(b)lines Ask the Experts – Post-Termination Contributions for Employee Receiving Severance Pay

“We are a 501(c)(3) private tax-exempt hospital that  sponsors a 403(b) plan. We have an employee who has been here for many years whom we are forced to terminate since we are phasing out his entire department.

“However, we want to reward him for his lengthy service and valuable contributions to the hospital as best we can. We are providing him with severance, but we understand that we cannot make contributions to the 403(b) plan based on that severance pay.

 

“But, could we make post-termination contributions under the 403(b) rules that allows for employer contributions following termination of employment? Or would that not be permitted in his case since we are already paying him severance? He is a non-highly compensated employee if that makes a difference.”

 

Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

 

You are quite correct that severance pay (i.e., payments to a former employee for NOT working) must be excluded from a 403(b) plan’s compensation definition, and thus you cannot make contributions to the 403(b) based on severance pay.

 

Post-retirement employer contributions to a 403(b) plan also may not be based on severance pay because only includible compensation for the employee’s most recent one-year period of service may be taken into account. From the final 403(b) regulations:

 

(d) Employer contributions for former employees—(1) Includible compensation deemed to continue for nonelective contributions. For purposes of applying paragraph (b) of this section, a former employee is deemed to have monthly includible compensation for the period through the end of the taxable year of the employee in which he or she ceases to be an employee and through the end of each of the next five taxable years. The amount of the monthly includible compensation is equal to one twelfth of the former employee’s includible compensation during the former employee’s most recent year of service. Accordingly, nonelective employer contributions for a former employee must not exceed the limitation of section 415(c)(1) up to the lesser of the dollar amount in section 415(c)(1)(A) or the former employee’s annual includible compensation based on the former employee’s average monthly compensation during his or her most recent year of service.

 

Thus, assuming that nondiscrimination testing can be satisfied (and, in your case, since the individual is an NHCE, it would be satisfied) and that the 415 limit on total annual additions is not exceeded, you are free to make a contribution for the former employee in question for up to five tax years following the tax year when the individual ceases to be an employee. The contribution would be based on the compensation during the former employee’s most recent year of service, excluding severance. The fact that the employee is receiving severance is irrelevant to the ability for the plan sponsor to make this employer contribution to the 403(b).

 

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

 

 

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