First, some preliminary points: there are two sets of rules, one for employee deferrals (universal availability) and the other for employer contributions; the rules do not apply to churches or church-related organizations (see section 403(b)(1)(D)); and only the universal availability rules apply to school district plans; but both sets of rules apply to plans of tax-exempt entities.
In this column, we’ll discuss only the universal availability rules.
Unlike qualified plans, 403(b) arrangements have a very simple non-discrimination rule for deferrals, the universal availability rule. If any employee is eligible, all employees must be eligible. The new Regulations complicate things by adding an “effective opportunity” requirement (see Treas. Reg. §1.403(b)-5(b)(2)), though it makes sense that you have to tell employees of a right in order for them to exercise it.
Before looking at “effective opportunity,” let’s examine some exceptions. Employees who are eligible for another 403(b), 401(k), or 457(b) eligible governmental plan of the same employer can be excluded, along with non-resident aliens with no U.S. source income, certain student workers, and part-timers (those who normally work fewer than 20 hours per week – though this has to be back-tested every 12 months).
A couple of observations:
- Since everybody has to be given a chance to defer, coverage testing isn’t based on a comparison of high versus lower paid workers – and you can’t exclude up to 30% of the lower paid as you can in a qualified plan.
- Unlike 401(k) plans, you don’t test the amount of permissible deferral on a high versus lower paid basis – the highly paid can defer as much as they want (up to the legal limit) regardless of whether the lower paid defer anything.
- Union employees are not an excludable class. They were under old IRS guidance, but that exclusion was eliminated in the new regulation.
Arguably, leased employees can be excluded if the leasing company provides them with a 401(k) plan. By analogy to the IRS guidance on “professional employee organizations” (PEOs), the workers are considered employees of the recipient entity even though they receive their paycheck and W-2 from the leasing company. So, arguably, they fall under the first exclusion noted earlier, employees who are eligible for a 401(k) plan. However, the exclusion requires that it be a 401(k) plan “of the employer”, i.e., the recipient entity. Since it isn’t clear whether the exclusion would actually apply, it is probably better to assume that the leased employees cannot be excluded from the 403(b) plan.
Now, let's look at the new "effective opportunity" requirement created by the regulation. It isn't enough to say that everybody is eligible; "the plan" has to take affirmative steps in order to satisfy universal availability:
- The regulation seems to contemplate that the employees must receive notice of the availability of their right to make an election (though it doesn't say so explicitly). In other words, the fact that they are eligible must be conveyed to the employees. Just when the notice has to be given, how long the employees have to exercise the right, how it has to be delivered and what other information must be included is left vague. Presumably, something that describes the essential terms of the plan and is given 30 days in advance of the employee's entry date would do the trick.
- Employees must have a right to make an election to defer or change their deferral at least once during the year and to defer up to the maximum legal limit or limit under the contract.
- No other rights (except the right to receive a matching contribution) can be conditioned on an employee making or failing to make an election to defer. This is essentially the same concept that applies to 401(k) plans (see Code section 401(k)(4)(A)).
So what does it all mean? To have a 403(b), somebody has to take steps to make sure that everybody is able to make a salary deferral election and that they know about that right. I say "somebody" because the regulation does not say this has to be the employer. Presumably the obligations under the "effective opportunity" requirement can be delegated to one or more service providers, with the employer's role limited to sending out materials given to it by a provider or giving the provider a list of employees.
In the next column, we'll address the employer contribution non-discrimination rules.
- Bruce Ashton, Reish Luftman Reicher & Cohen
NOTE: This feature is to provide general information only, does not constitute legal advice as part of an attorney-client relationship, and cannot be used or substituted for legal or tax advice.