Source: https://www.exec-comp.com/stetson.html
Timestamp: 2019-03-19 14:45:33
Document Index: 719560527

Matched Legal Cases: ['§ 401', '§ 501', '§ 403', '§ 457', '§ 401', '§ 401', '§ 401', '§ 403', '§ 501', '§ 403', '§ 501', '§ 403', '§ 401', '§ 401', '§ 401', '§ 401', '§ 401', '§ 401', '§ 401', '§ 402', '§ 457', '§ 401', '§ 501', '§ 401', '§ 457', '§ 501', '§ 501', '§ 401', '§ 501', '§ 501', '§ 501', '§ 501', '§ 501', '§ 501', '§ 501', '§ 501', '§ 501', '§ 501', '§ 415', '§ 401', '§ 401', '§ 414', '§ 401', '§ 401', '§ 403', '§ 401', '§ 415', '§ 415', '§ 403', '§ 415', '§ 415', '§ 415', '§ 403', '§ 415', '§ 403', '§ 415', '§415', '§ 402', '§ 415', '§ 415', '§ 401', '§ 501', '§ 501', '§ 403', '§ 415', '§ 403', '§ 415', '§ 501']

"B" V. "K" PLANS:
A COMPARISON OF BROAD-BASED PLANS
UNDER SECTION 403(b) AND SECTION 401(k)
AFTER JOPA
(26 Stetson Law Review 528(Fall 1997)
(Reprinted with permission; all rights reserved)
The Small Business Job Protection Act of 1996 ("JOPA") amended the Internal Revenue Code to permit tax-exempt organizations (other than state and local government units)1 (Footnotes) to maintain § 401(k) plans ("K plans"), effective for plan years beginning after December 31, 1996.2 This Article will assess the impact of this change, especially among the most numerous tax-exempt organizations, § 501(c)(3) organizations (charitable, educational, religious, and scientific organizations) that have been able for many years to sponsor § 403(b) plans ("B plans") and since 1986 have been able to sponsor eligible plans under § 457(b) ("E plans").3
As this Article will detail, all three types of plans have fundamental similarities: a participant has an account under the plan to which are credited employee pre-tax contributions and employer contributions; the participant acquires a nonforfeitable interest in employee contributions immediately and in the employer contributions either immediately or upon completing a designated period of employment with the plan sponsor; the participants can direct the investment of their accounts among several investment alternatives (usually, mutual funds and funds provided under a group annuity contract) and earnings are free from income tax while held in the account; the account is distributable generally upon termination of employment with the plan sponsor, and certain portions of the account may be distributable earlier for hardship or made available through participant loans; and amounts distributed from the account (other than loans) are taxable income when received by the participant. However, E plans, other than those maintained by government units, may not be funded and thus are of limited use compared to K and B plans.
A. Situation Before JOPA
Most tax-qualified pension and profit sharing plans are organized under § 401(a).4 The original legislation was adopted in the 1930s.5
In the mid-1950s, the IRS recognized that tax-qualified plans could be established under § 401(a) that permitted employees to elect to reduce their salary or wages and to have an equal amount contributed to a § 401(a) plan.6 These arrangements were generally referred to as "cash or deferred arrangements."7
In 1958, Congress adopted § 403(b) to regulate retirement arrangements for employees of § 501(c)(3) organizations, and it was extended to educational units of state and local governments.8 Later the IRS ruled that § 403(b) plans could be established for employees of separately organized non-school units of governmental bodies that could qualify as § 501(c)(3) organizations.9 Under § 403(b), a tax-qualified arrangement could be established for a single highly compensated employee, while a § 401(a) plan would be required to include non-highly compensated employees to meet the coverage and non-discrimination tests under § 401(a).10 Expressly permitted were "salary reduction" (or cash or deferred) contributions by employees.11 Section 403(b) plans are often referred to as "tax-sheltered annuities" or "TSAs."12
In the early 1970s, the Treasury Department became concerned about the growth of tax-deferred arrangements because the taxes on deferred compensation were deferred to a later period and thus reduced current tax receipts. In 1972 the Treasury Department proposed a regulation calling into question the tax treatment of employees covered by § 401(a) plans with cash and deferred arrangements, as well as arrangements under plans that were not intended to be tax-qualified.13 Congress imposed a freeze on the regulation project, and the stay was extended several times until
In 1978, Congress adopted two different approaches to deferred compensation. First, responding to taxable employers, it adopted § 401(k) and § 401(m), which added for § 401(a) plans an additional layer of non-discrimination tests in the form of the average deferral percentage test for salary-reduction contributions and the average contribution percentage test for employee post-tax contributions and employer matching contributions (the "ADP" and "ACP" tests).15
Congress also adopted in 1978 a proposal submitted by state and local governments to permit salary reduction arrangements within certain limits but free of the non-discrimination limitations customary under § 401(a).16 The results were E plans,17 which had the following features:
(a) Maximum amount limited to the lesser of $7500 (not indexed) or one-third of taxable compensation. The $7500 limit was an individual limit coordinated under § 402(g) with contributions under K and B plans and other elective contributions. No nondiscrimination tests were imposed, such as an ADP or ACP. A special "catch-up" limit was available in the last three years before
(b) Assets of the plan continued to be assets of the employer, subject to the claims of its general creditors, and were not separately trusteed.
(c) Distributions were not available to participants until the earlier of age 701/2 or separation from service, subject to earlier distribution for an unforseen hardship.
(d) Distributions could be rolled over tax-free to another § 457 plan, but not to a § 401(a) plan, an individual retirement account or annuity (an "IRA") or a B plan.18
In the 1978 legislation, Congress barred tax-exempt organizations and state and local government units from access to K p1ans.19 While § 501(c)(3) organizations could continue to use B plans and state and local government units now had access to E plans, other tax-exempt organizations, such as trade associations and labor unions, had no access to a tax-qualified salary reduction plan (although they continued to have access to qualified money purchase and defined benefit plans under § 401(a)).20
In 1986, Congress amended § 457 to allow tax-exempt organizations to establish E plans.21 However, in combination with the general ERISA requirement that the assets of employee pension plans be trusteed 22 and the E plan requirement that such plans not be trusteed, 23 only a government unit or a church could maintain an E plan with broad-based coverage (i.e., including non-highly compensated employees), 24 and a non-church exempt organization could only maintain an E plan for highly compensated employees.25 Consequently, E plans were of limited utility for tax-exempt organizations compared to K and B plans.26
B. Non-§ 501(c)(3) Organizations After JOPA
JOPA permits trade associations or other non-§ 501(c)(3) tax- exempt organizations to adopt K ~plans for a broad-based group of employees.27 While they may still maintain E plans for their highly compensated employees,28 K plans have higher deferral limits (but with the ADP and other nondiscrimination limitations), separately trusteed assets, and rollovers to IRAs or other § 401(a) plans.29 And there is little reason to maintain both types of plans since the $7500 deferral limits are coordinated, rather than cumulative.30
JOPA provided other E plan improvements. The dollar deferral limits have been indexed, although they begin at $7500, and not at the $9500 level that K plans reached in 1996 and that B plans had enjoyed since 1978.31 E plans may now automatically cash out accounts of $3500 or less.32 And E plans maintained by government units must now be trusteed.33 Thus, the extension of K plans to non-§ 501(c)(3) tax-exempt organizations permits them to maintain broad-based funded salary-deferral plans for the first time since 1978.
C. § 501(c)(3) Organizations After JOPA
A § 501(c)(3) organization now can have either a B plan or a K plan.34 There are several situations in which a § 501(c)(3) organization has an obvious choice. First, in recent years, especially in the health service industry, § 501(c)(3) organizations have established taxable subsidiaries to conduct activities that would attract the unrelated business income tax if conducted by the parent; the taxable subsidiary cannot participate in the parent's B plan but the parent can now freeze its B plan and adopt the K plan to simplify administration. Second, some § 501(c)(3) organizations are paired with non-§ 501(c)(3) organizations, such as a social welfare organization (under § 501(c)(4)); while the non-§ 501(c)(3) organization cannot participate in the B plan, both organizations can now participate in a K plan to simplify administration. Finally, an organization that already has a B plan may simply choose to continue with its old plan in view of the disruptions in changing plans and perhaps the perceived lack of real improvement in a K plan. The rest of this Article will compare the two types of plans, technical issue by technical issue, with a summary at the end.
All of ERISA, including the disclosure, reporting, trust, funding, fiduciary, prohibited transaction, and bonding rules, applies to K plans.35
ERISA can be made not to apply to B plans that have only employee salary reduction contributions.36 If a B plan has employer matching contributions or an employer contribution not dependent on employee contributions, it is subject to all of ERISA.37 However, the reporting requirements for ERISA B plans are reduced to filing only a few portions of the Form 5500 Series reports. Two of the portions not required are the coverage information and the income statement and balance sheet information.38 As a result, a B plan with more than 100 participants is not required to file a certified financial with the Form 5500, 39, and the summary annual report is quite modest.40 However, the summary plan description, statement of material modifications, and other ERISA requirements apply.41
With respect to fiduciary issues, both B and K plans may use the procedures for participant investment direction to obtain some measure of protection.42 2. IRS Review and Assistance
For K plans, employers have access to the IRS voluntary determination letter process to obtain confirmation of the qualification of the plan language, coverage, and benefits.43 The IRS also provides programs to assist employers in making corrections to plans with- out triggering disqualification and by paying a penalty.44 The IRS has an active audit program for K plans.45
There is no determination letter program for B plans; employers may apply for a National Office private ruling on its plan,46 which requires a more substantial application and a higher user fee.47 The IRS provides the Tax Sheltered Annuity Voluntary Correction Program to assist employers with correcting defects in their plans, with a penalty payment.48 The Department of Labor maintains the Delinquent Filer Voluntary Compliance Program to correct late filing or non-filing of Forms 5500 with a penalty.49 The IRS has recently emphasized audits of B plans.50
K plans are available to taxable employers, tax-exempt employers (other than state and local government units), and certain rural cooperatives and mutual irrigation or ditch companies.51
B plans are available to § 501(c)(3) organizations and state and local governmental units with respect to their educational employees.52 Special rules apply to sponsors that are (i) churches and church-related employers ("church organizations") and (ii) to schools, hospitals, home health service agencies, health and welfare service agencies, and church organizations ("SHHWC organizations").53 Church organizations 54 schools 55 hospitals ,56 and 57 home health service agencies are defined; health and welfare service agencies are not defined.
K plans are funded with trusts, group annuity contracts, and custodial accounts with mutual funds.58
B plans are funded with individual and group annuity contracts, custodial accounts solely with mutual funds, and, for churches and related organizations, retirement income accounts.59 There are some differences in the rules applicable to annuity contracts and to custodial accounts.60 Church retirement accounts need not be held by a trustee or custodian.61
5. Minimum Age and Service and Entry Requirements
K plans, within the eligible group of employees, may hold employees out of the non-salary reduction portion of the plan until they are age twenty-one and have a year of service.62 Alternatively, if the plan provides for 100% vesting on entry, the plan may require two years of service before a participant may be eligible for non-salary reduction contributions.63 Finally, if a school provides 100% vesting after a year of service, it may hold out employees from the non-salary reduction portion of the plan until age twenty-six and a year of service.64 However, the waiting period to make salary-reduction contributions is limited to one year.65 They must then be allowed to enter the plan within six months after qualifying.66
B plans have no comparable Code requirements, except that the waiting period for the salary reduction contribution portion of the plan must be the same for everyone.67 If a B plan is subject to ERISA, the same minimum age and service and entry requirements outlined for K plans will apply to the B plan under ERISA.68 6. Minimum Participation
All defined contribution plans, such as K and B plans, are excluded from the 50 employee/40% of all employees minimum participation requirements.69 7. Types of Contributions
B and K plans may receive salary reduction contributions, employee post-tax contributions, employer matching contributions, and other employer contributions.70 Salary reduction contributions may be extracted from salary, bonuses, and other taxable compensation not currently available to the employee.71 Participants may make changes in their rates of salary reduction contributions at
any time with respect to compensation not yet earned.72 Certain one-time elections are not treated as salary reduction contributions.73 No benefit, other than a matching contribution, may be conditioned upon the participant's salary reduction contributions to a K plan.74 Matching contributions in B plans may also be conditioned upon salary reduction contributions; however, B plans may condition employer non-matching contributions on the participant's salary reduction contributions.75 8. FICA and FUTA
Salary reduction contributions to both B and K plans are subject to FICA and FUTA taxes when made to the plan.76 Other employer contributions to B and K plans are exempt from FICA and FUTA taxes when made.77 All distributions from B and K plans are exempt from FICA and FUTA taxes.78
K plans have minimum vesting requirements.79 Salary reduction and post-tax contributions are 100% vested when made.80 However, matching contributions and other employer contributions must fully vest no later than at the end of five years or ratably over two to seven years (two to six years for top-heavy plans).81
B plans subject to ERISA are subject to the same vesting requirements (but not the top-heavy scale).82 However, B plans typically provide that all contributions are 100% vested when made.83 This results from the need to coordinate the 20% exclusion limit,84 which applies when the contribution vests, with the § 415(c) limit,85 which applies when the contribution is made.86
10. Nondiscrimination/Coverage - Control Groups
While the concept of not discriminating in favor of highly compensated employees is fundamental to much of § 401(a) and therefore to K plans,87 the nondiscrimination concept did not apply to B plans before the 1986 legislation.88 In the earlier period, B plans could be maintained for one executive, many executives, or all employees, and on different bases.89 For B plans sponsored by government units, the IRS suspended enforcement of the non-discrimination rules for government plans in 1977.90 The IRS extended the suspension for the purposes of § 401(k) and (m) until 1997 and for general purposes until 1999.91 The 1997 tax legislation has made the suspension permanent.92
The "employer" for both B and K plans is defined as the plan sponsor and other entities controlled by it or under its common control.93
11. Nondiscrimination/Coverage - Aggregation of Plans
All B and K plans of the same employer may be aggregated for testing purposes.94 However, special rules apply to plans covering collective bargaining units.95 12. Nondiscrimination /Coverage - Salary Reduction Contributions
(a) The salary reduction portion of a K plan generally must be available to a percentage of the employer's non-highly compensated employees ("NHCEs") that is at least 70% of the percentage of highly compensated employee ("HCEs") to whom the portion is available (the "ratio percentage test").~ There is an alternate average benefits test.97 Exclusions are provided for non-resident aliens, collectively bargained employees, and employees not meeting the minimum age and service requirements of the plan.98 For this purpose, the plan is available to an employee if the employee is eligible to elect to have his or her employer make a salary reduction contribution; it does not require that the employee has made the election.99 For this purpose, excluded employees are those in bargaining units, certain non-resident aliens, and employees not meeting the minimum eligibility requirements.
Additionally, salary reduction contributions must satisfy one of the actual deferral percentage ("ADP") tests:
ï the ratio of salary reduction contributions for HCEs to their compensation ("ADP") is not more than the same ratio for NHCEs multiplied by 1.25%, or
ï the excess of the ADP for HCEs over the ADP for NHCEs is not more than two percentage points and the ADP for HCEs is not more than the ADP for NHCEs multiplied by 200%. 100
JOPA has simplified the determination of HCEs; after 1996 they are (i) employees who own more than 5% of the employer, and (ii) employees with compensation from the employer in excess of $80,000 and who, at the employer's election, were in the top 20% of employees by compensation.101 Additionally, two safe harbors have been provided and NHCE data for the prior year may be used for the tests.102
(b) B plans must provide all employees an equal opportunity to make salary reduction contributions of more than $200 annually if the plan permits any employee to make such contributions.108 Exclusions are provided for non-resident aliens, collectively bargained employees, employees not meeting the age and service requirements of the plan, students performing services for a school in which they are enrolled, employees normally working less than twenty hours a week, employees who made a one-time election to participate on a pick-up basis in a government plan, certain professors on temporary service with another educational organization, and certain employees with a vow of poverty. 104 Units of the same employer (as defined in I.R.C. § 414(b), (c), (m), (o), etc.) historically treated as separate units may be tested separately unless they are in the same metropolitan area.105 No ADP testing is required.106 13. Nondiscrimination/Coverage - Matching Contributions andPost-tax Contributions
Under a K plan the participants eligible for the matching contribution and employee post-tax contribution portion of a K plan generally must satisfy the ratio percentage test.107 Additionally, the matching contribution and employee post-tax contribution portion must also satisfy one of the maximum contribution percentage ("ACP") tests under § 401(m):
ï the ratio of matching contributions and employee post-tax contributions for HCEs to their compensation ("ACP") does not exceed the same ratio for the NHCEs multiplied by 1.25%, or
ï the excess of the ACP for HCEs over the ACP for NHCEs is not greater than two percentage points and the ACP for HCEs is not greater than the ACP for NHCEs multiplied by 200%.108 However, the regulations limit multiple uses of the 2%/200% alternative limit under both the ADP and ACP tests.109
B plans, other than church plans, must satisfy the same tests with respect to matching and employee post-tax contributions.110 However, under a B plan, with no ADP test applying to the salary reduction contributions, the ACP test produces better results because it has full use of the 2%/200% alternative limitation.111 14. Nondiscrimination/Coverage - Employer "Profit-Sharing"Contributions
The participants actually receiving contributions to their accounts in the profit-sharing portion of a K plan generally must satisfy the "ratio percentage test."112 The allocation of such contributions must meet certain nondiscrimination requirements. For example, plans that allocate contributions based on the same percentage of compensation will satisfy one of the safe harbors.113 Other safe harbors are provided for formulas using age and service114 or taking into account Social Security benefits.115 Finally, the ratio percentage test can be satisfied on a rate grouping basis."6
The employer contribution portion of a B plan is subject to the same rules.117 However, pending issuance of regulations, the sponsor of a B "program" may satisfy these requirements by operating the program under a good faith, reasonable interpretation of these requirements, taking into account the legislative history of the 1986 and 1988 legislation, or by meeting one of the safe harbors in I.R.S.
Notice 89~23.118 The employer's B "program" consists of all B plans to which it makes contributions and the employer may elect to aggregate its § 401(a) and § 403(a) plans with the program under certain conditions.119 The I.R.S. Notice provides the following safe harbors:
Maximum disparity: (a) The highest percentage of compensation for a year contributed under the program for any HCE is not more than 180% of the lowest percentage of compensation contributed under the program for any NHCE, (b) at least 50% of the NHCEs are currently accruing benefits under the program, and (c) the percentage of employees currently accruing benefits under the program who are NHCEs is at least 70% of all NHCEs.120
Lesser disparity: (a) The highest percentage of compensation for a year contributed for any HCE under the program is not more than 140% of the lowest percentage of compensation contributed under the program for any NHCE, (b) at least 30% of the NHCEs are currently accruing benefits under the program, and (c) the percentage of employees currently accruing benefits under the program who are NHCEs is at least 50% of all NHCEs.121
No disparity: (a) The highest percentage of compensation for a year contributed for any HCE under the program is not higher than the lowest percentage of compensation contributed for any NHCE under the program, and (b) either (i) at least 20% of the NHCEs are currently accruing benefits under the program, and the percentage of employees currently accruing benefits under the program who are NHCEs is at least 70% of all NHCEs, or (ii) at least 80% of the NHCEs are currently accruing benefits under the program and the percentage of NHCEs in the program are at least 30% of all NHCES.122 15. Nondiscrimination - Penalties
Failure of a K plan to comply with the coverage and other nondiscrimination rules will result in loss of tax-free treatment for contributions and earnings of all HCEs in the K plan,123 while such failure under the B plan will trigger the loss of tax-free treatment for all participants in the B plan.124
The 10% excise tax on an employer maintaining a K plan that has excess salary reduction contributions125 does not apply to a B plan because the ADP test is inapplicable to B plans.126 Failure to withdraw excess from the K plan will adversely affect the qualified status of the K plan,127 but it will only affect the tax-free treatment of the offending B contract, not the entire B plan.128
The 10% excise tax on an employer maintaining a K plan that has excess matching and post-tax contributions, unless timely with- drawn with earnings,1~ also applies to such excess contributions in a B plan because § 401(m) applies to B plans.130 If they are not timely withdrawn, both the K plan and the B plan lose their tax- free treatment.131 16. Nondiscrimination - Other Rules
The $150,000 indexed compensation limit for K plans applies to B plans.132 The integration with Social Security rules for K plans applies to B plans.133 However, the top-heavy provisions (shorter vesting, minimum contributions and lower § 415 combined plan limits) applicable to K plans do not apply to B plans.134 17. Additional Limitations on Annual Contributions
There are additional limitations on the annual contributions to K and B plans. One limitation applies only to salary reduction contributions, but it takes into account all such contributions made by the individual to all B, K, and E plans and SEPs during the year.135 Two limitations apply to all annual contributions made for the employee by his employer during the year.136 The fourth limitation (§ 415(e)) applies in certain situations where an employer maintains both a defined benefit plan and a K or B plan.'37 The limitations are simply coordinated; the lowest controls.
(a) Salary reduction contribution limit (~ 402(g)). The annual contribution limit for both K and B plans is $9500 in 1997, and that number will increase for both types of plans with cost of living adjustments.188 This is a per-person limit, not a per-plan or per- employer limit; the limit applies to all contributions in the aggregate made for an individual under a K, B, E, or other deferral plan for the year.139 However, employees of SHHWC organizations140 may make "catch-up" contributions to a B plan in excess of $9500 annually. 141
(b) Overall defined contribution plan limit (~ 415(c)). The 25% of compensation/$30,000 limit on annual contributions applies to both K and B plans.142 The limit is on all contributions made to such plans by the same employer for the employee.143 The 25% limit is presently applied to compensation after the salary reduction contribution but, effective after 1997, the percentage limit will be applied to pre-salary reduction contributions.1~ Thus, in 1997 for an employee with compensation of $35,000, the maximum amount of all contributions is $7000 (.25 x $35,000I1.25), but after 1997 it will be $8750 (.25 x $35,000).
However, SHHWC organization employees are provided with three special catch-up elections for B plans:
(1) In the year of separation only, the employee may substitute his § 403(b) 20% exclusion allowance'~ for the 25% of compensation portion of the § 415(c) limit, taking into account only his last ten years of employment with the organization.'~
(2) The employee may replace the $80,000 portion of the § 415(c) limit with the least of (i) 25% of compensation plus $4000, (ii) his 20% exclusion allowance, and (iii) $15,000.147
(3) The employee may elect to have his 20% exclusion limit not apply.148~
A SHHWC election is made simply by making the excess contributions.'49 Once made, the employee may not subsequently make either of the other elections.150 Also, the "A" election may only be used once by an employee in his or her lifetime.151
Church employees are provided with special elections. Employees with incomes less than $17,000 may elect to make larger contributions than those permitted under the 20% exclusion allowance, and such contributions are deemed not to exceed the 25%/$30,000 limit.152 A church employee may elect to replace the 25% of compensation/$30,000 limit with $10,000, subject to a lifetime limit of $40,000 of such contributions and not in combination with the "A" election.153
Contributions in excess of the § 415(c) limits for a K plan are taxable to the employee and adversely affect its qualified status.'54 Excess contributions are taxable to the employee under a B plan; they do not affect its plan status; and in the case of a custody account (but not an annuity contract or a retirement income contract), they attract a 6% penalty tax.155
(c) Exclusion allowance (§ 403~)(2)). This limit applies only to B plans. The allowance is the excess of (i) 20% times the employee's "includible compensation" times his or her "years of service" over (ii) "excludible contributions" made by the employer in prior 156 years. The allowance applies to all salary reduction contributions and employer contributions made for the employee by the employer for the year. 157 Contributions to the B plan are taken into account when they become vested, not when paid to the plan. 158 The exclusion allowance has several important elements that are not common to K plans:
(1) "Years of service" means the employee's cumulative years of service with the employer through the close of the year for which the allowance is being determined.159 For full-time employees, years of service means the participant's years of employment, with one year of service being credited for the usual annual work period of individuals employed full-time in that general type of work.160~ For example, if the regular annual work period for a university professor is the fall and spring semesters, the professor has a year of service if he or she works full-time for both the spring and fall semesters in a calendar year. 161 Special rules apply to determine years of service for both part-time employees and full-time employees working a portion of the year.162 For example, if the professor works full-time only the spring semester in a given calendar year, he or she has one-half of a year of service; if the professor carried only a 50% load for that semester, he or she has one-quarter of a 161 year of service. However, an employee's years of service will never be less than one.164~ This concept is quite different from the year of service, based on 1000 hours of service in a twelve-month period, that is used in K plans for eligibility and vesting purposes.185
(2) "Includible compensation" is the employee's taxable compensation for the most recent year of service.166 Special rules apply to determine includable compensation for part-time employees and for full-time employees working a portion of the year.167 For example, if a full-time professor in his or her first calendar year (Year One) with the college works the fall semester, but only works the spring semester in the following year (Year Two), the professor has, for Year One, a year of service under the minimum one year rule and the includable compensation for Year One is the compensation earned for the fall semester.168~ For Year Two, the professor has one year of service (based on the fall and spring semesters) and the includible compensation for Year Two is the sum of the amounts earned for both semesters.169
Includible compensation is presently determined after reduction for the employee's salary contribution for the year, but effective after 1997, it will be determined before such contributions, and therefore is placed on the same basis as the § 415(c) limitation.170 Thus, for an employee with one year of service, current compensation of $35,000, and no previous contributions, the 1997 exclusion allowance is $5833 (.20 x $35,000/1.2), but after 1997 it will be $7000 (.20 x $35,000).171
(3) "Excludible contributions in prior years" means the total of all salary reduction and employer contributions made to the plan for the employee since the employee commenced employment.172 In addition, it includes the amounts contributed by the employer for the employee under another § 403(b) plan and a qualified plan that includes a defined benefit plan.173 The regulations provide procedures to determine the contributions made for an employee's defined benefit plan.174 There is no similar K plan concept.
Church employees with income of less than $17,000 may elect larger contributions.175
Contributions in excess of the exclusion allowance are currently taxable to the employee (and non-taxable when paid from the B plan).176 Excess contributions to a custodial account (but not an annuity contract or a retirement income account) also attract a 6% excise tax.177
Appendix C shows how the exclusion allowance is developed over a participant's career and compares it to the annual § 415(c) limit.
(d) Combined plan limit (§415(e)). If an employee participates in both a K plan and a defined benefit plan of his employer, the employee's benefits are subject to the combined plan limits.'78 However, an employee participating in both a B plan and a defined benefit plan of his employer will not be subject to the combined plan limit, except where the employee controls the employer maintaining the B plan, or the employee makes the "C" election.179 However, the combined plan limit is scheduled to expire at the end of 1999.180
(e) Combining the limits. As expected, for a salary reduction- only K or B plan, the maximum contribution is the lowest limit provided in this item. In the case of a K plan, the maximum contribution may be lower under the ADP test. For a plan with both salary reduction and employer contributions, (i) the salary reduction contributions are initially controlled by the § 402(g) $9500 limit and, in the case of a K plan by the ADP limit; (ii) the matching contributions and post-tax employee contributions are controlled initially by the ACP limit; and (iii) all contributions are subject to the § 415(c) limit, the exclusion allowance limit, and, until it expires, the § 415(e) combined plan limit.
Salary reduction contributions can be withdrawn from K and B plans only after age 591/2, death, disability or separation from service, or in the event of hardship (without earnings).181 K plans may permit in-service withdrawals of matching contributions and
other employer contributions as profit~sharing plans.182 Custodial account B plans may not make in-service withdrawals.'83 While annuity contract B plans are not subject to that limitation, typically they provide for distributions only on such events.184
The same rules for participant loans apply to both K and B ~plans.185
The sixty-day commencement of benefits rule applicable to a K plan186 is applicable to ERISA B plans.187 The rules requiring distributions to commence on the later of retirement or age 701/2 apply to both K and B plans.'80 The mandatory cash-out rule of accounts not exceeding $3500 ($5000 for plan years beginning after August 1997) applies to K plans and to ERISA B plans.189
The more favorable treatment of lump sum distributions under five-year averaging is not available to B plan participants.'~ However, at the end of 1999, this alternative is scheduled to expire for all K and other qualified plans.191
The rules for direct rollovers are parallel, but distributions from a K plan and a B plan can be combined only in an IRA. B plan distributions cannot be rolled over to a K plan (or other § 401(a) plan) or vice versa. 92 Sixty-day rollovers are subject to the same rules, and rollovers from an IRA to a B plan can only be made from an IRA having only B plan funds (and vice versa).193 The rules for trustee-to-trustee transfers are parallel, but do not permit transfers from a K plan to a B plan (and vice versa).194
Employees, such as educators, whose careers are likely to be with employers that maintain B plans, have benefitted from the account portability available to them by often continuing to have the new employer make contributions to the participant's account with his or her existing funding agent because B plans may have several funding agents, similar to plans that make contributions to IRAs.195 K plans generally have a relationship with a single trustee, insurance company, or mutual fund family that is not duplicated by the new employer. On termination of employment the participant's account is typically converted to cash and transferred to the participant's IRA sponsor or to the new K plan, neither of which may be maintained at the old K plan's funding agent. However, with the broad growth of mutual funds available to rollover IRAs, this may not be a substantial issue. Additionally, an individual moving from a tax-exempt employer to a taxable employer will have to rely on an IRA to pool accounts earned with previous employers.196
Unless the participant elects a life annuity, K plans are typically not subject to the qualified joint and survivor and spousal consent rules, because K plans are typically designated as "profit sharing plans."197 B plans are typically regarded as money purchase pension plans, and those subject to ERISA are subject to these rules as money purchase plans.198
Distributions from both K and B plans are taxable at ordinary income tax rates when received.199 Distributions are subject to mandatory 20% withholding unless an exception applies.200 The 10% early distribution penalty applies to both K and B plan early distributions.201 The excess distribution excise tax and excess accumulations estate tax addition, while applicable to both K and B
plans,202 were repealed effective in 1997.203 19. Anti-dilution
The anti-dilution rule on a merger or consolidation of a K plan applies to B plans subject to ERISA.204
20. Anti-alienation
The anti-alienation rules applicable to K plans are basically applicable to all B plans under a similar provision or under ERISA.205
D. An Evaluation for Section 501(c)(3) Organizations after JOPA
As indicated by the schedule in Appendix A, which is keyed to the Paragraph numbers in Part C, above, many technical provisions are substantially the same for both K and B plans. However, significant differences remain in the applicability of ERISA, the extent of reporting, the interplay in the contributions limits, testing requirements, and availability of safe havens for nondiscrimination purposes.
1. Salary Reduction-Only B Plans
A § 501(c)(3) organization may sponsor a salary reduction-only B plan and avoid all ERISA responsibilities, including disclosure, reporting, fiduciary, and bonding,206 as well as any ADP testing.207 Employees of SHHWC organizations can elect the "catchup" limit only in a B plan.208 This is a clear advantage of B plans. 2. Taxable Affiliates
To ease administration, a § 501(c)(3) organization with a taxable subsidiary that maintains a K plan may now freeze its B plan and extend the K plan to employees of the parent.209 The subsid
iary has had experience with K plan administration, including ADP and ACP testing. And, with JOPA's simplification of the "highly compensated employees" definition and the adoption of modifications in the ADP and ACP testing under JOPA, testing is less onerous.210 However, the parent may elect to continue with its B plan because of the B plan's advantages. 3. Other Situations
(a) An employer sponsoring a B plan subject to ERISA files an abbreviated Form 5500 Series annual report; it does not include financial and coverage information.211 Since the abbreviated Form 5500 relieves a B plan sponsor with more than 100 plan participants from answering certain questions relating to certified financials, the practice is that B plan sponsors do not obtain certified financials.212 And, the sponsor will have only an abbreviated summary report to distribute annually.213
(b) B plans will have no ADP testing for their salary reduction contributions.214 The requirement that such contributions in B plans be made available to all employees215 is not onerous. Finally, employees of SHHWC organizations have a "catch-up" election under which they may contribute more than $9500.216
(c) For those plans that provide for employer matching contributions, there is ACP testing under both K and B plans.217 While B plans have no ADP testing,218 this is only a modest gain for the
B plan, because much of the information required for ACP testing- employee compensation and identification of HCEs - is carriedover to the ADP test.219
(d) Now, let's turn to the interplay of the § 403(b) exclusion allowance and the § 415(c) limit, both applicable to all employer and employee contributions.
(i) Generally, the § 403(b) 20% exclusion allowance will allow
greater contributions than the § 415(c) 25%/$30,000 limit - with the result that the 25%/$30,000 limit will be the effective limit in both K plans and B plans. The 20% exclusion allowance permits a current contribution based on current compensation for prior years of service (a "catch-up" feature) and, of significance for higher paid participants, it has no dollar limit.220 The 25%/$30,000 limit is based on current compensation - albeit with a higher percentage - and has a dollar limit that impacts higher paid participants.221 In such cases, the interplay is neutral, and the plan sponsor will probably favor a B plan to be free of ADP testing,222 although the issue is closer if the plan will have matching contributions and thus require ACP testing.223
(ii) However, a SHHWC organization224 will favor a B plan because participants can use the "A" and "B" elections to increase the annual contribution above the regular 25%/$30,000 limit.225 Under the "B" election, a participant can substitute the least of (i) $4000 plus 25% of "includible compensation," (ii) the exclusion allowance, or (iii) $15,000 for the 25% portion of the 25%/$30,000 limit.226 But note that the $30,000 limit continues to apply.227 Thus, employees of these organizations have an opportunity for higher contributions than a K plan permits, without ADP testing.
(iii) Employees of church organizations have special benefits under B plans that are not available under K plans.228
(e) The non-discrimination safe harbors provided in Notice 89- 23 are easily understood and applied.229
Even with K plans now available to them, the B plan is likely to be the plan of choice by § 501(c)(3) organizations.
Appendices (These are images and therefore large files)
Appendix A - comparison of K and B Plan Features
Appendix B - Comparison of K Plan (with ADP and ACP limits) with B Plan (with ACP limits only)
Appendix C - Comparison of 415(c), 403 (b) and 402(b) Limits