Many nonprofit organizations sponsor 403(b) plans. These plans have recently become heavily regulated by the IRS. Additionally, there has also been increased interest by the IRS in auditing these plans. Here are four of the most common (and costly) 403(b) mistakes our office tends to see:
- Failure to Apply the 403(b) Universal Availability Rules. There are two parts to satisfying this rule for 403(b) plans. First, does your plan allow all eligible employees to participate? We recently had a client that thought a 403(b) plan could exclude collectively bargained employees. While this was true before the advent of the new 403(b) regulations, it is no longer true. In general, collectively bargained employees must be offered the opportunity to make salary deferrals under the 403(b) arrangement.
The other part of universal availability includes some type of annual notice to employees. The reason I say “some type” is because although most employers use a written notice, there are other ways to notify employees of the existence of the 403(b) plan and their ability to participate in the plan. In general, this notice requirement makes the nonprofit employer give their employees the annual opportunity to learn how to enroll in the plan, to make a change to their deferral elections, or to make/change a deferral into their 403(b) plan. Later blogs will examine the enormous penalties the IRS regularly collects when it discovers that an organization fails to give this annual notice.
- Depositing Employee Deferrals. The next most important thing to check – because the IRS will most certainly look for it – is the requirement to make a timely deposit of employee salary deferrals. In other words, once money is withheld from your employee’s paycheck, the funds must be promptly deposited into the employee’s investment vehicle. What constitutes “prompt deposit”? The IRS puts it this way: “Contributions to section 403(b) plans must be transferred to… the entity holding assets… within the period that is not longer than is reasonable for the proper administration of the plan.”
So the employer must make every effort to transfer the salary deferrals into the financial products designated by the participants at the time the payroll check is cut. There are guidelines for taking more time beyond when the payroll check is cut, but the employer proceeds at his or her own risk when making deposits more than a few days beyond when the check is issued.
- Is it the Employee’s Money or the Employer’s Money? Many employees (and nonprofit employers) are sympathetic to an employee’s argument that it is his or her money that the employee has deferred into the 403(b) plan and therefore the employee should be able to access his or her own money at any time. Unfortunately, this is not the IRS’s view of how 403(b) plans work. There are limited ways to access funds from the plan while still working. The ways to do this may include loans, hardship distributions or certain distributions upon attainment of age 59 ½. However, even if a current employee is able to access funds because of hardship, for example, there are specific rules dictating who can get a hardship distribution, and if the plan document does not provide for hardships, the IRS would view it as a major violation to distribute funds to a current employee.
The word to the wise here is to check your plan documents. If the plan document does not provide for a loan or a hardship or a distribution at age 59 ½, then the plan cannot make such a distribution unless it’s amended.