403(b) Plan Fix-It Guide - For a 403(b) plan offering a 5-year post severance provision, elective deferrals are permitted under the provision
|Mistake||Find the Mistake||Fix the Mistake||Avoid the Mistake|
|8) For a 403(b) plan offering a 5-year post severance provision, elective deferrals are permitted under the provision.||Understand how this feature works and seek the help of a retirement plan professional, if needed.||Distribute excess 415(c) contributions. Report corrections on Form 1099-R.||Consider using the services of a retirement plan professional. Know how the feature works and keep good records.|
Five-year post severance contributions are employer contributions made to a 403(b) plan after the employee’s severance from employment. In general, post severance contributions must meet the following:
- Employer contributions may be made for an employee for up to 5 years after the employee’s employment ends.
- Post severance contributions must be based on includible compensation for the employee’s last year of service.
- Includible compensation doesn’t include amounts contributed by the employer to the employee’s 403(b) account.
- Compensation for an employee working less than full-time should include a time period that would constitute a year of service.
- Contributions may be made up to the limits under Internal Revenue Code Section 415 for each of the 5 years.
How to find the mistake:
If your 403(b) plan offers post severance contributions, it’s important you understand how this feature works. It’s likely you’ve already sought the help of a retirement plan professional. Post severance contributions should have an outside review of the eligibility and contribution calculations.
How to fix the mistake:
ABC College properly maintains a 403(b) plan with 5-year post severance contributions. After separation from employment, employees will have a contribution made to the plan in an amount equal to the highest compensation the employee received during the previous three years. During a compliance review of the plan for the 2011 year, ABC noted that employee, Sue, had an employer contribution of $40,000 per year made to its 403(b) plan for each of 5 years after termination from service (2007 – 2011); however, Sue’s final year of compensation was only $35,000. The result is Sue received an extra $5,000 contribution for each of those 5 years. ABC discovered the error in 2014. At the end of 2013, the plan had 48 participants.
Correction programs available:
If ABC determines it has the proper practices and procedures in place and the mistake was insignificant, ABC may use SCP to fix this mistake. Insignificant failures can be corrected at any time. If ABC deemed the failures to be significant, SCP wouldn’t be available because correction would be occurring beyond the 2-year timeframe that is available to correct significant operational failures.
Voluntary Correction Program:
ABC may correct this mistake under VCP. This is an Internal Revenue Code Section 415 failure so the following correction methods would be available:
- ABC should remove the accumulated $25,000 from Sue’s 403(b) account and place it into a taxable 403(c) account. This would generate a taxable event to Sue and would require ABC to issue a W-2 or 1099-R.
- If the extra $5,000 payment made for the 2011 plan year was not consistent with the plan’s written terms, ABC could request that Sue return the payment since the plan’s terms did not authorized it.
Under appropriate circumstances, the $5,000 excess for the 2011 plan year could be returned to ABC. ABC would submit an application in accordance with Revenue Procedure 2013-12 to correct under VCP. The fee for ABC’s VCP submission (based on 48 plan participants at the end of 2013) is $1,000. This assumes ABC makes the VCP submission in 2014. ABC should make its VCP submission using the model document in Appendix C - Part I and include Forms 8950 and 8951.
Audit Closing Agreement Program:
Under Audit CAP, correction of this mistake is the same as described above. ABC and the IRS enter into a closing agreement outlining the corrective action and negotiate a sanction based on the maximum payment amount.
How to avoid the mistake:
If your plan contains these features, you should consider using the services of a retirement plan professional to help avoid mistakes. As usual, knowing how the feature should work and keeping good records are essential to keeping your plan in compliance.