IRS Exams of 403(b) & 457 Plans

Contact Information Robert J. Architect TEGE Washington, DC 202-283-9634 (Feel free to change this slide to include your own information as a presenter.)

Current Exam Issues – 403(b) Ineligible Employer Excess Elective Deferral contributions Review of payroll records & HR records & W-2 Universal availability Review of payroll records and HR records Plan Loans violate IRC 72(p) Review of account records & 1099-R Impermissible distributions-bad hardships Review of account records & HR records & 1099-R Contract provisions Review of contract

5 Year Post-Severance Contributions No CODA must be employer contributions Audit steps Will review plan Will review employment contracts Will review all documents for any cash options Will review for guaranteed payouts upon death

Sick & Vacation Pay Issues Sick & Vacation Payments Avoiding constructive receipt Payroll records; Benefits Handbook; Union Contracts Elective Deferrals to 403(b), 457(b), or 401(k) – Timing 415 regulations

Sick & Vacation Pay Issues (cont) Contributions to 401(a) plan If have cash option – Impermissible CODA -Governmental Contributions to 403(b) If subject to a cash option treated as elective deferral and not eligible for special 5 year post-retirement contributions Converting to employer contributions Attempts to avoid FICA Seek expert advice – many pitfalls

How 403(b) Regulations may impact exams –Based on Current content of proposed regulations- Caution (a work in progress)

Plan In Form & Operation Must be maintained pursuant to a written DC plan Both form and operation Future timely amendments Audit Steps Will review plan provisions for form and compare to plan operation

Universal Availability – 20 hour requirement ER must reasonably expect employee to work < 1000 hours for ensuing 12-month period Subsequent plan year or 12-month period the employee actually worked < 1000 hours in the preceding 12-month period Audit steps – Must track hours

Universal Availability (cont) Permissive exclusions - not allowed Collective bargaining employees Visiting professors Employees who have taken a vow of poverty Employee with a one-time election to participate in a governmental non-403(b) plan

Form Requirements -Contract 401(g) – Transferability of annuities 401(a)(30) – Elective deferral limit 401(a)(31) – Direct rollover 401(a)(9) – Required minimum distribution Incidental benefit requirement Audit Issue Current audit issue – first 3 above Now plan form requirement

Timely Payment of Elective Deferrals Contribution amounts must be transferred to providers within a period no longer than is reasonable for proper plan administration. – 15 day example Audit – Review operation

New Elective Deferral Requirement 401(k) Hardship suspension Effective opportunity to make cash or deferred election Anti-conditioning Audit Steps Will compare form and operation

Life Insurance No separate life insurance contracts Incidental death and disability permitted Audit steps Will review contract provisions

Non-Taxable Contract Exchange In the past – Rev. Proc. 90-24 Potential changes Transfer language must be in plan Transfer must be related to the plan Audit Steps Will review the form & the operation

Excess Contributions – IRC 415 Old rules – did not impact contract going forward Potential rules Must have separate account No separate account Contract does not qualify for exclusion in current and future years.

457(b) Eligible Plan: Exam Issues

457(b) Exam Issues Misunderstanding employer contribution limits & payroll taxes: Dollar limit for 2006 is $15,000 for both employer and employee contributions IRC 415(c) limit does not apply (FICA applies to both types of contributions.)

457(b) Exam Issues Final 3-year catch-up causing excesses: Counting under-utilized limit for years before the plan existed. Using the year of retirement rather than the 3 years before year of normal retirement age in the plan.

457(b) Exam Issues Final 3-year catch-up causing excesses: Errors in counting prior contributions to determine underutilized limit. Especially years before 1/1/02 when limits were coordinated.

457(b) Exam Issues Multiple plan document issues: More than one normal retirement age. Attempt to use multiple 457(b) limits. Contribution limits apply to the individual.

457(b) Exam Issues Abuse of unforeseeable emergency withdrawal rules: Attempting to apply the less restrictive 403(b)/401(k) hardship withdrawal rules. Not monitoring requests.

457(b) Exam Issues Failure to monitor loan limits: Often due to multiple 457(b) plans or 457(b) providers, or Loans in multiple plans. E.g., 403(b) and 457(b). Loan limits apply to all plans of the current employer.

Violations in Non-Governmental Plans Permitting loans Permitting rollovers Permitting the age 50+ catch-up

Exam Issues – 457(f) No substantial risk of forfeiture or risk has expired Review Employment contacts Review of benefits handbook Inadvertent 457(f) arrangements Review of union contracts Announcement 2000-1 Severance pay arrangements

IRC 409A and Impact On 457 Plans

Deferred Compensation Under 409A 409A added by American Jobs Creation Act of 2004 Notice 2005-1 – Guidance on scope of coverage – Q&A- 6,10,15 particularly Notice 2005-94 –Suspends 2005 Reporting previously set out in Announcement 2004-96 W-2 Box-12, Code Y – Report deferrals Announcement 2005-5 W-2 Box-12, Code Z – Report income

Application of IRC 409A to IRC 457 Plans Eligible 457(b) Plans IRC 409A does not apply – Notice 2005-1 Q&A -3 IRC 457(f) plans IRC 409A applies when vested but 409A and 457(f) work independently Satisfying 409A may not satisfy 457(f) – 2 ½ month rule Grandfathered arrangements under 457 No exception for 409A

Proposed 409A Regulations Issued – 09/29/2005

Substantial Risk of Forfeiture Same definition as 457(f)? Not necessarily a substantial risk of forfeiture Salary reduction deferrals Rolling Risk – Unilateral extensions Covenants not to compete

Severance Pay If valid not 457(f)/409A But Limits; Circumstances - Windows Dollar amounts Timing

Publications Available 4406 – Comparison Chart 403(b)/457 4482 – 403(b) for Participant 4483 – 403(b) for Sponsor 4484 – Chart of Retirement Plans for Tax Exempt & Governmental Entities

Visit - www.irs.gov/retirement