Pre-Tax purchase of retirement benefits. Part of 402(g)?

[Guest fiddler]

A school employee is allowed to purchase up to five years of retirement benefits on a pre-tax basis. The school also has a 403(b) plan, of which this employee is a participant. Is the pre-tax purchase of the retirement benefits included in the overall annual 402(g) limit ($13,000 + $3,000 catch-up for 2004)?

[Guest Yanikoski]

No, pre-tax purchases of retirement plan years-of-service credit are not elective deferrals, as defined in section 402(g) of the IRC. Therefore they are not subject to the 402(g) limits.

However, since they are not elective deferrals, they DO reduce the "includible compensation" that helps define the contribution limit. For example, imagine a part-time employee with an existing 403(b) account, earning $15,000/year. This employee wishes to contribute $5,000 to the retirement plan to purchase years-of-service credit, and elects to do so by transferring funds out of the 403(b) plan (as permitted by EGTRRA). Includible compensation would then be $15,000 MINUS $5,000, and so new elective deferrals to the 403(b) would be limited to $10,000 (i.e., the lesser of $13,000 or includible compensation).

[Ellie Lowder]

Hey, Chuck - a transfer of assets from the 403(b) account to purchase the credits would not reduce includible compensation. I think you meant to say that, if the employee in your example chooses to contribute the $5,000 pre-tax from the paychecks, it would reduce includible compensation.

[Guest Yanikoski]

Thanks for the correction, Ellie. (I have to stop looking at these things late in the workday!)