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403(b) Plan Fix-It Guide - Your 403(b) plan didn’t limit elective deferrals, including catch-up and designated Roth contributions, to the amounts specified under the law in a calendar year

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7) Your 403(b) plan didn’t limit elective deferrals, including catch-up and designated Roth contributions, to the amounts specified under the law in a calendar year. Track deferrals for each employee. Conduct a year-end review of deferrals for each participant and compare to 402(g) limits for that year. If over the basic 402(g) limit, determine if the excess is based on a properly administered 15-years of service or age 50 catch-up program. Refund excess deferrals plus earnings. Report corrections on Form 1099-R. Understand that it’s the employer’s responsibility to limit deferrals and issue correct W-2s. With vendors, establish procedures to limit deferrals. Educate employees. Conduct year-end review of deferrals and refund any excesses prior to April 15.

A 403(b) plan may permit participants age 50 or over by the end of the calendar year to make additional employee elective deferral contributions. These catch-up contributions are not subject to the general limits that apply to 403(b) plans, including the limits under IRC Sections 402(g) (discussed below) and 415 (discussed in mistake #5). An employer is not required to provide for catch-up contributions in its plan. However, if a plan allows catch-up contributions, they must offered to all plan participants who are eligible to make employee elective deferrals. A 403(b) program offering the opportunity to make age 50 catch-up contributions must be based on written documentation.

The features and requirements of catch-up contributions in a 403(b) plan include:

  • The catch-up contribution limit for 2014 is $5,500, subject to cost-of-living increases.
  • Catch-up contributions are additional to the maximum 402(g) limit ($17,500 in 2014, subject to cost-of-living increases).
  • Employees eligible for both types of catch-ups may contribute up to $3,000 extra for the 15-year catch-up, together with an extra $5,500 for the age 50 catch-up (in 2014).

Internal Revenue Code Section 402(g) limits the aggregate amount of elective deferrals that a plan participant may contribute to any 403(b) plan.

  • 402(g) limits elective deferrals to the lesser of the basic limit of $17,500 (in 2014, subject to cost-of-living adjustments in later years), or 100% of the participant’s includible compensation.
    • While the age 50 catch-up doesn't count against the 402(g) limits, the 15-year catch-up raises the basic 402(g) limit for certain employees for certain organizations (see mistake #6). So, for employers that offer the 15-year catch-up, the 402(g) limit is higher for those employees who qualify for the catch-up.

  • The ordering for employees eligible for both types of catch-up contributions is:
    • 15-year catch-up, then
    • age 50 catch-up.

  • Designated Roth contributions in a 403(b) plan are included within all the different limits.
  • Any catch-up contributions made are in addition to the basic 402(g) limit. However, total elective deferrals, including catch-up contributions cannot exceed the participant’s includible compensation for the year.

The 402(g) limit is an individual limit. An employee who participates in more than one plan that allows elective salary deferrals is subject to a single 402(g) limit.

  • An employee who participates in more than one 403(b) plan must combine all elective deferrals to all 403(b) accounts.
  • An employee who participates in both a 403(b) and a 401(k) plan must combine all elective deferrals to the 403(b) and 401(k) plans.
  • An employee who participates in both a 403(b) and a 457(b) plan may defer up to $17,500 to the 403(b) plan and another $17,500 to the 457(b) plan in 2014.
  • To avoid complications with the limitations imposed by IRC Section 415(c), elective deferral contributions may have to be limited to ensure that plan participants stay within the limits.

The law requires that a 403(b) contract or custodial account may not exceed the current calendar year’s section 402(g) limit. For a 403(b) plan, this means that all of the contracts or custodial accounts held by a participant exceeding the deferral limit will lose their 403(b) status. To avoid the loss of 403(b) status for affected 403(b) contracts or custodial accounts, the plan may correct this mistake using EPCRS if it didn’t distribute excess deferrals before the April 15 deadline.

The timing of the return of excess deferrals determines how and when the excess is taxed.

Timely withdrawal of excess deferrals by April 15

  • Excess deferrals withdrawn by April 15 following the calendar year the deferral was made are taxable in the calendar year contributed
  • Earnings through the date of correction are taxable in the year distributed
  • There is no 10% early distribution tax, 20% income tax withholding and spousal consent requirement on amounts timely distributed

Excess not withdrawn by April 15

  • Under Internal Revenue Code Section 401(a)(30), if the excess deferrals aren’t withdrawn by April 15, each of the 403(b) contracts or custodial accounts of an affected participant is subject to the loss of the 403(b) status and would need to be corrected through EPCRS.
  • Excess deferrals not withdrawn by April 15 following the calendar year the deferral was made are subject to double taxation.
  • Excess deferrals are taxed both in the year contributed and in the year distributed.
  • Earnings on excess deferrals are taxed in the year distributed.
  • Under EPCRS, these excess deferrals are still subject to double taxation.
  • These late distributions could also be subject to the 10% early distribution tax, 20% income tax withholding and spousal consent requirements.

Reporting requirements for excess deferrals

  • The plan must report corrective distributions of excess deferrals (including earnings) on Form 1099-R.
  • Excess deferrals and earnings distributed during the year the excess occurred should be reported on one Form 1099-R (Code 8).
  • Excess deferrals and earnings distributed between January 1 and April 15 of the following year may have to be reported using two Form 1099-Rs.
    • One Form 1099-R (Code P) for the excess deferral, and
    • One Form 1099-R (Code 8) for the earnings.

  • Excess deferrals and earnings distributed after April 15 should be reported on one Form 1099-R (Code 8) for the year they are distributed.

IRC section 72(t) imposes a 10% additional income tax for taxable distributions that do not meet one of the Code’s exceptions, such as death, disability or attainment of age 59 ½, among others. To avoid the 72(t) tax, correct excess deferrals no later than April 15 following the year the excess was made. Imposition of the 10% additional tax is not correctible under EPCRS.

How to find the mistake:

You can identify this mistake by tracking each employee’s deferrals through your payroll process. If employees are eligible to participate in both a 403(b) and a 401(k) plan, add these amounts together and ensure that the total doesn’t exceed the current year 402(g) limit or the employee’s total compensation. If the employee is also eligible to participate in a 457(b) plan, the amounts in that 457(b) plan don’t count against the employee’s 402(g) limit. Conduct a year-end review of deferrals for each employee to determine that the employee hasn’t exceeded the 402(g) limit. For each employee with deferrals in excess of the 402(g) limit ($17,500 in 2014), determine if the excess is based on a properly administered 15-years of service catch-up or an age 50 catch-up program. Timely withdrawal of 402(g) excess deferrals is very important to avoid some onerous tax consequences.  

Review your 403(b) written plan to determine if the age 50 catch-up is an option offered by your plan. One of the requirements is if you include the age 50 catch-up in your plan, you must offer this option to all employees who make elective deferrals. If your 403(b) plan offers age 50 catch-up contributions, you should review the procedures used to notify employees of this special plan provision. Educating employees on the availability of this option is key to meeting the requirements.

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 elementary school cafeteria or maintenance workers who are age 50 or over are participating significantly less than similar workers in secondary schools, it may signal a problem that those groups have not been properly notified of their right to make age 50 catch-up contributions.

How to fix the mistake:

Corrective action:
The plan sponsor must ensure that the insurance company or financial institution that holds the 403(b) assets refunds deferrals in excess of the 402(g) limits, plus any earnings, to affected plan participants. If you determine that an employee was not eligible for an age 50 catch-up contribution, you must distribute any amounts in excess of the 402(g) limits, adjusted for earnings. In addition to making the corrective distributions, a plan sponsor should make certain the plan, annuity contract or custodial agreement contains the necessary language limiting the 402(g) limits. The law provides plan sponsors the opportunity to take corrective action to resolve this problem through the timely return of the excess deferrals.

Excess deferrals not timely removed from the plan by April 15 of the year following the deferral may cause all of the 403(b) contracts held by an affected participant to lose their 403(b) status. Plan sponsors who didn’t timely distribute the excess deferrals may use EPCRS to avoid this. These mistakes are correctible by distributing the excess deferral to the employee as a taxable amount. The timing of the return of the excess to the participant decides how and when that refund is taxed. An excess deferral returned after April 15, following the calendar year of the deferral is subject to double taxation.

Example 1:
University J maintains a 403(b) plan. At the end of 2013, there were 3,300 current and former plan participants. For the 2010 year, five participants exceeded the 402(g) limit by $2,000 each and the excess was returned on October 1, 2011 (after April 15, 2011).  

Example 2:
Jolly School District sponsors a 403(b) plan for its employees. At the end of 2013, there were 12,350 current and former plan participants. Beginning in 2005, Jolly permitted participants age 50 and over to make catch-up deferrals to its 403(b) plan. During a compliance audit, Jolly determined that it only informed employees in the district’s secondary schools of their right to make catch-up deferrals. Jolly verified that 10 employees were age 50 or over in 2010, with five of those employees contributing the 402(g) limit in 2010, 2011 and 2012. The written 403(b) plan adopted by Jolly permitted catch-up contributions.

Correction programs available:

Self-Correction Program:

Example 1:
If University J determines the plan had the proper practices and procedures in place to help keep the plan operating in compliance with all laws, the mistake is correctible under SCP. Correction is to distribute the 402(g) excess.

  • Excess contributions, plus earnings, were returned on October 1, 2011 (after April 15, 2011):
    • Excess deferrals ($2,000 for each affected participant) are taxed both in the year contributed (2010) and in the year distributed (2011).
    • Earnings on the excess deferrals are taxed in the year distributed (2011).
    • These late distributions are subject to the 10% early distribution tax, 20% income tax withholding and spousal consent requirements.

Example 2:
If Jolly determines it has the proper practices and procedures in place and that in the aggregate this was an insignificant failure, Jolly may correct using SCP by making a corrective contribution for each of the five participants who contributed up to the 402(g) limit.

First you must determine the “missed deferral” attributable to this failure. Under the EPCRS Appendix A safe harbor, the “missed deferral” attributable to catch-up contributions is 50% of the catch-up contribution limit for the year in which the employee was improperly excluded. The catch-up limit was $5,500 for 2010, 2011 and 2012.In this example, the missed deferral for catch-up contributions is assumed to be $2,750 for each year during the 2010-2012 period. The corrective contribution that Jolly must pay to the 403(b) plan for each affected plan participant represents the missed deferral opportunity. This number is equal to 50% of the missed deferral for catch-up. Using the lost opportunity cost concept, Jolly may correct by making a corrective contribution for $4,125 (((50% X ($5,500 X 50%)) = $1,375 x 3 years), adjusted for earnings. This would have to be adjusted increased further for earnings determined through the date of correction.

Voluntary Correction Program:

Example 1:
Correction and tax consequences are the same as for SCP; amounts in excess of the 402(g) limit have to be distributed. University J may determine they must correct the mistake under VCP if they didn’t have proper practices and procedures in place, or if they choose to correct the error under VCP. In our example, if the reason the limits were exceeded is the annuity contract or custodial accounts didn’t include the proper language with the 402(g) limits, the mistake would be a special failure and correction would have to occur using VCP. For 2009 and later plan years, if the written 403(b) plan didn’t include proper language that complied with the 402(g) limit, this would be considered a plan document failure and could only be resolved under VCP if the written plan was not determined to be in compliance with the requirements of Notice 2009-3 and Announcement 2009-89.   

Correction under VCP would require University J to make a VCP submission according to Revenue Procedure 2013-12. The fee for University J’s VCP submission (based on 3,300 employees) is $15,000. University J should make its VCP submission using the model documents in Appendix C, including Schedule 7 and Forms 8950 and 8951.

Example 2:
Jolly may also correct this mistake under VCP. Correction would be identical to correction under SCP. Jolly would complete a submission, according to Revenue Procedure 2013-12. The fee for Jolly’s VCP submission (based on 12,350 plan participants at the end of 2013) is $25,000. Jolly should make its VCP submission using the model document in Part I of Appendix C and include Forms 8950 and 8951.

Audit Closing Agreement Program:  
Under Audit CAP, correction is the same as described above. University J or Jolly 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:

Employers must understand that they have a responsibility to limit deferrals to the plan and to issue correct W-2s. Many organizations rely on vendors to limit the deferrals; however, the vendor may only have knowledge of a portion of the participant’s deferrals. Review your practices and procedures to help eliminate these mistakes. Establish procedures with your plan vendors to help identify these problems. These mistakes may affect the participants' tax liabilities, so it’s also a good idea to educate participants. If an employee participates in the 403(b) plan and a 401(k) plan sponsored by the same employer, the total of all 403(b) and 401(k) deferrals made to both plans is limited to the single 402(g) limit. However, if the employee participates in a 401(k) plan sponsored by an unrelated employer and this information is not shared with the 403(b) sponsor, the aggregate contributions to both plans must comply with the 402(g) limit and the employee has responsibility to communicate this to both employers.   

Develop a procedure for notifying participants of the availability of the age 50 catch-up contribution. Employers are responsible for providing this notice to all plan participants who are age 50 and over. Make certain you have each employee’s birth date. Before allowing participants to make age 50 catch-up contributions, make certain the written program contains the proper language.

At the end of each year, compile a list of participants and their deferrals. For each participant with deferrals over the 402(g) limit, determine if one of the available catch-ups allows the excess. If not, remove the excess from the plan no later than April 15 of the following tax year.

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: 05-Jun-2014