How Should 403(b) Plans Calculate Employer Contributions for Former Employees?

Q: I realize that 403(b) plan sponsors can make employer contributions for a former employee for up to five taxable years following the year in which such individual ceases to be an employee. However, what compensation figure should I use to calculate the employer contribution?

Kimberly Boberg, Kelly Geloneck, Emily Gerard and David Levine, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

A: Sometimes both the Internal Revenue Code and Treasury regulations can be quite helpful in obtaining answers to questions, and this is no exception! Let’s take a look at Treas. Reg. 1. 403(b)-4(d):

(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.

(Experts Note: Paragraph (b) of this section merely describes the maximum annual contribution that may be made.)

Thus, in order to arrive at the proper compensation amount, you take the employee’s total compensation for the employee’s most recent year of service and divide that number by twelve. That amount is the compensation you are permitted to use each month to calculate contributions for the remainder of the taxable year containing the employee’s termination, as well as for the following five taxable years.

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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