Another 403(b) Question

I don't do a lot of 403(b) work, and I have had another question proposed to me.

A Non-ERISA 403(b) for a private high school provides a "Profit Sharing" contribution based on the following:

0-9 years of service - 6% of gross salary

10-14 years of service - 7% of gross salary

15+ years of service - 8% of gross salary

However, the principal of the school, no matter how many years of service that they have, receives an 8% of gross salary contribution; this is written into the contract of the principal. The principal by definition is an HCE, and at this point, the principal has less than 9 years of service, and, per the document, should be receiving a 6% allocation, save for the provision in the contract.

Our firm, who is the auditor of this plan, is concerned that the higher percentage given to the HCE principal is a discriminatory allocation, and the 2% over the document prescribed allocation should be forfeited. As I have no clue as to the answer, I thought I'd throw this out here and see what opinions you have have. Thanks for any replies!

Unless you’re already confident that the school’s plan is administered by or under the control of a church so that it is a church plan not governed by ERISA, your firm might evaluate whether the plan is “non-ERISA”.

The plan provisions you describe seem logically inconsistent with saying there is no plan the employer established or maintains.

After you’ve sorted out what kind of plan this is (and the scope of your engagement), you’d consider whether you should consider a nondiscrimination issue, and (if you do) which tax-law provision governs.

It is under the control of the Catholic church, so it is indeed a Non-ERISA 403(b)(9) plan.

The American Institute of Certified Public Accountants’ Auditing Standards Boards’ Forming an Opinion and Reporting on Financial Statements of Employee Benefit Plans Subject to ERISA, Statement on Auditing Standards No. 136 (July 2019) applies only for audits of the financial statements of an ERISA-governed employee-benefit plan. Its first numbered paragraph states: “This SAS should not be adapted for plans that are not subject to ERISA.”

If your engagement’s scope is only an audit of a church plan’s financial statements with no added agreed-upon procedures, your firm might evaluate whether it is necessary or appropriate to consider whether the plan meets or fails an Internal Revenue Code § 403(b)(1)(D) non-discrimination condition. Even a failure of such a condition might be immaterial, insignificant, or even irrelevant, in some circumstances, to a plan’s financial statements.

Consider also, in a particular church plan’s facts and circumstances, whether a § 403(b)(1)(D) nondiscrimination condition applies. See I.R.C. (26 U.S.C.) §§ 403(b)(1)(D), 403(b)(12)(B), 3121(w)(3)(A) (referring to “an elementary or secondary school which is controlled, operated, or principally supported by a church or by a convention or association of churches”).

Building on Peter's latest response, another factor worth considering is whether the church or association or convention of churches made the election described in Code Section 410(d)(1). If it did, then the nondiscrimination provisions would nevertheless apply. Please note that, once made, the election is irrevocable.

There are still tax benefits associated with a Church plan, deferral of income for the participants for instance.  Are church plans allowed to ignore the terms of their plan documents and allocate benefits as they see fit?

4 hours ago, LANDO said:

There are still tax benefits associated with a Church plan, deferral of income for the participants for instance.  Are church plans allowed to ignore the terms of their plan documents and allocate benefits as they see fit?

The answer is no. See 1.403(b)-3(d)(ii) "...a failure to operate in accordance with the terms of a plan adversely affects all of the contracts issued by the employer to the employee or employees with respect to whom the operational failure occurred".  So, even if nondiscrim rules don't apply (if it's a church or QCCO under 3121(w)(3)), I believe such a failure could cause the contract to become taxable as a nonqualified annuity contract under 403(c).

If they make the 8% contribution for the principal, to avoid that possibility, they may want to amend the plan doc to match what the principal's employment contract says. There's an argument that the principal's employment contract forms part of the plan document, but it would probably be safer not to have to rely on that. 

Non-ERISA... and you're auditing what exactly that requires you to question non-discrimination??  Otherwise, yes a retroactive amendment to the Plan for the 'Principal' class of employee.  Otherwise, out of the eight(?) ways you can run non-discrimination, one of them should pass just fine, unless the principal is only 22 years old.

 I am commenting on the assumption that the Church is actually the Plan Sponsor. I don't have enough information to evaluate that conclusion.

Peter Gulia's comments are excellent.

Rocknrolls2: The Roman Catholic Church has not, to my knowledge, made any 410(d) elections ("electing church").

I agree with bito'money:  This contribution should have been and needs to be written into the document.  b9's have to have plan documents. 

Nate S.: I don't think this is a "discrimination test" problem.  These plans are ERISA (DOL) exempt.  Such testing is DOL not IRS.  The problem is that they are making a contribution which is not provided for in the plan document.  That is an IRS issue and problem.

On 5/31/2022 at 1:02 PM, Patricia Neal Jensen said:

Nate S.: I don't think this is a "discrimination test" problem.  These plans are ERISA (DOL) exempt.  Such testing is DOL not IRS.  The problem is that they are making a contribution which is not provided for in the plan document.  That is an IRS issue and problem.

I didn't say it was, the OP did, last paragraph.

However, I would still use that to determine if the additional allocation could be left in the HCE participant account, with a retroactive amendment to conform the Doc to the operations; or if the amount, plus earnings, should be forfeited.  If nondiscrimination passes then the Participant may keep it since the Plan is to be administered to their benefit.