Module 6 403(b) Plans & Other Plan Issues

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMRetirement Planning & Employee Benefits Module 6403(b) Plans & Other Plan Issues

Learning Objectives 6–1 Explain the basic provisions of a 403(b) tax-sheltered annuity (TSA) plan. 6–2 Describe the investment options and catch-up provisions available in 403(b) TSA plans. 6–3 Explain the similarities and differences between 403(b) and 401(k) plans.. 6–4 Identify basic characteristics of retirement plan trust regulatory issues, including plan installation, fiduciary requirements, and reporting and disclosure. 6–5 Describe the multiple plan rules for retirement plans. 6–6 Describe the controlled group and affiliated service group rules, and explain incidental benefits and unrelated business taxable income (UBTI). 6–7 Explain the basic provisions of a Section 457 plan.

Questions to Get Us Warmed Up

Learning Objectives 6–1 Explain the basic provisions of a 403(b) tax-sheltered annuity (TSA) plan. 6–2 Describe the investment options and catch-up provisions available in 403(b) TSA plans. 6–3 Explain the similarities and differences between 403(b) and 401(k) plans. 6–4 Identify basic characteristics of retirement plan trust regulatory issues, including plan installation, fiduciary requirements, and reporting and disclosure. 6–5 Describe the multiple plan rules for retirement plans. 6–6 Describe the controlled group and affiliated service group rules, and explain incidental benefits and unrelated business taxable income (UBTI). 6–7 Explain the basic provisions of a Section 457 plan.

Qualified Employer & General Plan Features Qualified employers • Public educational systems • 501(c)(3) organizations • Ministers performing religious services for for-profit companies • 403(b) plans are not considered to be qualified, were around before ERISA Two basic types of 403(b) arrangements • Employee-deferral only • Employer contribution and employee deferral

Age and Service Requirements Typical • Minimum age 21 • One year of service • If a plan has a two-year service requirement, 100% immediate vesting • If a plan has a minimum age 26 requirement, 100% immediate vesting and the two-year service requirement cannot be used

Salary Reduction Agreement • Multiple agreements with same employer in a taxable year are allowed. • Agreement is legally binding and irrevocable as to amounts already earned. • Employee may terminate agreement at any time for amounts not yet earned. • Employer may require $200 minimum annual deferral to meet nondiscrimination safe-harbor.

403(b) Plan Vesting Schedule

Employer 403(b) Contributions Nonelective Employer Contributions • Require the plan to meet coverage and participation tests: • Ratio percentage test • Average benefits test Matching Contributions • Require the plan to satisfy only the ACP test

Permitted 403(b) Investments • Annuity contracts • Custodial accounts holding mutual fund shares • Retirement income accounts (churches)

Maximum 403(b) Salary Deferrals The lesser of the following two limits: • The annual deferral limit: $17,500 in 2013 plus the long service catch-up ($3,000 limit) • Section 415(c) limit: lesser of 100% of compensation or $51,000 (2013) plus age 50 catch-up if eligible

403(b) Catch-Up Contributions • Age 50 catch-up provision • Long-service rule exception • Must have worked for the same employer for 15 years or more. • Must be a “HER” organization • Additional annual catch-up allowed up to the lesser of: • $3,000 • $15,000, reduced by increases to the general limit that were allowed in previous years due to 15-year rule • $5,000 times the number of years of service, subtracted by the total elective deferrals made by employee for earlier years

403(b) Withdrawals & Loans In-service withdrawals generally not permitted, except for • attainment of age 59½ • separation from service • death • disability (Soc. Sec. definition) • hardship (employee deferrals only). • loans (same terms as 401(k) loans)

Roth 403(b) Accounts • Same income tax premise as Roth IRA • after-tax contributions • tax-free qualified withdrawals • Contributions and distributions follow defined contribution rules • 403(b) contribution limits • required minimum distributions • Employer contributions must be made to a traditional 403(b) account • Roth 403(b) accounts can be rolled directly into Roth IRAs

401(k) & 403(b) Plan Comparison

401(k) & 403(b) Plan Comparison (2)

Plan Documents Every qualified plan is required by law to be available in the form of a written document. Three common approaches to plan documents: • Custom Plan—Drafted specifically for the company • Prototype Plan—Pre-approved plan document with separate funding medium (separate trust or custodial account) for each adopting company, and the ability to designate trustees • Master Plan—Pre-approved plan document with standard funding medium (only one trust or custodial account) and no ability to designate trustees

Advance Determination Letter • This is a formal determination by the IRS of whether the plan meets the requirements of the law. • Only if all legal requirements are met will the plan be considered qualified and the employer entitled to a tax deduction for plan contributions.

Fiduciaries A fiduciary is an individual who • has discretionary authority or control over the assets/administration of a qualified plan trust, or • provides investment advice regarding plan assets for compensation. An individual is not considered a fiduciary if services provided for the plan are limited to • legal • actuarial • consulting • accounting

Fiduciary Responsibilities ERISA requires a fiduciary to perform plan responsibilities solely in the interest of participants and beneficiaries • for the exclusive purpose of providing benefits to participants and defraying reasonable expenses of administering the plan • with the care, skill, prudence, and diligence that a prudent person familiar with such matters would use under the circumstances • by diversifying plan investments to minimize risk • in accordance with plan documents where such documents are consistent with ERISA

Prohibited Transactions • Self dealing by a fiduciary • Transferring plan assets to a disqualified person, or such a person using plan assets • Receipt of consideration by a fiduciary for his or her own account when dealing with a disqualified person • Buying, selling, exchanging, or borrowing between a disqualified person and the plan

Disqualified Persons A “disqualified person” is • the fiduciary • any person providing services to the plan • an employer or employee organization with employees covered by the plan • a 50% owner • a member of the family of (1), (2), (3), or (4) • a corporation, partnership, trust, or estate that is 50% or more owned by (1), (2), (3), or (4) • an officer, director, 10%-or-more shareholder, highly compensated employee, or 10%-or-more partner in (3) or (6)

Exemptions from Prohibited Transaction Rules • Receipt of benefits under plan provisions • Distribution of plan assets in accordance with allocation requirements • Loans made to plan participants and beneficiaries that are: • available to all participants and beneficiaries on a substantially equal basis • not available to highly compensated employees in greater proportions than to others • made in accordance with plan provisions • at reasonable rates of interest and adequately secured • Loans made to ESOPs • Purchase or sale of qualifying employer securities by an individual account plan, for adequate consideration, and without commission • Providing office space or services for the plan for reasonable compensation

Plan Administrator Duties The plan administrator has the primary responsibility for carrying out the operational requirements of the plan. It may be the employer or a third party (TPA). The plan administrator is responsible for • determining annual contribution amounts • determining who is eligible for participation, who is vested, and the accrual of benefits • communicating with participants and beneficiaries, including counseling regarding plan choices and distribution options • ruling on claims • ensuring that actuarial functions are carried out • hiring attorneys and accountants • reporting, disclosing, and keeping plan records

Reporting & Disclosure Requirements Federal Government • Filing forms 5500 and 1099-R • Plan summaries Plan participants and beneficiaries • Personal benefits statements • Summary plan descriptions (SPD) • Summary of material modifications (SMM) • Summary annual report (SAR) Other required notices include • Report of investment performances • Description of types of benefit payments and distribution options permitted under the plan

Example of Single Employer with Two Defined Contribution Plans The limit on ABC Corporation’s deduction for total contributions tothe plans is $250,000 (25% of $1 million covered payroll). Profit Sharing Plan Money Purchase Pension Plan ABC Corporation is required to contribute $100,000 (10% of covered payroll) to the money purchase pension plan. ABC Corporation can contribute up to $150,000 (0% to 15% of covered payroll) to the profit sharing plan. Bob, a participant in both plans, earns $100,000 this year. Annual additions to his two plan accounts are limited to an aggregate of $51,000 (the lesser of 100% of pay or $51,000).

Single Employer with Defined Benefit & Profit Sharing Plans Multiple Plans of a Single Employer (DEF)—Defined Benefit (DB) Plan not subject to PBGC, Required Minimum Funding Is $300,000 (30% of a $1 million covered payroll) for this year, and Profit Sharing (PS) Plan contribution is 6% or less – overall limit does not apply. Since the minimum finding requirement is $300,000, the limit of DEF Corporation’s deduction for total contributions to the two plans is $360,000 (DB plan funding + up to 6% to profit sharing plan + 401(k) elective deferrals + catch-ups). Profit Sharing Plan Defined Benefit Plan DEF Corporation is required to contribute $300,000 to the definedbenefit pension plan. This amounts to 30% of covered payroll. DEF Corporation can contribute up to $60,000 (6% of covered Payroll) + 401(k) elective deferrals + catch-ups to the PS Plan.

Another Single Employer with Defined Benefit & Profit Sharing Plans Multiple Plans of a Single Employer—Defined Benefit (DB) Plan subject to PBGC, Required Minimum Funding is $300,000 (30% of $1 million covered payroll) for this year, then Profit Sharing (PS) Plan is limited to 25% or less – overall limit does not apply. Since the minimum funding requirement exceeds 30% of covered payroll, the limit of DEF Corporation’s deduction for total contributions for DB funding + 25% to PS plan is $550,000 (+ 401(k) elective deferrals + catch-up contributions). Profit Sharing Plan Defined Benefit Plan DEF Corporation is required to contribute $300,000 to the defined benefit pension plan. This amounts to 30% of covered payroll. DEF Corporation can contribute up to $250,0000 or 25% of covered payroll (+ 401(k) elective deferrals + catch-ups contributions) to the PS plan.

Employee with Multiple Plans—Unrelated Employers An individual (John in this example) who has more than one unrelated employer generally may participate in the qualified retirement plans of each employer. The Section 415 limits will apply to the individual’s participation in each employer’s plan(s) separately.

Employee with Multiple Plans—Employee Elective Deferral Limit An individual’s elective deferrals to different plans generally must be aggregated to comply with the limits. For example, Ann works full time for a corporation and also teaches at a local community college. She participates in the salary deferral plans offered by each employer—a 401(k) plan and a TSA. Her compensation and other relevant factors make her eligible to defer the maximum to each plan; however, her aggregate deferrals are limited to $17,500 (2013).

Employee with Qualified Plan & 457 The salary deferral limits for participants in a Section 457 plan are separate from the salary deferral limits to qualified plans and 403(b) plans.

Parent-Subsidiary Controlled Group A group of organizations with a common parent: Each organization is under control of one or more of the other organizations, and the common parent has direct control (at least 80% ownership) over at least one member of the group. • For example, if Regis Industries owns 80% of Climate Controls, both companies would then need to be considered and treated as one company for retirement plan purposes.

Brother-Sister Corporation Brother-Sister test • Five or fewer people own at least 80% of the voting power. • The same five or fewer shareholders own more than 50% of control, taking into account ownership only to the extent of identical ownership for each business.

Affiliated Service Group Example First Service Group and “A” Organization Partners in Health (partnership) Owns 100% of FSO. Dr. A’s P.C. (A Organization) owns 50% of the Partnership ... Dr. B’s P.C. (A Organization) owns 50% of the Partnership ... Greenville Medical Services, Inc. (first Service Organization) provides medical care to third persons. and performs services for third parties through the FSO. and performs services for third parties through the FSO. Nurse Nurse/Receptionist Billing clerk Clerical assistant

Affiliated Service Group Example First Service Group and “B” Organization Market Shares (First Service Organization) provides marketing services to third parties and its four partnerseach own 3% of Good Words, Inc. (B Organization) performs services for the FSO Writer #1 Writer #2 Editor #1 Editor #2

UBTI UBTI (unrelated business taxable income) is derived when a qualified plan participates in running a business. Income not considered to be UBTI • Passive income (interest, dividends, royalties, rent) • Capital gains • Leveraged real estate that is held directly Income considered to be UBTI • Income from a directly held business • Dividend income, if stock is margined • Partnership income (general and limited)

Incidental Benefit Definition

Qualified & Nonqualified Plans

Section 457 Deferred Compensation Plan A 457 plan is a deferred compensation plan, not a qualified plan, and therefore not subject to many of the qualified plan rules. Two main categories of 457 plans • 457(f) (non-governmental) • Participation limited to a select group of highly paid or management employees (“top hat” plan) • 457(b) – “eligible” • Governmental • Nongovernmental

Eligible Employers for 457(b) Plans & Deferral Amounts

Funded & Unfunded 457(b) Plans

Catch-up Provisions of 457(b) Plans Age 50 catch-up • Additional $5,500 for those age 50 and older not in the final three years prior to retirement Final three years catch-up • Available for each year of the three years preceding normal retirement age • Catch-up contribution up to the allowable deferral for the current year, resulting in total deferrals up to two times the allowable deferral for the current year • From unused deferrals only • Cannot use with age 50 catch-up

Multiple Choice Question 1 Which one of the following is not a provision of TSAs? • The contract between the employer and the employee must be legally binding. • The employee can execute more than one contract per employer per year. • Salary reduction contributions generally are subject to a $17,500 limit in 2013. • The annual TSA contract is irrevocable; the employee may not terminate the agreement during the year. • Loans are permitted in accordance with qualified plan rules.

Multiple Choice Question 2 Which one of the following is not a provision of the special limits that are available to certain employees in a TSA plan? • It is available to employees of health, education, and religious organizations (HER organizations). • It may use both catch-up provisions if qualified. • It may typically defer at least $200 to their TSA during the first year of service. • With 15 or more years of service, a participant may increase each year’s deferral limit by $3,000 (up to $15,000 of cumulative increases). • If prior salary reductions exceed $5,000 times years of service, no increase to the deferral amount is available to employees with more than 10 years of service.

Multiple Choice Question 3 Which one of the following is not a provision of Section 457 plans? • Elective deferrals are subject to a $17,500 limit in 2013. • Employees of tax-exempt organizations and state/local governments may establish Section 457 plans. • An employee retiring at age 65 is not permitted to receive payments until age 70½. • An additional deferral catch-up of up to twice the regular deferral, less any deferral for the current year, is allowed in the three years prior to retirement.

Module 6 403(b) Plans & Other Plan Issues