403b plus New Comparability

[zimbo]

I have an existing 403b plan with an Profit Sharing provision. We are amending the allocation provisions of the PS portion of the plan to become a New Comp (previously it was a straight proportion of pay PS). In running the a4 non discrimination tests, do I include the 403b deferrals in my average benefit test?

Would the answer be any different if my 403b deferrals were in a Non ERISA 403b plan?

[Laura Harrington]

Yes, the 403(b) deferrals are included in the average benefits percentage test.

As to your second question, if the plan has employer contributions, I don't believe it can be a non-ERISA 403(b) plan.

[Mike Preston]

Laura, I thought, although I may be misremembering, that 403(b)'s were not qualified plans, and because of that they are specifically excluded from all 401(a)(4) non-discrimination testing. Do you have a cite that says it should be included?

[Laura Harrington]

From Treas. Reg. 1.403(b)-5(a)(1):

(a) Nondiscrimination rules for contributions other than section 403(b) elective deferrals--(1) General rule. Under section 403(b)(12)(A)(i), employer contributions and after-tax employee contributions to a section 403(b) plan must satisfy all of the following requirements (the nondiscrimination requirements) in the same manner as a qualified plan under section 401(a):

(i) Section 401(a)(4) (relating to nondiscrimination in contributions and benefits), taking section 401(a)(5) into account.

(ii) Section 401(a)(17) (limiting the amount of compensation that can be taken into account).

(iii) Section 401(m) (relating to matching and after-tax employee contributions).

(iv) Section 410(b) (relating to minimum coverage).

[zimbo]

As to the ERISA status, what if employer has 2 403b plans. The ERISA plan is a new comp PS allocation with 401(a)(4) testing and the other plan is the non-ERISA employee deferral only plan. Do you believe that we would still test those deferrals in the average benefit test? You seem to believe that we generally test in the same manner as a qualified plan.

While I agree with that overall concept, I'm still not totally sure that the employee deferrals (ERISA or non-ERISA) fall into the tests since those deferrals are NOT subject to non discrimination testing under the universal availability rulese.

[Laura Harrington]

I was just about to post a reply retracting my first response. The truth is that I do not think the code or the Treas. Regulations are clear on whether or not the 403(b) deferrals should be included in the average benefits percentage test. I cannot find guidance that states either way.

My firm tests them in the average benefits percentage test, although the argument could be made against including them.

Unfortunately this appears to be one of the many "gray" areas in the retirement plan world.

[Tom Poje]

The IRS audit guidelines for 403b plans are as follows: (ok, so I 'bolded' some stuff)based on these I'd say 403b deferrals are ignored.

VI. NONDISCRIMINATION AND COVERAGE

A. Technical Overview

(1) General

(a) TRA '86 imposed nondiscrimination and coverage rules on 403(b) plans under § 403(b)(12). These rules generally must be satisfied for plan years beginning after December 31, 1988.

(b) These rules do not apply to churches, including qualified church-controlled organizations, as defined by § 3121(w)(3).

© For tax years prior to August 5, 1997, governmental 403(b) plans are deemed to satisfy nondiscrimination (except for § 401(a)(17)) and coverage requirements with respect to non-salary reduction contributions. After that date, these requirements (except § 401(a)(17)) do not apply to governmental 403(b) plans. A governmental plan (within the meaning of § 414(d)) is one maintained by a State or local government or political subdivision, agency or instrumentality thereof.

(d) Notice 89-23

1 Currently there are no nondiscrimination regulations under § 403(b)(12).

2 Pending the issuance of regulations or other guidance, Notice 89-23, 1989-1 C.B. 654 (extended by Notice 96-64, 1996-2 C.B. 229), provides guidance for complying with the nondiscrimination rules.

a Notice 89-23 deems a 403(b) plan to satisfy nondiscrimination if the employer operates the plan in accordance with a good faith, reasonable interpretation of § 403(b)(12). One means of satisfying this test is through the safe harbors set forth in Notice 89-23.

b Under the notice, salary reduction and non-salary reduction contributions are tested separately for nondiscrimination. Only non-salary reduction contributions (both matching and non-elective) are subject to the coverage requirements of § 410(b). See subparagraph (3) below.

3 Under § 414(u), a 403(b) plan is not treated as failing nondiscrimination or coverage requirements by reason of the making of employer or employee contributions(or the right to make such contributions) made pursuant to veterans' re-employment rights under USERRA.

(2) Salary Reduction Contributions

(a) Salary reduction contributions are tested separately from non-salary reduction contributions for nondiscrimination. See § 403(b)(12)(A)(ii).

1 The nondiscrimination requirement for salary reduction contributions is satisfied only if the plan in operation allows each employee to elect to defer more than $200 annually. Unlike a qualified CODA, nondiscrimination with respect to salary reduction contributions is not satisfied through compliance with the ADP test.

2 The test for salary reduction contributions focuses on eligibility and generally requires universal eligibility. However, there is no requirement that the opportunity to make salary reduction contributions be available; but once that opportunity is available to any employee, it must be available to all nonexcludable employees to satisfy nondiscrimination.

3 Until future guidance is issued, both public education institutions and 501©(3) organizations MUST currently operate their 403(b) plans in accordance with a good faith/reasonable interpretation of the nondiscrimination requirement for salary reduction contributions. No plan provisions are currently required, but faulty plan language may indicate an operational violation.

(b) Excludable employees may be disregarded in applying the nondiscrimination test for salary reduction contributions. These include:

1 nonresident aliens with no U.S. source income,

2 employees who normally work less than 20 hours per week,

3 collectively-bargained employees,

4 students performing certain services,

5 employees whose maximum salary reduction contributions under the plan would be no greater than $200,

6 participants in an eligible § 457 plan, a qualified CODA, or other salary reduction 403(b) plan, and

7 certain ministers described in § 414(e)(5)©.

Unlike a qualified plan, a 403(b) plan is not permitted to have any minimum age and service exclusion for salary reduction contributions.

© Like elective deferrals under § 402(g), salary reduction contributions for nondiscrimination testing consist of employer contributions made pursuant to a salary reduction agreement.

(d) Under Notice 89-23, "employer" means the common law employer (and not the controlled group) for purposes of testing salary reduction contributions for nondiscrimination. A good faith, reasonable interpretation as to the identity of the employer is sufficient for this purpose.

1 Salary reduction contributions made pursuant to a one-time irrevocable election at initial eligibility to participate in the salary reduction agreement, or pursuant to certain other one-time irrevocable elections to be specified in regulations, and pre-tax contributions made as a condition of employment are treated and tested as non-salary reduction contributions. See text V.A for a discussion of a similar definition for elective deferrals under § 402(g).

EXAMPLE 28: Employer is a large public university located in City Y. Employer maintains an annuity plan ("Plan") intended to be a 403(b) plan. Both non-elective, non-matching contributions and salary reduction contributions are provided under the Plan. Under the Plan, only senior administrative staff and faculty are eligible to elect to defer a portion of their salary pursuant to salary reduction agreements with Employer. Employer also maintains a defined benefit plan for remaining employees. Employer maintains no other plans of deferred compensation. The salary reduction contributions are discriminatory. The Plan does not satisfy the requirements of § 403(b).

EXAMPLE 29: Same as Example 28, except that all full-time employees are eligible to participate in the Plan. There are 40 part-time clerical employees who are not students and who normally work 29 hours per week (or 1,508 hours per year). Since the part-time employees in this example are not excludable, the salary reduction contributions are discriminatory. The Plan is not a 403(b) plan.

EXAMPLE 30: Employer is a small private school which maintains an annuity plan intended to be a 403(b) plan. All eligible employees may elect to defer at least four (4) percent of compensation. An eligible employee, A, has compensation of $25,000 for 1998 and elects prior to 1998 to defer 1.5 percent of compensation. The plan administrator declines to process the election and informs A that the minimum deferral is four percent of compensation. The salary reduction contributions are discriminatory, and the Plan fails to satisfy 403(b).

EXAMPLE 31: Employer is a private hospital maintaining an annuity plan ("Plan") intended to be a 403(b) plan. The Plan provides only a salary reduction arrangement. Under the Plan, all medical doctors and senior administrative staff are eligible to participate in the Plan immediately upon hire. Remaining employees, including nurses and other support staff, are eligible only after two years of service and attainment of age 21. Employer maintains no other plans of deferred compensation. The salary reduction contributions are discriminatory, and the Plan loses its status as a 403(b).

(d) Examples 28 through 31 illustrate that salary reduction contributions are tested separately from other contributions for nondiscrimination and that these contributions must be offered universally to non-excludable employees. The effect of violating nondiscrimination is the loss of § 403(b) status. Contributions to the Plans are therefore subject to income tax, employment tax and withholding.

(3) Non-Salary Reduction Contributions

(a) salary reduction contributions are all contributions that are not salary reduction contributions. salary reduction contributions are basically all non-elective and matching contributions.

1 Salary reduction contributions are tested separately from salary reduction contributions for nondiscrimination.

2 Non-elective (non-matching) contributions, and matching and after-tax employee contributions, are also tested separately for nondiscrimination. Section 403(b)(12)(A)(i) requires compliance with §§401(a)(4) (nondiscrimination), (5) (permitted disparity), (17) (the $160,000 ceiling on compensation, as indexed for 1998), and (26) (minimum participation), 401(m) (matching and after-tax employee contributions) and 410(b) (minimum coverage) for salary reduction contributions.

(b) Salary reduction contributions of 403(b) plans maintained by public education institutions, or governmental entities which qualify as 501©(3) organizations, are not subject to the nondiscrimination or coverage requirements (other than § 401(a)(17)) beginning in tax years on or after August 5, 1997 (prior to that date, governmental plans are deemed to satisfy these requirements, except § 401(a)(17)).

© For 501©(3) organizations, under Notice 89-23, nondiscrimination requirements for salary reduction contributions are deemed satisfied if the employer operates the plan in accordance with a good faith reasonable interpretation of the above Code sections. The safe harbors in the notice are one means of satisfying the good faith/reasonable interpretation test.

(d) Excludable employees are those employees who have not satisfied any permissible age and service requirements of the plan, in addition to those listed above in section VI(A)(2)(b).

(e) Employer is generally defined for purposes of nondiscrimination with respect to salary reduction contributions under §§ 414(b) (controlled groups), © (groups under common control), (m) (affiliated service groups) and (o) (other organizations or arrangements described by regulations). Until further guidance is issued, a good faith, reasonable interpretation applies in defining the employer for this purpose. See Notice 89-23 for more detail.

(4) Highly Compensated Employee

For years beginning after December 31, 1996, the definition of an HCE means any employee who: (a) was a five percent owner at any time during the year or the preceding year, or (b) for the preceding year has compensation from the employer in excess of $80,000 (as indexed for COLAs), and if the employer so elects for the preceding year, was in the top paid group of employees for such preceding year.

B. Examination Steps

(1) Ask the employer for the number of HCEs and NHCEs, which of these participate or are eligible to participate in the 403(b) plan or other plans of the employer, and annual compensation and contributions records.

(2) Using employment records, check to see who can make salary reduction contributions and when they can be made. Check to see whether salary reduction contributions are in fact available to all nonexcludable employees. Because the definition of salary reduction contribution and elective deferral are similar, refer to the Examination Steps in Section (V)(A) concerning whether contributions are elective or non-elective. Nondiscrimination requirements may be violated if the employer fails to properly characterize the contributions.

(3) Ask the employer which employees were excluded from participation and the basis on which they were excluded.

(4) Find out whether the employer aggregates plans to pass coverage under §§ 403(b)(12) and 410(b). Ask which test the employer uses to pass coverage, ratio percentage or average benefits.

(5) Consider whether employer contributions satisfy the safe harbors. If not, see if there is another basis on which employer contributions satisfy good faith/reasonable interpretation.

(6) See whether matching contributions satisfy the ACP test.

[AndyH]

I'm looking at this issue also for the first time in a long time.

Tom, how old are those audit guidelines? Did they predate the final 403(b) regs?

Is Regulation 1.410(b)-7(f) still in effect, which I think says that 403(b) contributions are excluded from testing of 401(a) money and that 401(a) money and 403(b) deferrals may be excluded or included in 410(b) ABT testing of nonelective ER 403(b) allocations.

This is how I always understood the rules. Did the final 403(b) regs eliminate the line of separation?

(After further review I think the rules are unchanged, but if I missed something I'd like to know that)

[Tom Poje]

at the ASPPA conference this year, the question showed up and the answer was look at 1.403(b)-5 which says 401(a)(4) does not apply to 403(b) deferrals.