Part-time exclusion from elective deferrals under ERISA 403(b) Plan

[Guest Pennysaver]

Treas. Reg. §1.403(b)-5(b)(4)(iii)(B)(2) indicates that an exclusion of employees who normally work fewer than 20 hours per week may not be used by an ERISA 403(b) plan due to section 202(a) of ERISA and IRC 410(a), which relate to disguised age and service conditions.

Does this mean that an ERISA 403(b) plan may never exclude employees who normally work fewer than 20 hours per week from making elective deferrals? Or does this mean that an ERISA 403(b) plan MAY exclude such employees, provided that some sort of fail-safe language is used to ensure that any employee excluded under this category who in fact completes a Year of Service is permitted to make elective deferrals?

[ETA Consulting LLC]

You have to remember to differentiate the 403(b) elective deferrals from the 'employer funding'. The universal availability rules (e.g. normally work less than 20) apply to the elective deferrals only and no other source. So, it is possible (unlikely, but possible) for an employee to work 1000 hours per year and not meet eligibility for the elective deferral within a 403(b). You cannot use this rule for other contributions to a 403(b) merely because it is a 403(b) plan. So, if you were to try to provide an employer contribution using the same eligibility conditions, then you could disqualify the 403(b).

Good Luck!

[Kevin C]

The problem is that the Universal Availability rules under 403(b) and the ERISA participation rules are not consistent. The <20 hour per week exclusion in 403(b) is based on expected hours the first year and for later years, whether the person is credited with 1,000 hours in the prior year. Under ERISA once you are credited with 1,000 hours in a year, you stay in the plan even if your hours drop below 1,000 for a later year. So, if someone works 1,000 hours in a year and then drops below 1,000 hours in later years, the <20 hour per week exclusion will exclude them from deferrals in the year following the year they first worked less than 1,000 hours. That is an ERISA violation since it has the effect of requiring more than one year of service for deferral eligiblity.

Add to that

1.403(b)-5(b)(4)Exclusions

(i)Exclusions for special types of employees.—

A plan does not fail to satisfy the universal availability requirement of this paragraph (b) merely because it excludes one or more of the types of employees listed in paragraph (b)(4)(ii) of this section. However, the exclusion of any employee listed in paragraph (b)(4)(ii)(D) or (E) of this section is subject to the conditions applicable under section 410(b)(4). Thus, if any employee listed in paragraph (b)(4)(ii)(D) 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)(D) of this section may be excluded under this paragraph (b)(4) and, 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).[/quote]

(E) has the <20 hour per week exclusion. So, if you have a fail-safe that keeps you from violating ERISA, when it applies, you lose the ability to use the <20 hour per week exclusion.

We have a marathon IRS audit going where they made a mistake in 2007 and 2008 and allowed a single person who was previously full time, but dropped to less than 20 hours per week to continue deferring. The agent insists the all or nothing rule in the new regs was also in effect under the pre 2009 rules. He is wrong about that, but starting 1/1/2009, the all or nothing rule does apply.

The best solution is to not use the <20 hour per week exclusion for an ERISA covered 403(b). Usually, the problem comes to light well after the ineligible person was allowed to defer. Retroactive corrections can be very expensive.