(b)lines Ask the Experts – Treatment of Contracted Employees

September 30, 2014 (PLANSPONSOR (b)lines) – “I work for a 501(c)(3) arts organization and, due to the nature of our business, I have several individuals on payroll who have not actually worked for us for at least a couple of years. 

“From time to time, an individual from this list may work for us on a particular production, but otherwise they receive no compensation from us. We sponsor an Employee Retirement Income Security Act (ERISA) 403(b) plan. How should such individuals be treated for purposes of a) the universal availability requirement b) receipt of employer contributions, and c) whether they have experienced a “severance from employment” that would enable them to receive a distribution from the plan (our plan does not permit withdrawal of employer contributions until termination of employment, and in-service withdrawals of elective deferrals are limited to age 59 ½ and hardship)?”

Michael A. Webb, vice president, Cammack Retirement Group, answers: 

Excellent question! Fortunately, the final 403(b) regulations are quite clear as to who is an employee for purposes of the 403(b) plan and who has experienced a “severance from employment” for distribution purposes. Thus, treatment of the individuals you described for 403(b) plan purposes should be fairly straightforward. However, you should keep in mind that this discussion is focused on your 403(b) plan; the issue of who is an employee and who is not (e.g. an independent contractor) can often be a complex one, and employment law counsel should be consulted regarding such issues. 

Having said that, the final regulations define an employee as a common-law employee performing services for the employer, and it does not include a former employee or an independent contractor. The key phrase applicable to your situation is “performing services for the employer,” and, as you stated, in the vast majority of cases, these individuals have not performed services for a number of years, nor have they received compensation. Thus, they would not be considered employees for 403(b) plan purposes, which means they would not be subject to the universal availability requirement, nor would employer contributions be provided to them. However in those situations where such an individual performs services for you on a particular production, he/she is indeed an employee if he/she otherwise meets the common-law definition of an employee. Such an individual would be treated as an employee for universal availability purposes, as well as eligibility for employer contributions. 

The regulations go on to define severance from employment as an event where the employee ceases to be employed by the employer maintaining the plan. From the fact pattern that you provided, it appears that the individuals in question ceased to be employees at some point in the past, even though they were not removed from payroll. If that is the case, such individuals should be eligible to receive a distribution from the plan as former employees who have experienced a severance from employment, with the exception of those individuals who have been hired for a particular production, who would need to wait until they cease to be employed before receiving a distribution from the plan unless eligible for distribution for another reason as permitted by the plan. 

As an aside, you may wish to have a conversation with your payroll department as to the rationale for retaining such individuals on payroll, since such retention may create issues extending beyond your 403(b) plan. 


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.