Carol V. Calhoun

I update mine immediately when the IRS numbers come out. But I always like to have the projected numbers when they are available, because the IRS has gotten later and later in releasing its numbers. And with the pandemic, I expect it to be even later than usual this year.

I know that the IRS won't announce the new 415, etc., limits until at least late October. However, in past years, @Tom Poje used to project the limits about now. Given his retirement, is anyone else doing this?

You are correct. The required updates are announced each year (although in some years, there are no required amendments). But required amendments merely have to be adopted by the end of the remedial amendment period. In the case of a governmental plan, there are extensions to the normal remedial amendment period depending on the timing of the legislative sessions of the legislature with the authority to amend the plan. (Details can be found in Rev. Proc. 2016-37.) In the case of a legislature which meets only every other year, this could result in the amendments to comply with two different required amendments lists in the same year, followed by a year of not having to adopt plan amendment requirements.

Yes, the VCP submission was successful. The basis for allowing a rollover to the new 457(b) would be a complete termination of the 401(k) plan. A 457(b) plan is not considered a successor plan for purposes of the successor plan rules. However, in the end, the client decided not to go this route, because it wanted to maintain a 401(a) plan for employer contributions. It therefore just left the existing money in the 401(k) plan, but barred future contributions. Practical note: The client had hoped simply to bar future deferrals under the 401(k) plan, but use it as the 401(a) plan for future employer contributions, in order to avoid the need to maintain three different plans. This proved impossible to do, not for legal reasons but because of vendor issues. The vendor had a pre-approved 401(k) plan, but it was not intended for governmental entities. It had a pre-approved 401(a) plan for governmental entities, but that did not contain the restrictions on distributions required for 401(k) deferrals. And it had a 457(b) plan. So rather than adopt an individually designed plan, the client ultimately went with having three different plans.

The six-year restatement period applies only to pre-approved plans. Thus, it would apply equally to a governmental pre-approved plan as to a nongovernmental one, and the relevant dates would be the same. Individually designed plans are required to be updated each year, but are not entitled to receive determination letters at all except upon adoption, termination, or certain corporate transactions. However, for a variety of reasons, governmental defined contribution plans are far less likely than private plans to be pre-approved plans: Many governmental plans are adopted on a statewide basis, and cover all employees in a particular job category (e.g., teachers, judges, legislators) within that state. Because they are larger than most private plans, they often have access to the kind of legal expertise that enables them to have individually designed plans. State and local governments, other than certain grandfathered ones, cannot legally adopt 401(k) plans, which are the most common type of pre-approved plans. The same pre-approved plan document cannot be used by both governmental and nongovernmental plans. Rev. Proc. 2017-41, Section 9.06. Thus, many pre-approved plan sponsors simply don't offer pre-approved plans to governmental employers. Governmental plans are subject to state law, and of course there are 50 different state laws, so it is harder to have documents that will work for all of them than it is to have documents that will work for ERISA-covered plans. To the extent that a governmental plan is not a pre-approved plan, the six-year cycle does not apply to it.

Are you having success in getting pre-approved plan sponsors to let clients use their plans? We've had issues in the past with some of them saying they won't let you use their documents if your plan is already out of compliance.

A lot of the problem arises because the treatment of 403(b) plans as non-ERISA plans was based on an extremely old type of 403(b) arrangement. As 403(b)s morphed into being something more like qualified plans, the DOL was faced with a situation in which it either had to impose unforeseen burdens on often struggling nonprofits that had done what seemed right at the time, or come up with a strained interpretation to save such plans. In the years since the guidance was issued, the guidance has become even more obsolete, but the nonenforcement has meant that a lot of plans are just plain ignoring it. I'm old enough to remember the early 403(b)s, having been around before the dawn of time. They weren't really "plans" as we would think of them today. Rather, what would happen is that an insurance agent would come through town and say to an employer, "Hey, you can give your employees a tax benefit that is not only cost-free to you, but actually provides you with a tax benefit. Just allow your employees to buy these annuity contracts through payroll deduction. Not only will your employees save on income and Social Security taxes, but you will save on the employer's share of Social Security taxes. And we'll do all the work, while you just send us the money out of employees' paychecks." Typically, these weren't even group annuity contracts, just an individual contract for each employee. So in 1979, when the DOL adopted 29 C.F.R. § 2510.3-2(f), you already had a bunch of these contracts. The employers had always thought of them sort of like an arrangement in which employees got a group discount on baseball tickets if the employer collected the money from them and paid it all at once. If the DOL had suddenly declared these to be ERISA plans, there would have been a whole lot of questions about those existing contracts. Suddenly imposing a slew of new requirements on employers which were often underfunded nonprofit organizations was seen as a huge burden, and the DOL wanted to avoid doing that. So it came up with guidance to preserve the status quo as much as possible. Of course, in the intervening years, 403(b)s have changed radically. Employee deferrals no longer provide a Social Security tax advantage. They have to have formal plan documents. The contracts are more likely to be custodial accounts than annuities. They are likely to be group contracts rather than individual. Hardship distributions and loans have been added. All in all, today's 403(b) plans look almost like 401(k) plans. But meanwhile, the 1979 guidance remains in effect. It is no wonder that it is hard to apply to today's plans, which look nothing like the arrangements to which it was originally intended to apply.

Yes, unless it's a governmental or church plan, we advise the employer to keep its hands off to the maximum amount consistent with meeting its legal obligations. For example, it has to adopt a plan document, and determine what providers will be permitted to offer their products. However, distributions and loans should be left up to the providers (although of course the plan document would govern when they would be available).

Employer has two plans. HCEs are supposed to participate in the 403(b) plan. NHCEs are supposed to participate in the 401(k) plan. Each year, HCE or NHCE status is determined for the following year, and the person is supposed to be put into the correct plan accordingly. However, errors have been made in some instances, in both directions. Thus, for example, HCEs have contributed to the 401(k) plan, and NHCEs have contributed to the 403(b) plan. Obviously, this violates the terms of both plans. Does anyone have any experience as to the corrections IRS might be willing to accept in these circumstances? What we'd like to do is to treat this as a mistake of fact, withdraw the incorrectly contributed amounts from each plan and contribute it to the other plan. However, by the literal terms of the IRS Fix It Guides, the HCEs have been impermissibly denied the right to make contributions to the 403(b), and the NHCEs have been impermissibly denied the right to make contributions to the 401(k), which would require QNECs in both cases. And then the HCEs have made impermissible contributions to the 401(k) and the NHCEs have made impermissible contributions to the 403(b), all of which would have to be disgorged. All of that just seems to be excessive, given that no one has been denied the right to make contributions. And the investments of the two plans are the same, so no one has lost out in that area, either. What has been your experience? Will the IRS allow for a reasonable correction, or does it insist on following the technical terms of the Fix It Guides in this situation?

If not corrected, this could lead to employees being taxed on all contributions to the plan when they become vested, and rollover treatment being unavailable on distributions. In the case of a 403(b) custodial account (as opposed to a 403(b) annuity), it could lead to the custodial account becoming tax-exempt. To avoid this, the failure can be corrected under VCP (but not SCP). Rev. Proc. 2019-19.

There isn't one. For governmental plans, section 457(b)(6) permits them to correct at any time before the first day of the first plan year beginning more than 180 days after the date of notification by the IRS that there is a problem. There is limited ability to use VCP-like procedures for nongovernmental plans. See Rev. Proc. 2019-19. However, aside from that, there is no formal statement of when deadlines might be, or procedure for retroactive amendment.

Salary deferrals in a 401(a) plan can be provided only pursuant to Internal Revenue Code section 401(k), and governmental entities are not permitted to have 401(k) plans unless they had one back in 1986. And even if they had one back then, it would have to be a profit-sharing plan unless it was a pre-ERISA money purchase plan. So for the vast majority of governmental entities, salary deferrals would not be permitted in the kind of plan you describe. However, matching contributions are permitted. For example, in a 457(b) plan, any employer contributions directly to the plan would count against the maximum limit on contributions to a 457(b) plan ($19,500 in 2020). What many governmental entities do is to have employee deferrals made to the 457(b) plan, but to have contributions matching those 457(b) deferrals made to a money purchase or profit sharing 401(a) plan.

For a long time, that was true. Unless a governmental plan committed such egregious violations that they turned up on the front page of the newspaper, they didn't get audited. But we're involved in one at the moment, in which the IRS is alleging violations of minimum distribution requirements.

Yes, we have seen governmental plans audited. The motivation to challenge IRS actions is limited by the fact that the IRS is generally willing to accept a settlement that is far less costly than disqualification (and any applicable excise taxes).

The IRS has authority to audit the compliance of governmental 401(a) or 403(b) plans with Internal Revenue Code requirements.

We have a grandfathered split dollar arrangement based on a modified endowment contract (MEC). The employer is entitled to the premiums paid (without interest) upon surrender of the contract or upon death. At this point, the employer (which is a tax-exempt organization) would like to get out of the contract, by either taking its share as a loan or by taking a cash withdrawal of its share. At that point, the employee would own the contract. The issue is what the tax consequences of this would be. Normally, distributions from an MEC are treated as coming first out of income (taxable) and only after that out of basis (nontaxable). However, in this case, the party taking the distribution would be a tax-exempt organization. Does anyone believe that either a) the employee would be taxed on the amount withdrawn, even though it is the employer getting the money, or b) the employer would be subject to UBIT on amount withdrawn?

Section 457(f)(2)(E) contains an exception to the normal rules under section 457 for "a qualified governmental excess benefit arrangement described in section 415(m)." Among the requirements of section 415(m) is that the plan "is maintained solely for the purpose of providing to participants in the plan that part of the participant’s annual benefit otherwise payable under the terms of the plan that exceeds the limitations on benefits imposed by this section." Given that "this section" is section 415, it appears that a qualified governmental excess plan can provide only benefits in excess of the 415 limits, not benefits that are cut back due to the limitations on compensation in section 401(a)(17). However, a governmental 401(a) plan is not bound by the rules against discriminating in favor of highly compensated employees. Would it therefore be possible to say that for everyone except one individual, the benefit is for example 2% of compensation times years of service, but that for a specified individual, the benefit is for example 4% of compensation times years of service? The 4% would likely be developed in order that the individual's benefit would be the same percentage of total compensation as everyone else's, but it would not directly reference compensation over the 401(a)(17) cap. At that point, all benefits not in excess of the 415 limit could be provided by the qualified plan, while those above that limit could be provided by the excess plan. Alternatively, has anyone seen any flexibility on the part of the IRS to allow an excess plan to deal with the compensation limits as well as the 415 limits?

This is correct. An annuity under a 403(b) plan must be purchased "for an employee." The employee is the owner. So the employer can set up a new investment for future contributions, and can advise employees to move the old money. However, it can typically not move the old money itself.

If their intent was simply to stop making contributions to the old plan and start a new one, they could consider simply merging the old one into the new one. As Tom Poje says, it is possible to terminate a PS plan without 401(k) features, without worrying about a successor plan. However, merging the plans would avoid the administrative issues of either terminating the old plan or maintaining two plans.

If no employee had compensation of at least $120,000 or was a five-percent owner, then no employee is a highly compensated employee, and the tests will automatically be passed.

A citation isn't really possible, because we're talking about the absence of a statute, not the presence of one. The statute says you can't get a tax deduction for a contribution of more than $X. It doesn't say that there is an excise tax on contributions of more than that amount, or that your plan is disqualified, or that it's a violation of ERISA. So even if you were talking about a taxable employer, it could make contributions of more than $X. It just wouldn't get a tax deduction for them. So what possible penalty could there be in the case of an organization that doesn't get tax deductions in the first place?

In either case, the deductibility limits do not apply.

There are two ways a 403(b) plan can be a non-ERISA plan. One is to be a governmental or nonelecting church plan. The other is to be a plan, other than either of the preceding, which has minimal employer involvement (as described in DOL regulations). The author's statement is true if the latter exemption is being used, but not if the former one is.

Section 411 doesn't apply to a governmental plan. See 411(e)(1)(A). However, in many states, federal or state constitutional provisions on the impairment of contracts have been interpreted to prevent adverse changes to present or future benefits for current employees. (This is actually a tougher standard than 411(d)(6), as it prevents even changes to future benefit accruals for such employees.) You would therefore want to research court decisions in the relevant state.

Yes, it would be a problem. In theory, contributions under a 403(b) plan must be nonforfeitable. 26 C.F.R. § 1.403(b)-3(a)(2). As a practical matter, though, there is a workaround built into the regulations whereby forfeitable contributions are treated as not having been made to the 403(b) plan, but rather to a separate I.R.C. § 403(c) annuity (or a tax-exempt employee trust where a custodial account is used), when they are made. (Forfeitable contributions are required to be kept in a separate bookkeeping account than nonforfeitable contributions.) Then, as amounts become vested, and assuming all of the 403(b) plan conditions (other than nonforfeitability) are met for those contributions, those amounts are retroactively treated as having been made to the 403(b) plan for purposes of the maximum limits on contributions when they become nonforfeitable. 26 C.F.R. § 1.403(b)-3(d)(2). But in this case, the contributions were nonforfeitable when made. Thus, making them forfeitable again would amount to out taking money already in the 403(b), which would be impermissible.