The Good, The Bad And The Ugly Of 401(a), 457(b) And 403(b .

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10/17/2016The Good, the Bad and the Ugly of 401(a),457(b) and 403(b) Governmental PlansSue DiehlPresident PenServ Plan Services, Inc.sdiehl@penserv.com1

10/17/2016Agenda – Workshop #47 Overview and Review of GovernmentalEmployers and Plan types Interaction of contribution limits in multiple plansand the benefits Unique Rules Layering on the Benefits IRS Audits New Pre-approved Plan documents on their way!Types of 403(b) plans 403(b)(1) - Annuity Contracts–investments through Insurance Annuities 403(b)(7) - Custodial Accounts–investments through mutual funds 403(b)(9) - Church Plans (RICAs) – investments limited in Plan agreement– not necessarily limited to annuities and mutual funds– Trustee(s) may be Church official(s)– Retirement distributions available for housing allowance– 6% penalty for excesses does not applyPreviously referred to as ‘Wrap’ 403(b)(1)/(b)(7) Document combined annuity/mutual fund investments in a single document Today this is merely a 403(b) Plan (no longer needs reference to (b)(1) or(b)(7)2

10/17/2016403(b) Plan Documents Beginning in tax year 2009, IRS regulations required a “plan” to beestablished by the employer. The definition is the same as appliesunder the Qualified Plan rules. All Employers (except for certain church organizations) wererequired to have a plan document signed no later than 12/31/2009! RICAs must be maintained pursuant to a Plan as well. The plandocument must state the intent to constitute a retirement incomeaccount. A RICA that is treated as a annuity contract is NOT a custodialaccount even if the investments are solely in mutual funds. Thisallows for the more liberal distribution rules under a RICA.4 types of Qualified Employers403(b) Programs may be offered by:1. Tax exempt organizations under §501(c)(3) IRC"organized and operated exclusively for religious,charitable, scientific, public safety testing, literary,educational purposes to encourage national orinternational amateur sport competition, or for theprevention of cruelty to children or animals.“Examples – hospitals, nonprofits, Universities/Colleges3

10/17/20164 types of Qualified Employers2. Public Educational Institutions – Focus today!Includes primary, secondary, preparatory, or highschools, colleges and universities, and federalstate and other public supported schools.Examples – public schools, charter schoolstreated as public schools, StateColleges/Universities3. Self-Employed Ministers (must have a 403(b)(9))!4 types of Qualified Employers4.Church/Church Related Organizations - “With”and “Without” a Steeple With a Steeple – A church, place of worship Without a Steeple: QCCO (Qualified Church Controlled Org) For example, a Church School Non QCCO (Non-Qualified Church Controlled Org) Forexample, a Nursing Home run by the Church. Morethan 25% of income comes from non church resources.4

10/17/2016403(b) Plan Features Plan may include optional features:– Employer contributions– Roth contributions– Hardship withdrawals– Loans– Acceptance of rollovers– In service withdrawals– “Exchanges” to 403(b) products approved withinthe plan (for contributions or just exchanges)– Plan to plan transfers (in or out)Compliance Exchange AgreementsPost-Employment Employer ContributionsUniversal Availability for Elective DeferralsFinancial Hardship DistributionsFrozen and Terminated PlansTimely Contribution Remittance/DepositCatch-up Ordering Rule5

10/17/2016ExampleThe Private Big DiehlSchool6TPA5“Deselected Vendor”Signs an “ISA”Vendors1 2 3 4“Accumulated Benefit”Unique Features Post-employment Employer contributions Universal Availability– Does not apply to steeple churches or QCCOs ERISA VS NonERISA – Governmental Plansare always exempt from ERISA! Adding a 457 Plan– 457(b)– 457(f)6

10/17/2016Post-employment Employer ContributionsNon-elective employer contributions to retirees’accounts after death are limited to lesser of:– Monthly compensation to be determined based on 1/12 of finalcontract salary times number of months elapsed in the year ofdeath– Total contributions that would have been made on retiree’s behalfif s/he had survived to end of 5-year period– 415 limit for relevant year (final 12 months of compensationbefore severance)– What happens if the Employee dies while working?Universal Availability– Effectively requires schools to count actual hours ofservice for all employees if they want to excludeemployees with fewer than 20 hrs/week (or lessthan1000 hours per year)– Most TPAs encourage employers not to exclude anyemployees, especially if they can’t/don’t count hours.– Failing Universal Availability can cause plandisqualification!– New Annual 415 notice for years after pre-approvedplans approval7

10/17/2016Universal Availability Requires “meaningful” written notice to employees ofeligibility to participate at least annually Employees must have “reasonable opportunity” tomake deferral elections IRS will want to see UA notices that are sent toemployees and the method by which they are provided Most Employers use multiple avenues to provide thesenotices/information on universal availabilityNon-ERISA 403(b) Coverage andNondiscriminationNondiscrimination Rule For Elective Deferrals - the UniversalAvailability Rule - An “effective opportunity" to make electivedeferrals of more than 200 is "made available" to all employees.Permitted to Exclude the following Employees –1. Employee participating in 457(b)**, 401(k), or another 403(b) ofthe employer.2. Nonresident aliens with no US income.3. Certain students (generally on work study programs).4. Employees who normally work less than 20 hours per week.**Not limited to governmental.8

10/17/2016Non-ERISA 403(b) NEVER SUBJECT TO ERISAGOVERNMENTAL EMPLOYERS, INCLUDING:– PUBLIC SCHOOLS– STATE COLLEGES/UNIVERSITIESCHURCHES (WITH AND WITHOUT A STEEPLE!)– CAN ELECT TO BE COVERED BY ERISA– WITHOUT STEEPLE INCLUDES QCCOs AND NONQCCOs402(g) LimitTaxpayer limit for 2016 18,000 401(k) 403(b) SARSEP SIMPLE-IRA (limit 12,500)Limited on calendar year basis.457(b) not subject to 402(g) limit9

10/17/2016403(b) Catch up Rules One “Catch-up” limit for all 403(b), 401(k),SARSEP ( 6,000) & SIMPLE-IRAs ( 3,000) Separate “Catch-up” for 457(b) governmental No Age 50 “Catch-up” permitted for tax exempt457(b) Both Age 50 “Catch-up” and 15-year ruleavailable in the same year for 403(b)s. Catch-ups first treated as the 15-year catch-upand then age 50 catch-ups403(b) allowable distributions -But Check the plan!ProvisionElective DefER-AnnuityER- CustodialAttainment of 59 1/2Severance from employmentDeathDisability under 72(m)(7)Unlesscontract hasdifferentdefinitionDisability other than 72(m)(7)Plan TerminationIf annuity & groupcustodialagreements onlyIf annuity &group custodialagreements onlyFinancial HardshipAttainment of stated ageStated event or # of yrs.10

10/17/2016403(b) Allowable DistributionsHardship (must follow 401(k) rules)- Hardship distributions may only includeprincipal amount of elective deferrals, notincluding earnings thereon.IMPORTANT TO RECEIVE THIS INFORMATION WITHTRANSFERS/EXCHANGES/TAKEOVERS!- Exception for pre-1989 monies, excludingearnings.- Employer must have written hardship policyor custodial agreement/annuity has language21What is a Tax-Exempt Organization? Section 501(c) of the IRC contains 29 differentnonprofit organizationsFor example: 501(c)(6) includes Business leagues, chambers ofcommerce, real-estate boards, boards of trade, orprofessional football leagues. 501(c)(3) includes certain hospitals, educationalorganizations, etc.11

10/17/2016501(c)(3) Organizations are Unique! Only tax-exempt that can establish a 403(b) Plan. 501(c)(3) are –“Corporations, and any community chest, fund, or foundation, organized andoperated exclusively for religious, charitable, scientific, testing for publicsafety, literary, or educational purposes, or to foster national or internationalamateur sports competition (but only if no part of its activities involve theprovision of athletic facilities or equipment), or for the prevention of crueltyto children or animals, no part of the net earnings of which inures to thebenefit of any private shareholder or individual, no substantial part of theactivities of which is carrying on propaganda, or otherwise attempting, toinfluence legislation (except as otherwise provided in subsection (h)), andwhich does not participate in, or intervene in (including the publishing ordistributing of statements), any political campaign on behalf of (or inopposition to) any candidate for public office.”What is a Governmental Employer? Waiting on Proposed Regulations Announcement that proposed regs were beingworked on came on November 7, 2011 (ANPRM –Advanced Notice of Proposed Rulemaking) Would describe the multiple factors underconsideration for determining whether an entity usan agency or instrumentality of the US or of a Stateor political subdivision Would propose a ‘facts and circumstance’ test On the Guidance Priority Plan for 2016-201712

10/17/2016What Types of Plans can they Establish? 401(k) – Grandfathered only – adopted by agovernmental unit before May 6, 1986! Profit-sharing/Money Purchase – 401(a) 403(b) 457(b) 457(f) SEPs SIMPLE-IRAs MEPs – Multiple Employer PlansA word about Charter Schools Also unique in that they typically have “dualtaxuality” They are both a governmental entity and a taxexempt organization under 501(c)(3) State law will determine how they are treated forState law purposes and what plans they mayadopt Many are required or permitted to participate inthe State Teachers Retirement plan, which meansthat they are deemed to be governmental entity13

10/17/2016A word about Charter Schools For Example in Pennsylvania– Charter Schools are treated as agovernmental employer– Employers are required to either coverthem under the State Retirement System orcover them with a comparable 403(b) plan.A word about Charter Schools In Michigan if there is a management company that isused, the plan is typically set up as a MultipleEmployer Plan Plan typically adopted by the Plan Sponsor(management org) and the Charter schoolsparticipate in that plan. In Michigan these are usually set up as401(a) plans14

10/17/2016What does being subject to ERISA mean? Protection of Employee Benefits, rightsand Features Additional Reporting and Disclosures:– SPDs– SMMs– Form 5500 filings (includes audits)– SARs– Benefit Statements– Fee disclosuresWhy would an Employer adopt a 401(k) in lieuof a 403(b) Plan? Lack of understanding Eligibility of 1 or 2 years would reduce eligibleemployees and may not subject the Plan to anaudit Employer should compare UniversalAvailability rule to the ADP test to see whichone may work better.15

10/17/2016457(b) vs. 457(f)FEATURES OF Tax-Exempt 457(b)Gov./Tax-exempt 457(f)ParticipationSelect/Top Hat GroupSelect/Top Hat GroupContribution Limit 18,000 for 2015No LimitTypes of PermittedDeferralsAge 50 Catch-upPre-Tax only, No Roth deferralsN/ANot applicableNot applicableSpecial 3-year catch-upUp to 2 X the normal deferral limitNot applicableResponsibility forWithholdingRollovers to other PlansTax-exempt EntityEmployerNoNoTransfersYes. To another tax-exempt 457(b)NoTransfer to State Plan topurchase service creditsNoNo457(b) vs. 457(f)FEATURES OF Tax-Exempt 457(b)Tax-exempt 457(f)Distributable EventsBased on document and employee electionsGenerally lump sum or over 5 years;based on documentLoans PermittedNoNoRMD RulesYes. Later of 4/1 after 70 ½ or retirementNot applicableVestingPermitted for Employer ContributionsNot applicableFICA TaxYes. Applies later of: when services areperformed or when no longer substantial riskof forfeitureYes. Applies later of: when servicesare performed or when no longersubstantial risk of forfeitureFUTA TaxYes, except 501(c)(3) OrganizationsYes, except 501(c)(3) OrgsReporting ContributionsN/AN/AReporting DistributionsForm W-2, except decedentsForm W-2, except decedentsForm 5500One-Time “Top-Hat” Declaration” 120 daysafter establishmentOne-Time “Top-Hat” Declaration”120 days after establishment16

10/17/2016457(b) vs. 457(f)FEATURES OF Tax-Exempt 457(b)Tax-exempt 457(f)Curing Excess DeferralsSimilar to 401(k)N/ACuring other ExcessesWaiting for EPCRS updateWaiting for EPCRS updateInvestmentsDepends on document; “hypothetical”investment directionDepends on document;“hypothetical” investment directionDeemed IRAsNot permittedNot permittedSavers tax credit available NoNo10% premature taxNoNoQDRO rulesAppliesNoSubject to 15 day Planasset ruleTrust requiredNoNoNot permitted unless a Rabbi or secular trustis establishedNot permitted unless a Rabbi orsecular trust is establishedSpecial Control Group Rules for501(c)(3) Orgs New rules applied beginning for years after12/31/08 with respect to “controlled groups ofbusinesses” If there is commonality in directors, trustees,or individuals on boards of directors inmultiple organizations, such organizationsmay need to be treated as one employer.17

10/17/2016PTO contributionsRevenue Rulings 2009-31 and 2009-32 permitteddeposits of unused sick and vacation leave to only401(k) Plans.Many 403(b) plans are written to offer this optionIRS indicated that this may be added for 403(b) and457 plans, but as of this date has not had officialguidance! Although IRS permitting in pre-approvedplans.Adjunct ProfessorsAdjunct Professors – Challenging endeavor for years Affects all retirement plans not just 403(b)plans Can affect eligibility and vesting A “part-time” professor hired on a contractualbasis FACT – They are employees of the school!18

10/17/2016Adjunct ProfessorsAdjunct Professors (cont’d) – Cannot exclude by class Violation of Universal Availability Rule Affordable Care Act and ACA regulations andpreamble Counting hours can be any ‘reasonable’method May not be added to Plan DocumentAdjunct ProfessorsOne reasonable method that is acceptable underIRS audit is – an employer would credit hours asfollows: 2.25 hours per week for each hour of teaching orclassroom timePLUS 1 hour of service per week for each additionalhour of service outside the classroom performingrequired duties (e.g., office hours, departmentmeetings).19

10/17/2016Adjunct Professors-ExampleThe University maintains a 403(b) Plan that excludesemployees that normally do not work 20 hours per week.Adjunct Professor has 8 hours per week of scheduledclassroom time. He is also is required to be in his office atleast 5 hours per weekUnder this method he would have 17.6 hours for the week (8x 2.25 17.60) PLUS 5 or a total of 22.6 hours per week.Therefore this particular adjunct professor would be eligiblefor the 403(b) Plan.Now lets look at Plan DesignGovernmental Employers 403(b) 457(b) 457(f) 401(a) Profit-Sharing, Money Purchase 401(k) – Grandfathered Plans (5/6/1986) SEP/SIMPLE-IRA (but not with Model 5305SEP)20

10/17/2016Special Employee/Employer Contributions FICA Replacement Plans 7.5 % required between Employer and Employee Depends on Government Employer’s State, type of Employee, etc. I.e., “Part time” individuals in PA can participate in a FICA replacementPlan PTO Contributions Mandatory Employee Contribution vs. Auto Enrollment Mandatory Employee Contribution – Treated as a Non Elective Employer Contribution Is Subject to FICA taxStructure of Multiple Plans (2016)Now let’s look at a few plan designs to maximum benefits.John, age 40 is the Superintendent of a public school andearns 75,000. He anticipates retiring in 20 years. Hiscontract also requires the Employer to contribute to a457(f) for John in the amount of 15,000 per year.403(b) Defers the maximum457(b) Defers the maximum457(f) Employer ContributionESTIMATED TOTAL FOR YEAR 2016 18,000* 18,000* 15,000 48,000* These amounts reduce the annual compensation21

10/17/2016Structure of Multiple Plans (2017)Jane, age 60 is the superintendent of a public school andearns 100,000. She is retiring next year (2017) and willbe receiving a post-employment amount of 10,000beginning in 2017 for 5 years. Her contract also hasrequired the Employer to contribute to a 401(a) plan forJane in the amount of 20,000 per year since 2012.403(b) Defers the maximum403(b) Employer Contribution457(b) Defers the maximum401(a) Employer ContributesESTIMATED TOTAL FOR YEAR 24,000 10,000 24,000 20,000 78,000(For 2017-2021)Structure of Multiple Plans (2016)Why are we layering these types of plans?Remember that one plan – 403(b) or 401(a) cannot acceptmore than 53,000 (for 2016).By establishing multiple plans the employees canmaximize their contributions and not run afoul of thelimitations.By law, 401(a) plans and 403(b) plans are not aggregatedwhen looking at the 53,000 (415) cap.22

10/17/2016Pre-approved 403(b) Plan Update Submission day – April 30, 2015 came and wentIRS indicates that they received approximately 80 BPDs. That means thatapproximately 50 entities submitted 403(b) documents. Compare this tothe 1000s of submitters for qualified plans.Estimate of final approvals probably sometime late in 2016 with 2 yearsfor the employers to restate back to 2010.***Approval emails will first go out to mass submitters so they can formattheir plans.All approval letters will be mailed out from the IRS on the same day!Administrative Appendix part of all pre-approved plans***Important reminder – this is also the deadline to have contracts andcustodial account agreements updated to be coordinated with the newPlans.What is a Pre-approved 403(b) Plan? A pre-approved plan is a plan that receives IRS approvaland receives an approval letter that provides theEmployer adopting the plan with reliance on the form ofPlan. As of today all 403(b) plans are customized and havelimited reliance for the Employer. K-14 plans have limited reliance if their plan adopted thesample language that the IRS provided in 2007.**** This sample language contained errors that have neverbeen corrected by the IRS so be careful!23

10/17/2016What is a Pre-approved 403(b) Plan? There are 2 types of Pre-Approved 403(b) Plans– Prototype Plans Receives an Opinion Letter Basic Plan Document (BPD) with Adoption Agreements– Volume Submitter Plans Receives an Advisory Letter Specimen Plan** Document with Adoption Agreements** These are not the ‘specimen plans’ that some companies offered inpast years. Prototypes – no changes after approval not even typos Volume Submitter – changes can be made that are minorWhat is a Pre-approved 403(b) Plan? Both versions will have as an attachment called anAdministrative Appendix– will not technically be a part of the plan document.– This will contain the vendor attachment information– Will not need to be resigned if there is a vendor changeanymore – since it is not a part of the document!– Will be shared with all parties under the plan to indicate tothe Employer what responsibilities under the plan arehandled by the vendors, TPA, or other entity and whatremains is the responsibility of the Employer.– See Sample in separate handout!24

10/17/2016Outstanding LRM IssuesWin and Loss record Definition of Disability now refers to sec 72(m)(7) forall but employer contributions Charter Schools are not included in the definition ofPublic Schools, if they are treated as a public schoolunder the State NonQCCOs can not be included in a 403(b)(9) QCCOs can BUT not in a pre-approved plan Severance from Employment only with the employernot all entities under the StateOutstanding LRM IssuesWin and Loss record We have entry dates for 403(b) Plans! But we needguidance for those employers that have always used90 days not the new 60 day rule Annual 415 aggregation notice; not a statutory orregulatory requirement; still in the LRMs and IRSrequiring this notice beginning with the January 1st 20 hour rule for elective deferrals– ANSWERED – ONCE YOU ARE IN THE PLAN – YOU AREALWAYS IN THE PLAN25

10/17/2016Outstanding LRM IssuesWin and Loss record Allow exclusion for 457(b) only for a governmental457(b) Separate Accounting for vestingMiscellaneous Issues Paperclip Rule for Document Failures– Preamble to the final regs indicates rule;– Gather all documents including annuitycontracts, mutual fund company custodialagreements;– All policies and procedures (loan and/or hardshippolicies)26

10/17/2016Miscellaneous IssuesOnce paper clipped Create a document that reflects all of the itemsthat were treated as a part of the plan; Correct any operational errors ASAP (this shouldhave been corrected by the end of 2009. Check all policies and procedures (loan and/orhardship policies)Miscellaneous Issues ACT Report – 403(b) Plans–Focused on four areasUniversal AvailabilityOrphan ContractsTerminating a 403(b) PlanEPCRS27

10/17/2016Miscellaneous Issues Exam – Document Request Consistency– ACT requested IRS look at their IDRs(Information Document Requests)- 403(b) Compliance Planning Group project- Still seeing some that are incorrect- For example, W-2 corrections for excessdeferralsMiscellaneous IssuesRecent EPCU Project Findings–Universal availability still an issue–The larger the plan, the fewer issues–Top issues in small & medium plans include Communications to begin/change deferralsConditioned eligibilityExclusion of part-time employees28

10/17/2016Audit Process Initial phone callFollow-up letterInformation Document Request (IDR)InterviewsIRS reviews IDR responsesPossible request for more informationDiscuss issuesClosing conferenceClosing letterAudit ProcessReview of Internal Controls Key in the IRS deciding whether to expand audit If weak then IRS must do more due diligence to validateoperations matches the plan Key Internal control areas: Eligibility/discrimination nsVendor reconciliation and monitoring documents29

10/17/2016Audit ProcessCommon Failures Failure to follow written plan (Notice 2009-3) Churches and QCCOs do not need plan unless403(b)(9) Payroll/HR system does not match document Plan amended and no longer matches operations Misunderstanding of document provisionsAudit ProcessCommon Failures Universal Availability Failures Must provide annual notice to ALL eligible Failure to perform non discrimination testing orerrors in test data Wrong definition of compensation used Excess deferrals Improper 15 year catch-up 415 excesses – treatment of excesses30

10/17/2016Audit ProcessCommon Failures 5-year post employment contributions–––– Must not be electiveTreatment of sick and vacationWhat happens if employee diesWatch 415 limitsPlan loans – plan vs. contract policyHardship distributionsTransfers/Exchanges125 Plans cannot contain a 403(b) as an optionAnd in Passing New proposed regulations for 457(b) and 457(f); and409A– Will require some form of amendments for at least the457(f)– Can rely on these until final– Will become effective for the calendar year following theissuance of final regulationsRemember your new allocation rules when rolling froma 403(b) to an IRA or another employer Plan31

10/17/2016QuestionsCopyright 2016 PenServ Plan Services, Inc.6332

Transfer to State Plan to purchase service credits No No 457(b) vs. 457(f) FEATURES OF Tax-Exempt 457(b) Tax-exempt 457(f) Distributable Events Based on document and employee elections Generally lump sum or over 5 years; based on document Loans Permitted No No RMD Rules Yes. Later of 4/1 after 70 ½ or retirement Not applicable

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