Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits Avoiding IRS Penalties: Understanding Constructive Receipt Richard A. Turner VALIC Vice President and Deputy General Counsel Lynne L. Wilson PSEA General Counsel 1 WEBCAST PARTICIPANTS: Listen to audio over your computer speakers. (If you prefer to listen by phone, you may dial-in using the numbers provided in your invitation. Phone lines will be available 10 minutes prior to the event start.)

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits DISCLAIMERS This presentation relates solely to structuring collectively bargained retirement incentives or severances in compliance with IRC § 457 and other tax code provisions, and federal and state anti-discrimination law. IRS Circular 230 Disclosure: Any advice contained in this presentation is not intended or written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market, or recommend to another party any transaction or matter addressed herein. There are no third party beneficiaries to this presentation, and it should not be relied upon by any individual for advice and counsel. 2

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits THE PROBLEM OF CHOICE IN EARLY RETIREMENT INCENTIVES Examples of Constructive Receipt Health insurance after retirement OR cash Medical insurance for 5 years OR $20,000 3

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits A 125 PLAN IS NOT A SOLUTION A choice in a 125 plan of medical insurance for 5 years OR $20,000 –Cannot be used for retiree choice –Use it or lose it rules –Deferred compensation problem –Does not meet the definition of “cash” 4

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits PROBLEMS WITH CASH ONLY PAYMENTS Cash spread out over time (tax owed before money received) Solutions –Lump sum (pay in tax year of retirement) –403(b) for 6 years (tax year of retirement and 5 more years) –Cash in first year and 403(b) in later years. 5

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits 403(b) PLANS ALLOW THE DEFERRAL OF FEDERAL TAXES “Regular” 403(b) – money grows tax free; federal taxes paid upon distribution “Roth” 403(b) – new twist; federal taxes paid up-front; grows tax free 6

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits ADDED TAX BENEFIT Added benefit for both types of 403(b) plans Nonelective (employer) contributions are exempt from FICA tax This saves employer and employee money 7

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits 403(b) CONTRIBUTION LIMITS Elective deferrals – $16,500 – $17,000 Catch-up contributions (persons over 50) –2011 & $5,500 Total amount that can be contributed –Lesser of 100% of compensation – $49,000 – $50,000 8

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits NONELECTIVE (EMPLOYER) CONTRIBUTIONS Limits – $49,000 – $50,000 This is the ONLY type of contribution that can be made to retirees 9

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits QUERY: WHAT IF THE RETIREE DIES PRIOR TO RECEIVING ALL CONTRIBUTIONS? Acceleration? –Contribution limits –Month of death Death benefit? 10

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits PSEA’S RECOMMENDED LANGUAGE “In the event of the retiree’s death, the maximum amount allowed of all remaining nonelective contributions will be timely paid to the retiree’s 403(b), as provided for by the Internal Revenue Code and its corresponding regulations.” 11

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits ERIPS WITH MEDICAL INSURANCE Paid health insurance –Participation in group plan –Participation in self-funded plan Health Reimbursement Account –Reimbursement of premium expenses –Reimbursement of allowable health care expenses, meaning all 213(d) allowable expenses 12

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits HEALTH REIMBURSEMENT ACCOUNTS A fund to reimburse medical expenses Employer contributions only, with pre- tax dollars (tax-free to employee). Money can roll over from year to year. Money cannot be cashed out but can only be used for out-of-pocket medical expenses. Payments can be made into an HRA after retirement. 13

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits HRA CONSIDERATIONS Bargain uniform contributions for retirees –Not a percentage of salary –Not based on years of service –Avoid tax consequences for highly compensated employees Cover the retiree’s spouse and dependents (of both retiree and spouse) 14

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits QUERY: ARE CONDITIONAL HRA OR 403(b) CONTRIBUTIONS ALLOWED? Medical insurance unless the retiree has other health care coverage in which case the payment goes to an HRA/403(b) Payment into an HRA unless the retiree has other health care coverage in which case the payment goes to a 403(b) 15

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits QUICK SUMMARY 16 –Cash ERIPs Lump sum in tax year of retirement 403(b) for tax year of retirement and five more years Lump sum in tax year of retirement and 403(b) Address problem of death –Health insurance Continue in group plan HRA (uniform amounts, no time limits, broad coverage possible) Questions regarding conditional payments

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits CAUTION – AGE DISCRIMINATION 17 Benefits cannot decline based on increasing age or years of service Windows with benefits are permissible –Retire at age 55 –Retire at superannuation Watch out for combinations of benefits –Retire with 15 years of service in district (for medical insurance) and in first year of superannuation (for cash incentive = 25% of salary)

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits TAXABLE v. NONTAXABLE BENEFITS 18 Taxable –Cash –Cash-out of unused sick leave/vacation leave –Employer contributions into a 403(b) –Term Life insurance that exceeds $50,000 Nontaxable –Participation in group health insurance * –HRA contributions (by employer) –Term life insurance under $50,000

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits CHOICES NOT ALLOWABLE UNDER TAX LAW 19 HRA v. anything else (cash, 403(b), health insurance, life insurance) 403(b) v. anything else (cash, health insurance, life insurance) Choice in 403(b) contributions –10,000 in 2011 or –$6,000 in 2011 and $6,000 in 2012

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits CHOICES ALLOWABLE BY TAX LAW BUT CAUSE UNNECESSARY TAX 20 Cash or health insurance Constructive receipt

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits FOR ACTIVE EMPLOYEES 21 Opt-outs for health insurance –Constructive receipt problem –Put into 125 plan to avoid tax for persons keeping insurance Cashing out personal days –Constructive receipt problem –Difficult to put into 125 plan –Require mandatory cash-out at end of year or cash-out of any days over “x” amount

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits Time for Questions! CONFERENCE ATTENDEES: Please come to a microphone to ask your questions. WEBCAST PARTICIPANTS: Send text questions using the “Chat” function at the left side of your screen. Type message in box and click the arrow to send. 22

Pennsylvania Association of School Business Officials 2012 Annual Conference & Exhibits Thank you for your participation! 23 CONFERENCE ATTENDEES: If you are requesting CPE credit, return the CPE form to the moderator before leaving the room WEBCAST PARTICIPANTS: Attendance Forms are required to receive either PASBO CEU or CPE credit. Webcast sites are asked to collect Attendance Forms from each participants and return to the PASBO office by March 16.