While both governmental and non-profit entities can sponsor a 457(b) plan, the rules differ for each plan type. Unlike their governmental counterparts, non-profit organizations offering 457(b) plans:
· Can only extend eligibility to select management and highly compensated employees and independent contractors;
· Must hold amounts contributed to a top hat 457(b) plan as the organization’s assets – subject to that employer’s general creditors – until those amounts are paid or made available to the participant; and
· Cannot permit an age 50+ catch-up or Roth 457 contribution, loans, or rollovers into or out of the plan.
Given the unique rules that apply to
non-profit 457(b) plans, the Internal Revenue Service (IRS) has been
increasingly interested about the level of understanding employers of these
organizations have about how operating their plan in compliance with IRS
regulation differs from their governmental counterparts.
As a result of this compliance check, the IRS anticipates it will be better able to assess whether (and the extent to which) non-profit 457(b) plans may be mistakenly operating by the rules applicable only to governmental 457(b) plans, which results in improperly operating as a funded plan, extending eligibility beyond the “top hat” group and offering loans and age 50+ catch-up contributions for employees.
Potential Traps for the Unprepared
The IRS expects to send a compliance questionnaire to approximately 200 non-profit organizations nationwide in fiscal year 2013 (which ends on 9/30/2013) and an additional 200 in fiscal year 2014 (ending on 9/30/2014). Plan sponsors whoreceive this questionnaire can expect it to focus on five themes:
1. Verification that the deferrals reported to the IRS on Form W-2 were made to a 457(b) plan
The questionnaire requests employers to identify all of the 457(b) plans it sponsors. To ensure the plan satisfies the Employee Retirement Income Security Act (ERISA) exemption as a top hat plan covering select management and highly compensated employees, a sponsor will also be asked to confirm it notified the Department of Labor (DOL) of the top hat status (which should occur within 120 days of the plan’s adoption), and, if so, to include a copy of that letter.
2. Determination of the employer’s eligibility to sponsor a 457(b) plan
The questionnaire also requests employers to validate the organization’s tax-exempt status by identifying the applicable sub-section under Internal Revenue Code (IRC) Section 501(c). Recognizing that the employer may be considered either a governmental or dual status entity, the questionnaire also asks whether the sponsor is a governmental employer within the meaning of IRC Section 115 (which includes an entity that performs an essential governmental function).
3. Confirmation that participation in the 457(b) plan is limited to the “top hat” group
An employer receiving the questionnaire should identify whether plan participants include highly compensated employees, management, all employees (which would not be permissible under a 457(b) top hat plan), or others (which presumably includes any independent contractors participating in the plan). To ensure that the plan only covers the “top hat” group, the employer will be asked to indicate the number of participants who are deemed as highly compensated or management.
4. Validation that the 457(b) plan is not operating under the rules attributable to governmental 457(b) plans
The questionnaire asks whether the plan document permits loans or the age 50+ catch-up – neither of which are permitted under a non-profit 457(b) plan. In addition, the sponsor will be asked to confirm that assets in the 457(b) plan are unfunded and are not held in trust for the exclusive benefit of plan participants and beneficiaries.
In addition, sponsors will be asked to supply a copy of the plan provision that permits participants to use the Special 457 catch-up, which, to the extent available under the plan, would require an eligible individual to elect this option within three years prior to the year in which he would reach normal retirement age (as defined in the plan document).
5. Identification of unforeseeable emergency withdrawals
To assess the prevalence of unforeseeable emergency withdrawals (which are held to a stricter standard than hardship withdrawals under a 403(b) or 401(k) plan), the questionnaire asks the sponsor to determine if the 457(b) plan permitted “hardship distributions” in the past three years.
Be Prepared
The IRS’s stated objective of this compliance check includes recommending ways to remove any compliance barriers. While the check is not a formal plan examination, if it is determined that the employer’s plan is not operating in accordance with the plan rules, the IRS will notify the sponsor of next steps. This could include an audit of the plan or corrective action under the IRS’ Voluntary Compliance Program.
If you receive this questionnaire, proceed with caution. Seek help from your legal and tax adviser in responding to the questions. The ability to anticipate the lines of inquiry included in the questionnaire is the best preparation you can take. Even if your 457(b) plan is not included in the compliance check, this serves as a good reminder to review your plan so that you can identify and fix any outstanding issues in the event of a potential audit in the future.
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Linda Segal Blinn, J.D.*, is vice president of Technical Services for ING U.S. Retirement’s Tax-Exempt Markets. In this capacity, Blinn leverages her nearly 25 years of experience administering and designing defined contribution plans to provide general legislative and regulatory information to assist public and non-profit employers in operating their retirement plans.
This material was created to provide accurate information on the subjects covered. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document. The taxpayer should seek advice from an independent tax advisor.
* Linda is not a practicing attorney.