THE 2004 403(b) CONTRIBUTION RULES

402(g) Limits Set by Statute; 415 Limit Cost of Living Adjusted

For an individual in a 403(b) plan, the deferral limit has increased in 2004 to $13,000. In addition, if the employer is contributing, the maximum that can be allocated is the lesser of 100% of earned income or $41,000 for plan years that end in 2004. Thus, in the case where an employee contributes the maximum of $13,000, the employer contribution can go as high as $28,000, if the employee earns $41,000 or more. In addition, if the individual will attain age 50 or older during the year, a catch-up contribution of $3,000 is also permitted.

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COORDINATING THE TWO TYPES OF CATCH-UPS

The 15 Years of Service Catch-up Contribution

There is also a special catch-up contribution under Code Section 402(g)(8) for employees with more than 15 years of service with an educational, hospital, home health care or church organization. The additional contribution for 2004 is the lesser of $3,000 or $15,000 minus previous contributions under (g)(8) or $5,000 multiplied by years of service minus previous deferrals.

For example, John Quincy Adam Sandler, age 45, worked for 18 years for the same 501(c)(3) charitable employer. During that time, John deferred a total of $56,000 into the employer's 403(b) plan, and in the last 3 years, has deferred a total of $9,000 above the elective deferral limit under the special 402(g)(8) election. What would John's catch-up amount be? Following the formula, the catch-up is the lesser of:

1. $3,000 or
2. $15,000 less $9,000 = $6,000
3. $5,000 x 18 = $90,000 - $56,000 = $34,000

Therefore, the amount determined to be eligible for catch-up would be $3,000. Once the $3,000 is contributed, the total special catch-up used in this example would be $12,000.

With this type of catch-up, there is no age 50 requirement. However, if the individual is age 50 or over, there is a coordination of the two types of catch-up that must be carefully done.

Coordination of the Two Types of Catch-up Contributions (15 Years of Service Catch-up (402(g)(8)) and the EGTRRA Catch-up 414(v)). The following analysis is based on the comments of Robert Architect of the IRS.

Now that there are two types of catch-ups, there are also rules for how they are to interact. Specifically, the $3,000 is to be used first. If this is not understood in advance, the 414(v) catch-up could be lost. If a participant is over age 50 and has over 15 years of service and has not yet used the catch-up due to the 15 years of service, the 15-year catch-up must be used first.

For example, in 2003, if an individual over age 50 with 15 years of service made an elective deferral contribution of $14,000, the first $12,000 would exhaust the 402(g) limit. However, the $2,000 above the 402(g) limit would be considered a catch-up towards 15 years of service, $15,000 catch-up amount (assuming it had not already been used up). Thus, the individual would not have used the 414(v) $2,000 catch-up amount for 2003, and it could never be made up in a future year. However, if the participant wanted, he or she could have put in the $3,000 catch-up towards the 15 years of service catch-up and an additional $2,000 for the 414(v) catch-up for a total of $17,000 in 2003 ($12,000 + $3,000 +$2,000). In other words, the first dollars contributed above the base elective deferral limit are deemed to be Section 402(g)(8), years of service amounts and not the annual 414(v) catch-up contribution limit.

The rule of thumb to keep in mind is that even though the individual is over age 50, the 15-years-of-service catch-up is required to be used before the 414(v) catch-up can be used.

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FIVE YEAR POST-RETIREMENT RULE

Up to 5 years of Post-Retirement Contributions based on includible compensation from last year of work prior to retirement.

EGTRRA Section 632(a)(2)(C) (and clarified by JCWAA 411(p)) allows for contributions to a 403(b) annuity to be made for an employee for up to five years after retirement based on includible compensation from the last year of service before retirement. Includible compensation for purposes of the 403(b) contribution is the amount of compensation received from the employer and includible in the employee's gross income for the most recent period (ending not later than the close of the employee's tax year) that can be counted as a full year of service. This compensation may not precede the taxable year by more than five years. Finally, includible compensation may not include any amount contributed by the employer to the employee's 403(b) annuity. This significant change is a major advantage available to a 403(b) participant, because it can allow for an employee to arrange for the employer to contribute up to $205,000 (5 years x $41,000, as adjusted) to the plan after he or she terminates employment. For example, for school districts wishing to buy out the contract of an administrator, this provides added flexibility for both parties. The district receives pay out amounts over time and the employee receives contributions to a tax-favored arrangement.

JCWAA also clarified that 403(b) contributions are subject to 415 limits for the year in which the contributions are made - regardless of whether the contributions are vested or not at the time they are contributed.

For 2004 (and 2003), Deemed IRAs are possible in a 403(b). Now that “Deemed IRA” Proposed Regulations have been issued, the IRS has provided guidance on adding Deemed IRAs to “qualified plans.” “Qualified plans” for the purposes of Deemed IRAs include 403(b) plans. This option for a 403(b) would require the incorporation of model IRA language to the 403(b).

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403(b) DEEMED IRAs

On May 20, 2003, the IRS issued proposed regulations on the addition of Deemed IRAs to qualified retirement plans. The regulations reinforce Rev. Proc. 2003-13 , which requires the inclusion of Deemed IRA provisions in plan documents. Deemed IRAs are an optional plan provision that may be made available as either a traditional IRA or a Roth IRA. The regulations support the principal that the Deemed IRA must operate under the IRA rules, and the 403(b) arrangement operates as a 403(b) plan. The proposed regulations provide the following guidance.

Deemed IRA Contributions

The deadline for Deemed IRA contributions is the April 15th of the year following the year for which the contribution is made. No contributions for the prior year will be accepted after April 15th . Contributions may, but are not required to be made by payroll deduction. IRA Rollovers and transfers to and from Deemed IRAs may generally be made. The surviving spouse of a deceased participant may elect to treat the Deemed IRA as his or her own for tax purposes. However, the surviving spouse may not contribute to the Deemed IRA because contributions may be made only by the employee.

Distributions

Required minimum distributions (RMDs) on a traditional Deemed IRA must begin by April 1 of the year after 70½ is attained. The Roth version of the Deemed IRA is not subject to the age 70½ required minimum distribution requirements.

If the IRA account holder has more than one IRA, the RMDs may be calculated from each though the aggregate of the IRA RMDs may be taken from just one IRA. Likewise, if a 403(b) participant has more than one 403(b), the RMDs may be calculated for each 403(b) and the total of all the 403(b) RMDs may be taken from one 403(b). However, the IRA total RMD and the 403(b) RMD may not be combined and withdrawn from just the IRA or just the 403(b).

Deemed traditional IRA distributions made due to early retirement between age 55 and before age 59½ remain subject to the 10% premature distribution penalty and are not eligible for the qualified plan exception for early retirement at age 55. However, if the payments are based upon the life expectancy of the owner and paid for a period of at least 5 years or attainment of age 59½, if later, then no 10% penalty will be applicable.

The substantially equal payment early distribution exception of 72(t) is applied separately to amounts distributed from the Deemed IRA and the 403(b) plan accounts. This means that the substantially equal payment amounts will also be determined separately.

IRS Required IRA Trustee or Custodian 

The Deemed IRA portion of the qualified plan must follow the regular IRA rules that require the Trustee or Custodian of IRA assets to be a bank or IRS-approved Trustee or Custodian. Therefore, Deemed IRAs cannot be self-trusteed. This does not really become an issue; since 403(b)s don't have trusts either and are not typically self-custodianed, because of the mutual fund or insurance investment requirement.

IRA Custodial Account or Annuity

A separate custodial account may be established for each Deemed IRA or all Deemed IRAs may be held in a single custodial account provided the separate custodial account is apart from the custodial account that contains the 403(b) plan assets.

Deemed IRAs that are individual retirement annuities may be held under a single annuity contract or under separate annuity contracts. However, any such contract must be separate from any annuity contract or contracts for the 403(b) plan. In addition, such contract must satisfy the requirements of section 408(b) and there must be separate accounting for the interest of each participant.

Commingling of IRA and Qualified Plan Assets

All of the Deemed IRAs' assets may be held in one custodial account. However, the IRA custodial account must be a separate custodial account from the 403(b) plan assets.

Section 408(q) expressly provides that the assets of the Deemed IRA custodial account and the 403(b) plan may be commingled for investment purposes. This is an exception to the IRA rule that does not allow commingling of IRA assets with qualified plan assets.

Disqualification Caveats

If any Deemed IRA within the 403(b) plan fails to follow the IRA rules, the entire 403(b) plan may be disqualified. If the 403(b) plan is disqualified, the Deemed IRAs may be treated as regular IRAs. However, if the Deemed IRA assets were commingled with the 403(b) plan assets, then upon a qualified plan disqualification, the Deemed IRAs would also be disqualified.

Qualification errors involving Deemed IRAs may be corrected under the IRS Employee Plans Compliance Resolution Program.

Availability of the Deemed IRA is not a benefit, right or feature.

Deemed IRAs may be made available on a discriminatory basis that favors highly compensated employees.

Bill Grossman, QPA

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