a brave new world…
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March 10, 2005 Kades Margolis Corporation
A Brave New World…
How Proposed 403(b) Regulations May Affect Public Schools in
Pennsylvania
By Kades-Margolis Corporation
March 10, 2005 Kades Margolis Corporation
Proposed 403(b) Regulations
Over 200 pages of material Cannot cover everything in this presentation Highlights of changes affecting employers Not effective until later of January 1, 2006
or issuance of final regulations MAY NOT rely upon these proposed
regulations until finalized Translate that into “do not panic…yet”
March 10, 2005 Kades Margolis Corporation
Biggest Changes to 403(b) Plans
Written plan documentation requirement for all plans
Control and Responsibility shifted to Employers Changes to Rules Governing Employees’ Rights
to Move Accounts Unlikely that “severance payments” or
accumulated leave payments may be used as source of elective deferrals for employee contributions
March 10, 2005 Kades Margolis Corporation
Plan Document Requirements
What Must the Document Include? Document must contain provisions explaining:
Eligibility Benefits Contribution limits, The designation of products available in the plan, The time and form of benefit distributions, and A statement satisfying the universal eligibility requirements
Possibility: “wrap around” document incorporating underlying annuity contract/custodial accounts
March 10, 2005 Kades Margolis Corporation
At Employer’s Discretion… Plan May Include Optional Features
Hardship withdrawals Loans Acceptance of rollovers In service withdrawals Whether plan will permit “exchange” to
products approved within the plan And, whether plan to plan transfers are
permitted or accepted
March 10, 2005 Kades Margolis Corporation
Key Concepts to Understand IRS treating the §403(b) program as an employer plan
with all control at the employer level Plan document will determine all terms of the plan
NOT underlying contracts and custodial accounts Plan may prohibit loans and withdrawals even if underlying
contracts permit such transactions May restrict transfers to/from accounts
If conflicts in underlying custodial accounts and annuity contracts, the plan document must resolve inconsistencies
Will restrict access to employees Only products specifically named in plan document may contact or
service employees
March 10, 2005 Kades Margolis Corporation
Implications of Document Requirement
Each employer will be responsible for document How?
Board resolution authorizing adoption of plan– And naming of employee or “office” with authority for
support and maintenance of program
– Otherwise, have to go to board for every change and modification
March 10, 2005 Kades Margolis Corporation
Implications of Document Requirement
Employer is responsible for maintenance and support of plan Amendments for law or tax changes Adhering to terms of document
Potential CBA issues on access to employees and approved products
March 10, 2005 Kades Margolis Corporation
Possible Sources of Documents
Private vendors Like me! Other attorneys or consultants
Product providers Like Kades-Margolis Corporation Other product providers But be careful of using plan document that limits products
to one vendor Will offer “free” document for restrictions on access to employees Scheme to market other products/services to employees
– Often “noncompetitive” products or services
March 10, 2005 Kades Margolis Corporation
Reminder…Rules NOT in Effect Yet!
Time to reflect and consider options Can comment directly to IRS or through
associations (PASBO or ASBO) Address is:
CC:PA:LDP:PR (REG-155608-02)Room 5203Internal Revenue ServiceP. O. Box 7604, Ben Franklin StationWashington, D. C. 20044
Start researching options for plan document support
March 10, 2005 Kades Margolis Corporation
New Transfer Restrictions…
Repeals existing rules that permit employees to “transfer” their accounts to any provider of their choosing
Can only transfer to products “authorized” under the employer’s plan
Proposed regulations impose an “active employment” requirement on transfers
Restricts transfers to “exchanges” between approved products under the current employer’s plan, or
Plan to plan transfers from former employer’s plan to current employer’s plan
No transfers “outside” of the plan No transfers for “retirees,”however, rollovers permitted
March 10, 2005 Kades Margolis Corporation
New Transfer Rules
Employer’s plan would have to permit transfers Transfers are optional feature of plan
But plans must permit rollovers However, no rollover unless there is a
distributable event first! Employer would have to confirm “distributable
event” before rollover permitted
March 10, 2005 Kades Margolis Corporation
Implications on Employers?
New employees may not be able to continue their relationship with their vendors New superintendent? Union and negotiations on employee rights
Plan will have to be amended to add or delete vendors
Much more employer involvement Acknowledging that product is approved under the plan
or advising vendor that transfer may not be made because transferee is not authorized under the plan
March 10, 2005 Kades Margolis Corporation
Severance Pay Change
Regs appear to restrict the use of severance pay or accumulated leave payments as a source of employee deferrals Salary reduction contributions can only be made by
“former” employee if the affected payroll period begins before employment is severed
Severance pay, in general, is not based on a payroll period beginning before severance from service
Note: IRS promises separate guidance dealing with post severance elective deferrals from all types of deferral plans
March 10, 2005 Kades Margolis Corporation
Other Changes Under the Regulations
Investment Restrictions on 403(b)s Limited to Annuity Contracts and 403(b)(7)
Custodial Accounts Life Insurance contracts issued after *February
14, 2005 are not considered to be “annuity contracts”
– NOT permitted
*Effective date problematic since regulations cannot be relied upon until 2006 or finalization!
March 10, 2005 Kades Margolis Corporation
More Changes
Clarifications to “universal eligibility” requirements 20 hour per week exception has been expanded
to include 1,000 hours per year standard Employees must get written notice of eligibility
to participate at least annually and have “reasonable opportunity” to make deferral elections at least once per year
Violations result in plan failure
March 10, 2005 Kades Margolis Corporation
Frozen and Terminated Plans
Employers may “freeze” plans, not allowing future contributions
Employers may terminate §403(b) plans and make distributions from the terminated plans without violating the restrictions on early distributions If the employer follows the requirements Difficult to do unless plan uses group contracts or trust
because of mandatory distribution requirement
March 10, 2005 Kades Margolis Corporation
Impact of Plan Termination Proposals
Plan document would have to allow distributions upon plan termination.
Contracts and custodial accounts will have to be amended to permit distributions upon plan termination
Consideration will have to be given to who controls the assets of “terminated” plans
Will contracts be distributed upon request of employer? Must employees consent to distributions?
What about outstanding loans and the 10% early distribution penalty if there is a cash distribution?
March 10, 2005 Kades Margolis Corporation
Timing Requirements for Deposits of Employee Contributions
Requires that salary reduction contributions be remitted to the vendor “as soon as administratively possible” Based on facts and circumstances Suggests standard of no later than 15 business
days in the month following reduction of salary May require changes to employer’s procedures
March 10, 2005 Kades Margolis Corporation
Other Issues Related to Retirement Plans
New Cost of Living Limits for 2005 PA Dept. of Rev. PIT 04-018 Revocation of IRS Approval for 401(a)
“special pay” plans Possible PA legislation changing state
taxation of benefit programs WFTRA redefines “dependent” for tax
purposes
March 10, 2005 Kades Margolis Corporation
Cost of Living Changes for 2005
Employee deferrals - $14,000 For 403(b) and 457(b) Limits are NOT combined if employee
participates in both types of plans
Age 50+ catch up – additional $4,000 415(c) limit - $42,000
Total limit to 403(b) for employer and employee contributions during the year
March 10, 2005 Kades Margolis Corporation
PIT 04-018
PA Dept. of Revenue responded to request from school district
Employer contributions of accumulated leave were contributed into a 401(a) plan
Question was whether or not those contributions were included as taxable income for PA state purposes Facts as presented “doomed” the response
March 10, 2005 Kades Margolis Corporation
PIT 04-018 con’t…
Ruling held that such contributions were includable as income for PA income tax purposes Otherwise paid as cash (in the past) Plan not an “eligible retirement plan” under PA rules
Employees could take the contribution out immediately Not a lifetime payment
My opinion? Ruling applies to all types of “special pay”
contributions into any type of retirement program
March 10, 2005 Kades Margolis Corporation
Repeal of IRS Approval for “Special Pay” 401(a) Plans
IRS sent letter to every “known” employer using an approved “special pay” plan Said IRS approval was revoked for years after 2004
unless plan satisfied several requirements, including: Requirement that employees participate before final year of
service Requirement that plan must make regular and ongoing
contributions for participants Requirement that amending plan alone is not sufficient; such
changes must be acted upon– No form over substance
March 10, 2005 Kades Margolis Corporation
What to Do if You Have a 401(a) Special Pay Plan?
Choice of actions Amend plan to conform to all requirements
Requires ongoing contributions for all participants New IRS filing of amended plan Funding and contract issues to consider
Terminate 401(a) plan and use 403(b) plan for “special pay” contributions
IRS letter does not affect 403(b) plans Special rules in 403(b) plans designed to accommodate
“special” employer contributions
March 10, 2005 Kades Margolis Corporation
Governor’s Veto
Gov. Rendell vetoed a bill that would have followed the federal rules of constructive receipt for purposes of applying PA income tax rules to nonqualified deferred compensation
Expected to be reintroduced in 2005 Formerly House Bill 176 Cited as costing PA $220 million annually
March 10, 2005 Kades Margolis Corporation
WFTRA Changes to “Dependents”
Working Families Tax Relief Act created a “uniform” definition of “dependent” for tax purposes
Dependent is now either a “qualifying child” or a “qualifying relative”
Created unintended problems with employee benefits
March 10, 2005 Kades Margolis Corporation
Dependents…
“Qualifying Child” bears a specified relationship with taxpayer lives with taxpayer for at least ½ of the year is less than 19 years of age (or 24 if full time
student) or is permanently disabled, and provides less than ½ of own support
Prior law had no age or residence requirement for qualifying children
March 10, 2005 Kades Margolis Corporation
Dependents…
“Qualifying relative” must bear a specified relationship with the taxpayer must live with the taxpayer and be a member of the taxpayer’s
household must have gross income of less than $3,200 (in 2005) must receive over ½ of support from taxpayer, and must not be a “qualifying child” of any other taxpayer
The change precludes any person with income in excess of $3,200 from being a dependent
March 10, 2005 Kades Margolis Corporation
Problems? Heath insurance often provides coverage to persons that
will not qualify as”dependents” under new rules Students over age 23 or Domestic partners
Special exception for healthcare IRS Notice 2004-79 eliminates the income limitation on “qualifying
relative” for healthcare purposes only
Hardship withdrawals, tuition reimbursement programs, dependent care programs, etc. all affected by new definitions
Impact on Employers? Must impute income to employee for any benefit received by an individual who is not a “dependent”
March 10, 2005 Kades Margolis Corporation
Thank You
Questions….if time permits?
March 10, 2005 Kades Margolis Corporation
M Kristi Cook
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March 10, 2005 Kades Margolis Corporation
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