403(b) Outlook: Contributions for Former Employees
April 23, 2008
What is the rule? The final 403(b) regulations confirm that employers may continue making non-elective contributions to 403(b) plans (but not 401(a) plans) for former employees for up to five years after they terminate employment. The maximum amount employers may contribute each year is the lesser of: the Section 415 dollar amount (currently $45,000); or the former employee’s includible compensation during his or her last one-year period of service. If you decide to provide this benefit you need to include this provision in your written plan document. Treasury Reg. 1.403(b)-4(d)
Caution: The amounts contributed on behalf of former employees by tax-exempt employers will be subject to the nondiscrimination rules. In addition, contributions for former employees and current employees are tested separately. As a result, tax-exempt employers can add this provision to their plans only if they make contributions for both highly and non-highly compensated employees. This provision is probably better suited to governmental employer retirement plans since these plans are not subject to nondiscrimination testing.
Note: This is not a change. The five-year timeframe has been available to former employees since 2002 (it was included as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)).
What has changed? According to the final 403(b) regulations, contributions for former employees must stop when an employee dies. This is the case even if the former employee dies before the end of the five-year period.
Effective date: Beginning Jan. 1, 2009, contributions for former employees must stop when an employee dies.
What happens if you fail to comply? Failing to satisfy the nondiscrimination rules could cause your plan to lose its 403(b) status. If your plan loses its 403(b) status, all contracts of all employees will be taxable (remember that if you are a governmental employer your plan is exempt from nondiscrimination testing.) You also need to be careful that the amounts contributed on behalf of former employees do not exceed the Section 415 limit. This type of violation could be cured under one of the IRS correction programs, however, by distributing the excess (adjusted for earnings) to the affected employees. The excess amount would be taxable in the year it is distributed to the employee.
Read more about nondiscrimination rules.
Next week’s issue: Form 5500 Filings