Module 6 403(b) Plans & Other Plan Issues

Module 6 403(b) Plans & Other Plan Issues
CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Retirement Planning & Employee Benefits Module (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
Completed Years of Service Cliff Vesting1 % Vested Graded Vesting2 Vesting schedules available 3-Year Cliff 2- to 6-Year Graded 1 2 3 4 5 6 0% 100% 20% 40% 60% 80% 1 Full vesting occurs after specified number of completed years of service 2 Participant vests at least 20% per year over a maximum five-year period

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 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
Characteristic 401(k) 403(b) Sponsor? Nongovernmental employers Public schools and 501(c)(3) Private employer? Yes No Qualified plan? Eligibility? ERISA requirements Any employee (typically) Salary deferral? Matching allowed? Yes, but seldom done Nonelective contributions? Nondiscrimination tests? No, if only salary deferral Yes, if employer contributions

401(k) & 403(b) Plan Comparison (2)
Characteristic 401(k) 403(b) Maximum deferral? $17,500 in 2013 (indexed) Overall limits? The lesser of the 415(a) limit or annual deferral limit Catch-up election? Yes, for those age 50 and older Yes, two, age 50 and 15 years of service Loans? Yes Hardship withdrawal? Investment Limitations? No (all ERISA investments) Yes, only mutual funds and annuities ADP and ACP testing? Yes, unless safe harbor plan Only ACP testing, safe harbors available

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 to the plans is $250,000 (25% of $1 million covered payroll). Money Purchase Pension Plan Profit Sharing 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). Defined Benefit Plan Profit Sharing 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 $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). Defined Benefit Plan Profit Sharing 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. Employer A’s Money Purchase Pension Plan Employer contributes and deducts 10% of covered payroll Annual additions to John’s account in Employer Plan A are limited to $51,000 Employer B’s Money Purchase Pension Plan Employer contributes and deducts 12% of covered payroll Annual additions to John’s account in Employer Plan B are limited to $51,000 Employer C’s Money Purchase Pension Plan Employer contributes and deducts 25% of covered payroll Annual additions to John’s account in Employer Plan C are limited to $51,000

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). Corporate 401(k) Plan Ann’s salary deferrals are limited to $17,500. Ann is allowed to defer a maximum of $17,500 to the two aggregated plans. College 403(b) Ann is allowed to defer a maximum of $17,500 to the two aggregated plans.

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. Corporate 401(k) Plan Ann’s salary deferrals are limited to $17,500. Ann is allowed to defer a maximum of $35,000 to the two aggregated plans. College 457 Plan

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 partners each own 3% of Good Words, Inc. (B Organization) performs services for the FSO Writer #1 Writer #2 Editor #1 Editor #2

UBTI Income not considered to be UBTI Income considered to be 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
Ordinary Life Insurance Defined contribution plans: Cost of ordinary life insurance must be less than 50% of the cost of all plan benefits (it is assumed that half of the cost of ordinary life is attributable to “term portion or current protection”). Defined benefit plans: Insurance benefit is not more than 100 times the expected monthly pension benefit. Term Life Insurance Term (including universal) life insurance is considered “incidental” if the cost of current protection is less than 25% of the cost of all plan benefits.

Qualified & Nonqualified Plans
Pension Plans Profit Sharing Plans (DC) Tax-Advantaged Plans Other Nonqualified Plans Defined Benefit (DB) Profit Sharing Traditional IRA Section 457 Plans Cash Balance (DB) Thrift Plan Roth IRA Stock Bonus SIMPLE IRA ISO Money Purchase (DC) ESOP (LESOP) SEP ESPP Target Benefit (DC) Age-Weighted (SARSEP) NQSO Cross-Tested (Comparability) 401(k) Plan 403(b) (TSA) Deferred Compensation Plans SIMPLE 401(k)

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
Eligible employers are either State and local governments Tax-exempt (501(c)) organization Deferral amounts allowed Lesser of $17,500 in 2013 or 100% of compensation ($5,500 age 50 catch-up) Amount is not reduced by contributions made to 403(b), 401(k), SARSEP, or SIMPLE plans

Funded & Unfunded 457(b) Plans
Nongovernmental 457(b) plans: Unfunded (money may be set aside, but is available to creditors) Participant does not have constructive receipt Since unfunded no loans allowed No rollovers allowed (such as to an IRA) Governmental 457(b) plans: Funded (funds are not at risk) Loans are allowed Can be rolled over to an IRA, Roth IRA, SEP, 403(b), or qualified plan

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.

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.

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.

John Billups, age 53, participated in his former employer’s 457 plan. He terminated several weeks ago and just received his distribution check. Which of the following statements is true? He will pay no tax and no penalty on the distribution. He will pay tax and a 10% penalty on the distribution. His distribution is subject to the mandatory 20% withholding. He will pay tax with no penalty on the distribution.

Which of the following would be considered an incidental benefit in a qualified plan? term life insurance that costs 37% of the cost of all plan benefits ordinary life insurance that costs 48% of the cost of all plan benefits term life insurance that costs 24% of the cost of all plan benefits ordinary life insurance that costs 27% of the cost of all plan benefits an insured death benefit that is 100 times the expected monthly pension benefit I only II and III only I, II, and V only I, III, and V only II, III, IV, and V only

EFG Corporation is considering establishing a qualified retirement plan for eligible employees. Which of the following groups would have to be considered in meeting the statutory coverage and participation tests? employees of HIJ Corporation, in which EFG owns 90% of the stock employees of KLM Corporation, in which EFG owns 75% of the stock leased employees working at EFG who are covered by their leasing organization’s profit sharing plan workers at EFG who are members of a union in which retirement benefits have been the subject of good-faith bargaining I only I and II only I and III only II and IV only I, II, and III only

Which of the following types of income generated by a qualified plan trust would result in unrelated business taxable income (UBTI)? dividends from margin stock royalties income from an energy limited partnership real property rental income I and II only I and III only II and IV only I, III, and IV only II, III, and IV only

Which of the individuals listed below would be considered qualified plan fiduciaries? a person providing legal services to the plan a person providing investment advice regarding plan assets for compensation a person providing accounting services to the plan a person who has discretionary authority over plan assets or administration I and II only II and III only II and IV only III and IV only

Rita, age 63, has worked for the local animal rescue shelter for the past 17 years. The shelter offers a 403(b) plan for all of its full-time employees. Rita is currently the Senior Accountant, and plans to retire within the next three years. Her current annual compensation is $75,000. What is the maximum amount that Rita could defer this year (2013)? $17,500 $20,500 $23,000 $26,000 $35,000

Which of the following statements is correct regarding 403(b) plans and Section 457 plans? Investment options in a 403(b) plan include annuities and stocks. Section 457 plans can be rolled over into an IRA account. Section 457 plans do not have required minimum distributions (RMDs). 403(b) plans may be subject to ACP, but not ADP testing.

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Retirement Planning & Employee Benefits Module 6 End of Slides

Module 6 403(b) Plans & Other Plan Issues

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