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403(b) Plan Fix-It Guide - You didn’t give all of the employees of the organization the opportunity to make a salary deferral

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4) You didn’t give all of the employees of the organization the opportunity to make a salary deferral. Perform a review of the plan and its operation. Review employees who received a W-2 but didn’t participate. Determine if you excluded any class of employees, such as janitors, cafeteria workers, bus drivers or union employees. Provide improperly excluded employees the opportunity to participate in the plan in current and future years. Make a corrective contribution to the plan for the employees that compensates for their missed deferral opportunity. Understand which employees you may exclude from the 403(b) plan. Provide proper notification to employees of their eligibility to participate in the 403(b) plan at least annually.

This universal availability rule means that if one employee is permitted to make 403(b) elective deferrals (including designated Roth contributions, if allowed by the plan), the employer must extend this offer to all its employees. However, an employer may choose to include a plan provision to exclude the following employees from participating in the plan:

  • Employees who will contribute $200 annually or less
  • Employees who are eligible to participate in a 401(k), 457(b) or other 403(b) plan of the same employer
  • Non-resident aliens
  • Employees who normally work less than 20 hours per week (meaning they don’t accumulate at least 1,000 hours in at least one year)
  • Students performing services described in IRC Section 3121(b)(10)

Note: Prior to 2009, a written plan provision was not necessary to exclude the above groups of employees. In addition, prior to 2009, Notice 89-23 allowed plan sponsors to exclude other groups of employees from the plan.

It’s easy to assume certain employees who only have a support role with the organization or work in what is typically considered a part-time position aren’t eligible to participate in the plan. However, under the universal availability rule, the plan may decline to cover only the employees who meet the above specific exclusions.

A mistake in this area can be disastrous. For instance, if a plan includes an employee it could have excluded, it may have to include all employees in that class. Another example is the failure to include an otherwise eligible employee in the plan. This may lead to the entire 403(b) plan losing its tax-deferred status.

The second part of universal availability is effective opportunity. This is a facts and circumstances test. A 403(b) plan satisfies the effective opportunity requirement if, at least once each plan year, the plan provides an employee with an effective opportunity to make or change a cash or deferred election.

How to find the mistake:

Employers should develop a strategy based on their organization’s structure. For example, you could discover this potential mistake by making a list of employees who received a W-2 but did not participate in the 403(b) plan. For employees on that list, determine if you properly notified them of their eligibility to participate in the plan or if you improperly excluded them from participation. For each employee you improperly excluded, you may have an issue that you need to correct.

Next, look at employees who received a W-2 and participated in the 403(b) plan. In this second sample, look for employees who should have been excluded from participation. If you improperly included an employee, you may have a universal availability issue to correct.

Although you can’t base exclusions on job classifications or groups, you may also have an issue if you note that participation by certain groups of employees is significantly less than other groups. For example, if bus drivers, cafeteria workers or maintenance workers are participating significantly less than another group, it may signal a problem that you haven’t properly notified those groups of their right to participate - or, at the very least, you may need to reach out to those employees to re-educate them on their plan rights.

In addition, before 2009, the law allowed certain administrative exclusions, such as union employees, visiting professors and employees affiliated with a religious order who have taken a vow of poverty. Beginning in 2009, under transitional rules, those exclusions are no longer allowed. Ensure that your plan no longer excludes these types of employees.

How to fix the mistake:

Corrective action:
To correct a universal availability failure, you should provide each improperly excluded eligible employee with the opportunity to participate in the plan in current and future years. In addition, you may be required to make a contribution to the plan for each eligible employee for the time that the employee was improperly excluded from the 403(b) plan.

The amount necessary to correct mistakes involving the failure to allow plan participants to defer salary uses the concept of “lost opportunity cost,” which generally represents the loss of the ability of the salary deferral to grow tax-free in the 403(b) plan. The IRS has determined that this lost opportunity cost is equal to 50% of the amount of the elective salary deferral the employee could have made to the 403(b) plan.

In accordance with the IRS safe harbor in Revenue Procedure 2013-12 Appendix A.05(6), you may deem the lost salary deferral amount to be the greater of:

  • 3% of compensation, or
  • the maximum deferral percentage for which the plan sponsor provides a matching contribution rate that is at least as favorable as100% of the elective deferral made by the employee.

Therefore, the corrective contribution you need to pay to the plan for the improperly excluded employees would generally be 1.5% of their compensation for each year you excluded them, adjusted for any lost earnings through the date of correction. If you provided matching contributions to the plan for the affected year, you would need to pay additional corrective contributions to the plan to restore matching contributions you would have provided on the missed deferral amounts for the improperly excluded employees.

Example:
DEF Independent School District maintains a 403(b) plan for its teachers and staff. At the end of 2011, 350 employees were eligible to participate in the plan. Three part-time teacher’s aides worked more than 20 hours per week during 2008, 2009, 2010 and the first eight months in 2011; however, they were not included in the 403(b) plan. Assume each teacher’s aide earned $20,000 annually during 2008-2011. The school district discovered the failure on September 1, 2011 and allowed each of the three teacher’s aides to participate in the plan as of that date. Assume that the 403(b) plan provides for a 100% match up to 3% of participant compensation.

To correct this mistake, the school district should provide each eligible employee the opportunity to participate in the plan for the current and subsequent years. The plan sponsor must make a contribution to the plan for each of the three employees improperly excluded from participating in the plan in prior years. This contribution should be equal to 50% of the amount of elective deferral the employee could have made to the plan, adjusted for any lost earnings through the date of correction. The corrective contribution associated with the lost elective deferrals must be 100% vested and be subject to the distribution restrictions in IRC Section 403(b)(11). The corrective contribution for lost matching contributions, if applicable, can be subject to the plan’s regular vesting schedule and distribution restrictions in effect during the years the employees were excluded.

The school district can determine the amount it must contribute for each teacher’s aide that it improperly excluded in 2008, 2009, 2010 and part of 2011 as follows:

The school district can apply the IRS safe harbor correction method and deem the lost elective deferral amount to be 3% of compensation. In that case, the corrective contribution for each aide would be:

  • The total corrective contribution owed to each aide for the lost deferrals is $1,100 (($20,000 x 3%) x 50%=$300, $300 x 3 years 8 months).
  • Considering the lost deferral amount of $600 that the excluded employees could have made to the plan ($20,000 x 3%), the matching contribution owed per year is equal to $600. Total matching contributions owed to each teacher’s aide is $2,200 ($600 x 3 years 8 months).
  • Total corrective contribution owed to each teacher’s aide is $3,300 ($1,100 + $2,200), adjusted for earnings through the date of correction.

Other correction methods may be acceptable to fix this mistake. Any correction method used that is not described in Appendix A or B would need to satisfy the correction principles of Revenue Procedure 2013-12, section 6 and would be outside of the IRS safe harbor. For example, a 403(b) plan sponsor might determine the missed deferral for an excluded employee using a percentage based on the average deferrals for all employees in the plan.

Correction programs available:

Self-Correction Program:  
Operational mistakes may be corrected under the Self-Correction Program. Under SCP, there are no applications or reporting requirements. To use SCP to correct this universal availability issue, the school district needs to make two determinations:

  • First, it must determine if it has sufficient compliance practices and procedures in place to correct under SCP.
    • If it’s determined that sufficient compliance practices and procedures exist, it may correct under SCP.
    • If sufficient compliance practices don’t exist, it must correct under the Voluntary Correction Program.

  • Second, it must determine if this error is significant or insignificant.
    • If it’s determined the error is insignificant,
      • It may fully correct the mistake for 2008, 2009, 2010 and 2011 under SCP at any time.

    • If it’s determined the error is significant,
      • The school district wouldn’t be able to correct this failure under SCP because it needed to correct the oldest affected plan years within 2 years of the error. In this example, the deadline for taking corrective action for 2008 would’ve been the last day of the 2010-plan year.
      • The school district may not be able to use SCP to fix this error, however it could be resolved on a voluntary basis if it makes a submission to the IRS under VCP.

In our example, the school district determined the error was insignificant and it has sufficient practices and procedures in place to satisfy the requirements of operating a compliant plan. Therefore, it may correct 2008, 2009, 2010 and 2011 using SCP:

  • Determine the lost opportunity for each affected participant by assuming the lost deferral amount is equal to 3% of compensation.
  • Multiply 50% of that percentage times each employee’s compensation to determine the corrective contribution due the affected employees.
  • Increase the corrective contribution to include matching contributions that would have been attributable to the lost employee elective deferrals.
  • Adjust for lost earnings and contribute to the affected employee’s account.

Voluntary Correction Program:  
If the school district determined it didn’t have the proper practices and procedures or that the error was significant, this mistake is correctible under VCP. Correction would be the same, except that the district must make a VCP submission according to Revenue Procedure 2013-12. The fee for the school district’s VCP submission (based on 350 eligible participants) is $5,000. The school district should make its VCP submission using the model document in Appendix C – Part 1, including Forms 8950 and 8951.

Audit Closing Agreement Program:  
Under Audit CAP, correction of this mistake is the same as described under SCP. The school district 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:

Universal availability mistakes can be very expensive to correct, so avoiding this mistake is important. You must have a good understanding of which employees you may exclude from your organization’s 403(b) plan. Many organizations assume they can exclude part-time or certain classes of employees, but that’s not how it works.

A common mistake is to improperly exclude employees who work more than 20 hours per week, or 1,000 hours per year, for example substitute teachers or adjunct professors. Many governmental plan sponsors avoid this mistake by making these types of employees eligible for a 457(b) plan. If each employee is either eligible for the 403(b) or 457(b) plan (or both), a governmental plan sponsor may be able to avoid the expensive fix associated with a universal availability failure.

Another important feature is to provide proper notification to employees of their right to participate in the 403(b) plan. You should provide proper notification to each employee of their eligibility to participate in the 403(b) plan at least annually.

403(b) Plan Fix-It Guide
EPCRS Overview
403(b) Plan Fix-It Guide (.pdf)
403(b) Plan Checklist (.pdf)
Additional Resources

IRS.gov / Retirement Plans / Correcting Plan Errors / Fix-It Guides / Potential Mistake

Page Last Reviewed or Updated: 30-Oct-2014