income tax: Contribution is "picked up," and therefore pretax for income tax purposes, only if three requirements are met: a) the plan calls a contribution an employee contribution, b) the employer agrees to pay it, and c) the contribution is nonelective. "Nonelective" means that the employee either a) has no option as to whether the salary reduction will occur, or b) has only a one-time option as to whether the salary reduction will occur upon initial hire or initial participation in any plan of the employer. The employer can pay the contribution a) in addition to wages, or b) via salary reduction. As you suggest, salary reduction means that although the employee is nominally paid $30,000, only $20,000 appears on the W-2 after reduction by the $10,000 pension contribution. FICA tax: A picked-up contribution is exempt from FICA tax only if in addition to the three requirements of #1, above, the employer pays the contribution in addition to wages, not via salary reduction. So in our example above, FICA taxes would be due unless the employee received the full $30,000, and the employer paid the $10,000 contribution in addition to that. While all governmental entities are tax-exempt, not all tax-exempt entities are governmental. A 401(a) trust, a charitable organization, and many other entities are tax-exempt, but not necessarily governmental.

"Pick-ups" apply only to governmental plans. Under Code section 414(h), the general rule is that any contribution that the plan calls an "employee" contribution is after-tax. Section 414(h)(2) (the "pick-up" provision) provides an exception that allows an employee contribution to a governmental plan (and only a governmental plan) to be treated as an employer contribution (and therefore made pretax) if certain requirements are met. As to your examples: In Example 1, you are correct that the contribution is subject to both income and FICA taxes. In Examples 2 and 3, the contribution is not subject to income taxes (assuming that the employee has no option to receive the amount in cash instead of having it contributed to the plan). However, because the contribution reduces the employee's salary, it is subject to FICA taxes. As an alternative, the employer could simply agree to pay B a salary of $20,000, and to pay the $10,000 contribution without a salary reduction. In that case, the contribution would be free of both income and FICA taxes. Clearly, the economic effect is identical to that described in 2 and 3, so it might at first blush appear incomprehensible that the tax consequences would be different. However, the thinking seems to be that the employer can go either way, but must pick one, so that an employee cannot get the benefit of reduced FICA taxes now and then argue years later that Social Security benefits should be based on the full unreduced salary.

Yes, I actually dealt at length with those uncertainties in my article.

First, it is quite common for a defined benefit plan to prohibit employee contributions. In the private sector, it is actually fairly unusual to find a defined benefit plan that permits them. Second, a pick-up technically refers to a situation in which an employer pays a contribution referred to in the plan as an employee contribution. So if there is no provision in a plan for employee contributions, technically there is no pick-up. If the plan provides for employer contributions beyond those mandated, the employer could make such contributions (and might be able to reduce employees' salary to reflect this). However, most defined benefit plans that preclude employee contributions also make no provision for employer contributions beyond the mandated amount. As the name suggests, a defined benefit plan typically provides a benefit that is defined in the plan, and mandates employer (and in some instances, employee) contributions to fund that benefit. If that basic structure is followed, additional employer contributions would not create any corresponding increase in the benefits provided to employees, and thus no employer would make them. If a defined benefit is to accept additional employer or employee contributions to increase employee benefits under the plan, it needs to provide explicitly for such contributions, and specify how they will increase the benefits of employees (e.g., are they allocated to a separate account for each employee, or do they provide for a percentage increase in the defined benefit for each employee?), in order to avoid issues with the definitely determinable benefits rule.

For anyone who is interested, my article on the above topic can be found at this link.

No governmental plan is subject to ERISA 203. What this sentence is doing is using "governmental plans and non-electing church plans" as examples of plans not subject to ERISA 203, not saying that some are and some aren't.

Yes, it can be rolled over to an inherited IRA. However, this will not eliminate required minimum distribution requirements, so the beneficiary (if not a spouse) will need either to start taking distributions within one year or to take a complete distribution from the IRA within 5 years.

In theory, a 457(b) for a nongovernmental tax-exempt is never "invested." That is because under ERISA, such a plan must be an unfunded plan. While in some instances, a trust is set up to measure the benefits, such a trust must be subject to the claims of the employer's creditors, and is therefore considered an employer investment, not a plan investment. As such, it can be invested in any investment which would be permissible for the employer.

Treas. Reg. section 1.403(b)-5(b) is the operative provision. Short answer: all employees outside of the excluded groups must have the same opportunity to make pretax and Roth contributions, but there is no nondiscrimination testing of the actual amounts contributed by HCEs versus others.

Alas, the domain registration for erisaadvisoryopinions.com expired, and the opinion in question doesn't seem to be available elsewhere on the Web.

This actually comes up a lot, and while I don't have a citation off the top of my head, my understanding is that a plan is considered "of the employer" if the employer contributes to it (via salary reductions or otherwise), even if the plan is administered at the statewide level. Certainly, this was the approach the IRS took years ago when we asked about maximum contributions to a 403(b) plan (back before the repeal of section 415(e)), and the IRS required us to take into account the employer's contributions to a statewide DB plan.

An employer can exclude from salary reductions under its 403(b) plan employees who are eligible to make contributions under the employer's 401(k) plan. §1.403(b)-5(b)(4)(ii)(B). Thus, if all employees can participate in either the 403(b) plan or the 401(k) plan, you shouldn't have a problem. The only issue I would see would be if the 401(k) provided for exclusion of some employees who were ineligible for the 403(b), but did not fall within one of the permissible exceptions to the 403(b) universal availability rule.

So long as the insurance company has transferred the contracts to the employees, that should work. The only issue we've seen in this instance is that if the contracts were initially set up under a group contract, it may be difficult to get the insurance company to do the necessary paperwork to make them individual contracts.

You are correct. A fully insured plan (private or governmental) need not have a trust. The only concern would be to make sure that the group annuity contract or custodial arrangement meets any fiduciary requirements imposed by state law or Internal Revenue Code section 401(a)(2) or 503. For example, who would be responsible for moving money from the contract to a different one if the issuer were in such financial trouble that there was a risk of it not paying benefits under the contract?

You would need to incorporate the limits applicable to that plan with respect to all participants. However, in the case of eligible participants, the limit would be the lesser of a) the normal limit under 401(a)(17), or b) the amount of compensation that was taken into account (for purposes of determining a participant's benefit) under the plan on July 1, 1993. The reason you can't limit 401(a)(17) to noneligible employees is that if the plan is amended after July 1, 1993 to increase the compensation taken into account, even the benefits of eligible employees will potentially be limited.