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Consider a 403(b) Retirement Option for Your Staff

Employer-sponsored plans play an increasingly significant role in retirement planning as individuals worry about the future of Social Security and their ability to finance the kind of retirement they envision. They also help employers attract and retain better employees, cutting the costs of having to find and train new hires.

For certain tax-exempt institutions, one option is to offer a 403(b) plan. These defined contribution plans are similar to 401(k) plans, allowing money in the account to grow tax-deferred until the funds are withdrawn at retirement.

Some plans also offer a Roth 403(b) option, in which employee contributions are taxed, but all growth and withdrawals are tax-exempt, so the employee's retirement income is tax-free if certain requirements are met.

Broadly, there are two types of 403(b) plans:

1. Employee-only contribution accounts that generally aren't subject to the Employee Retirement Income Security Act (ERISA). From a sponsor's perspective, the plans offer the advantages of not being required to undergo period discrimination testing and they don't require special account or due process for being fully funded by the organization.

2. Double contributions plans, where employees and the employer both put money into the account. These are subject to ERISA.

It's in your organization's best interests to consult with a professional advisor to determine whether ERISA applies to the plan your group is offering or considering.

Contribution Limits

For 2015, employee contributions are limited to $18,000 (up from $17,500 for 2014). Designated Roth or 401(k) contributions to other plans count toward that limit. Employees can contribute an additional $6,000 in "catch-up" contributions every year once they turn age 50 (up from $5,500 for 2014). In addition, certain individuals with 15 or more years of service can contribute another $3,000 a year.

Employer contributions are tax deductible and automatic in most 403(b) plans. With 401(k) accounts, vesting periods of as long as three years are common.

Elective deferrals in a 403(b) plan are not subject to nondiscrimination testing (the ADP test). So there is no need to refund contributions to highly compensated employees because of a failed test. Such refunds are common where the deferrals among most employees are low. Instead of the test, the 403(b) plans must make elective deferrals universally available to all employees except those whose deferrals would not be more than $200 or who:

  • Can participate in another employer-sponsored 401(k) or 403(b) plan, or in an eligible governmental 457(b) plan that permits elective deferrals.
  • Are students performing a service for a school, college or university.
  • Are nonresident aliens.
  • Work fewer than 20 hours a week.

The rules and regulations governing 403(b) plans are complex, particularly when it comes to employee deferrals, nondiscrimination rules and after-tax employee contributions.

Annual Checkup

The following checklist should be completed annually and can help uncover potential trouble spots and keep your organization's account in compliance with income tax rules.

1. Does your organization qualify as a public educational institution or a tax-exempt charitable organization? (The plans can be offered by public elementary and high schools, colleges and universities; research institutions; churches or church-related organizations; not-for-profit hospitals; charities, and museums.)

2. Does the plan meet the universal availability rule whereby all employees who normally work 20 hours or more a week are given the opportunity to make a contribution to the plan? (Failure to meet this rule is often due to excluding part-time employees who would otherwise be eligible to participate.)

3. Do employee contributions, including any designated Roth payments, meet the required limits in a calendar year? (Failure to limit these elective deferrals may result in penalties and additional taxes to the employee and employer.)

4. If your organization makes contributions, do the combined annual contributions fall under the regulatory limits?

5. If the employee is making catch-up contributions based on 15 years of service, were those years full time with the same employer? (Even if this requirement is met, a calculation must still be made to determine the level of entitlement. Consult with your tax advisor.)

6. If your program permits age 50+ catch-up contributions, were all eligible employees informed of this right?

7. Do the annuity contracts or custodial accounts state the employee contribution limits for the taxable year and contain direct rollover provisions? As well, if there is an annuity contract does it state that the account is non-transferable?

8. If your plan offers a five-year post severance provision, are amounts contributed through a non-elective method? (Amounts contributed to a 403 (b) plan that an employee had an option of receiving in cash are considered elective deferrals and are not eligible for the five-year provision.)

9. Does your organization and its plan vendors enforce participant loan repayments and limit aggregate loan amounts as required? (If not, loans in default of violating certain regulations may be deemed taxable distributions and reported as income to the participant.)

10. Are your group and the vendors requiring documentation that hardship distributions meet IRS definitions and requirements? (Your organization should certify, based on the facts, that the affected plan participant has an immediate and heavy financial need.)

If there are any "No" answers, there may be a problem with the plan. Bear in mind, however, that even if you answer "Yes" to all the questions, your group's plan might still not meet all the requirements. Your tax advisor can help determine compliance and correct any errors that pop up. Many problems can be easily fixed without penalty and without having to contact the IRS.

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