My last year of service; OK to contribute more than $13,500 as a &quot

[Guest Bev Kemmer]

From my reading of the IRS Pub. 571 regarding "last year of service" it seems as if $30,000 can be contributed to my 403b. The example given is about Bob who has made only elective deferrals to his account. My carrier says that only applies to employer contributions, not elective deferrals and that at no time can a contributor defer more than the $13,500 allowed by the "catch up" provision. Can you give me any information to clarify this seemingly contradictory information? Thank you, Bev Kemmer

[Michael Devault]

Your carrier is correct. Contributions to a 403(B) are subject to three limitations:

1. The exclusion allowance, defined in Section 403(B)(2),

2. The section 415 limit, and

3. The elective deferral limit.

If contributions are made by elective deferrals, the limit is the smaller of the three. If employer contributions are involved, the total contribution (employer and employee) cannot exceed the smaller of 1 or 2, and employee contributoins cannot exceed 3.

There are some catch up provisions for section 415 and one catch up provision for the elective deferral limit. The year of separation from service catch up is a way to exceed the normal 415 limit in the employees final year of service. While it may allow the normal 415 limit to be exceeded, you're still "stuck" with the elective deferral limit of $10,500 (in 2000), with the possibility of a $3,000 catch up on that limit, bringing the maximum that may be contributed by salary reduction to $13,500.

Hope this helps.

[Guest Harvey Carruth]

Michael's responses are thorough and correct, with one small proviso mentioned below. However, the example in IRS Publication 571 to which Bev refers deserves further attention. I am assuming that the version of Publication 571 is for use in preparing 1999 returns and that the example appears as Example 3 in the section entitled "Examples of Catch-up Elections."

I believe that Bev's first confusion arises from use of the phrase "employer contributions." Even Michael backslides somewhat by suggesting that the phrase "employer contributions" somehow distinguishes "employer non-salary-reduction contributions" from "elective deferrals." Both "elective deferrals" and "employer non-salary-reduction contributions" are "employer contributions" in tax law and policy, as are all other contributions that are not included in the employee's gross income for the year.

Returning now to Example 3 in IRS Publication 571, unfortunately this entire version of the publication is fraught with unclear, misleading, and simply wrong information, of which only the few listed below are mentioned here:

1) In Example 3, since Bob White separated from service at Elm School on May 30, 1999, presumably he was not employed by Elm School for the remainder of the calendar year. Depending on the employment policies of Elm School, Bob's "months of service" with Elm School during 1999 were at most eight, and more likely would be considered as six. For purposes of this discussion, let's assume that Bob "earned" only six months of service during 1999. It is unclear whether the "salary of $49,000" is the salary earned during 1999 or an "academic year" salary. If this $49,000 was earned entirely during 1999, then those calculations associated with the "standard 415 limit" are correct, but those calculations associated with the "403(B) exclusion allowance" and the "expanded 415 limit" for the "any year limit" are wrong. This is because Bob's "compensation as used in the standard 415 limit" is $49,000, whereas "compensation as used in the expanded 415 limit" and "compensation during the most recent period that may be counted as one year of service" are equal, and are larger than $49,000 (arguably $98,000). On the other hand, if this $49,000 is an academic year salary, then those calculations associated with the "403(B) exclusion allowance" and the "expanded 415 limit" for the "any year limit" are correct, but those calculations associated with the "standard 415 limit" are wrong.

2) Again referring to Example 3, a careful reading of IRC 415©(4)(A) yields that, along with the IRC 415©(1)(A) $30,000 limit, the "standard 403(B) exclusion allowance" (using all years of service at Elm School) must limit contributions, in addition to the "modified 403(B) exclusion allowance" (using only those years of service earned during the 120-month time period ending on the date of separation). However, this is not a critical issue, since only in the most bizarre circumstances is the "standard exclusion allowance (all years)" less than the "modified exclusion allowance (last 10 years)."

3) The following (most unfortunate) statement appears on the very first page of Publication 571, under the heading "Important Reminders:"

"Your exclusion allowance is the amount of employer contributions (including elective deferrals) to your tax-sheltered annuity contract or account that you can exclude from income."

This statement only perpetuates time-honored misunderstandings resulting from the phrase "Maximum Exclusion Allowance (MEA)" and its relationship with the phrase "exclusion allowance" as defined in IRC 403(B)(2).

4) The only definition given of "includible compensation" is the one listed in IRC 403(B)(3), whereas this quantity is treated as though it is the same as "the participant's compensation" as defined in IRC 415©(3) when applying the IRC 415©(1)(B) compensation limit. As illustrated above, this in only the case when the employee works 100% of full-time equivalent for the entire calendar year.

[Guest Bev Kemmer]

Michale and Harvey:

Thank you both for your replies. I have problems also with Worksheet 4 on Page 11. Bob again is used as an example. The final line allows him $30,000 limit on employer contributions. However, it is obvious from Example 3 that Bob only has elective deferrals--no employer matching funds. Therefore, if Bob, who only has elective deferrals, can have contributions up to $30,000--why can't I? It does not differentiate in that example. Therefore my confusion. If the publication is confusing and erroneous--where can we go for definitive information??? (I suppost that is rhetorical). Thanks again, I will go with the $13,500 as obviously the carrier won't support anything else.

[Michael Devault]

In their own round about way, I believe the Service is using this example to show how a 415 catch up provision can be used to increase a salary reduction contribution that would otherwise be limited. In the second paragraph describing the example, they conclude that Bob can contribute $13,000. In the column to the right, they make the statement that "without the catch-up elections, $12,250 would be the maximum excludable contribution Elm School could makde to a TSA on Bob's behalf for 1999." The contribution is limited by the 415 limit.

Then, they go on to show how the use of the year of separation from service limit can be used as a substitute for the 415 limit of $12,250. This increase then permits good ol' Bob to contribute the $13,000 amount stated in the original conclusion in the middle column.

Does this make sense? Sometimes, it helps to have a glass of wine or two before you read IRS publications. Then, have two more afterwards!

Mike

[Guest Harvey Carruth]

First of all, I agree with Michael's wine suggestion. Secondly, I agree with his understanding of why the example appears in the publication. Next, I agree with the publication statement regarding the "general rule" (Page 11, Column 3, middle paragraph), although it would have been helpful to include a statement to the effect that any combination of elective deferrals by Bob and discretionary or matching contributions by Elm School is permissible, as long as the sum of the two amounts does not exceed $12,250.

On the other hand, I think the discussion of the Year of Separation from Service Limit Election (Page 11, Column 3, above Worksheet 4) definitely needs enhancement by including a statement to the effect that any combination of elective deferrals by Bob and discretionary or matching contributions by Elm School is permissible, as long as the sum of the two amounts does not exceed $30,000 and Bob's elective deferral does not exceed $13,000.

Similarly, the discussion of the Any Year Limit Election (Page 11, Column 3, above Worksheet 4) would be significantly enhanced by including a statement to the effect that any combination of elective deferrals by Bob and discretionary or matching contributions by Elm School is permissible, as long as the sum of the two amounts does not exceed $15,000 and Bob's elective deferral does not exceed $13,000.

On the third hand, I continue to believe that the failure to mention the difference between 403(B) includible compensation and the participant's compensation as defined in 415 is unforgivable. Since this is a teacher, almost certainly the $45,000 was meant to represent academic year salary, not salary paid during 1999. This means that the standard 415 compensation limit would be at most .25 * (2 * $45,000 / 3) = $7,500, which changes the numbers involved in the analysis considerably.

The most unfortunate thing is that this example would be a wonderful illustration of the subtle differences between the limits that apply to the general rule election and the three catch-up elections, if only it were more carefully phrased and analyzed. In particular, had this example received proper treatment in Publication 571, Bev would not have been so confused about her contribution options.

I'll let that be my "final answer."