The long-awaited final 415 regulations were released by the Treasury Department on April 4, 2007. Code section 415 contains the limitations on the amounts of contributions that can be made to most retirement plans. This article highlights some of the changes applicable to defined contribution plans, with a special emphasis on 403(b) plans.
Post-severance compensation
The final rules clarify when elective deferrals (salary reduction contributions) and employer contributions can be based on compensation that is received after severance of employment.
Generally, contributions to a retirement plan can only be made from compensation received prior to severance of employment; however, the final Code section 415 regulations provide for certain exceptions to the “prior to termination” requirement:
- Unless the plan provides otherwise, compensation can include “regular” compensation paid by the later of 2½ months after severance of employment or the last day of the limitation year (generally the calendar year) in which the employee terminated. Regular compensation means compensation the participant would have received (salary, commissions, overtime, shift-differential, bonuses, etc.) if the participant’s employment had continued. The regulations clarify that severance pay and other “non-regular” compensation, such as payments of nonqualified deferred compensation plans made because of the severance of employment, cannot be counted as post-severance compensation.
- If provided for under the terms of the plan, compensation can include payments for unused accrued sick leave, vacation pay or other leave that is paid by the later of 2½ months after severance of employment or the last day of the limitation year in which the employee terminated, if the employee could have used the leave if employment had continued.
- If provided for under the terms of the plan, compensation can include payments for nonqualified deferred compensation plans that are paid by the later of 2½ months after severance of employment or the last day of the limitation year in which the employee terminated the employee, as long as the payments would have been received at the same time if employment had continued.
- A plan can count compensation (salary continuation) paid to former employees who are in the United States military or are permanently and totally disabled as defined by the Internal Revenue Code, regardless of whether such compensation is received after severance of employment and without the 2½ month limitation.
Although the proposed regulations modified the regulations for Code section 403(b) plans by including these post-severance compensation rules, the final 415 regulations do not include these provisions for 403(b) plans. The preamble to the final Code section 415 regulations indicates that these provisions will be incorporated into the Code section 403(b) regulations when they are finalized.
Special rules for 403(b) church plans
These regulations clarify how the special increased limitation rule for church plans under Code section 415(c)(7) is applied. Under this rule, annual contributions to a section 403(b) plan for an employee of a church or church-related employer (such as a seminary, church-related college, church-related hospital, etc.) are treated as not exceeding the contribution limitation of section 415(c) if the contributions for the year do not exceed $10,000, regardless of the employee’s compensation. For instance, if an employee has no taxable compensation because of minister’s housing allowance, his employer still may be able to contribute $10,000 for the employee. However, there is a lifetime limit of $40,000 that applies to the employee for purposes of this rule. Importantly, these regulations clarify that the $40,000 cumulative total only applies to amounts that are in excess the employee’s general section 415 limit.
The regulations also reflect a special rule for church employees performing services outside the United States (foreign missionaries). Under this special rule for foreign missionaries, contributions to a section 403(b) plan for any year are not treated as exceeding the limitations of section 415(c) if the contribution does not exceed $3,000 (but only if the individual’s adjusted gross income does not exceed $17,000 — applied separately and without regard to community property laws). The interaction between the generally applicable church employee rule discussed above and the rule for church employees performing services outside the United States has been clarified. It is now clear that if a foreign missionary is using the special rule described above, only $7,000 a year is applied toward the $40,000 lifetime cap. In other words, $10,000 can be contributed for a foreign missionary for five years, and then $8,000 for one year, before the foreign missionary reaches the $40,000 lifetime cap and begins contributing only $3,000 a year.
Illustration for foreign missionary
| Year |
Total Contributions |
Amount applied to $40,000
lifetime cap |
Accumulated $40,000
lifetime cap |
|
1 |
$10,000 |
$7,000 |
$7,000 |
|
2 |
$10,000 |
$7,000 |
$14,000 |
|
3 |
$10,000 |
$7,000 |
$21,000 |
|
4 |
$10,000 |
$7,000 |
$28,000 |
|
5 |
$10,000 |
$7,000 |
$35,000 |
|
6 |
$8,000 |
$5,000 |
$40,000 |
Learn more about contribution limits.
Correction of excesses
As expected, the final regulations remove the correction methods provided for since 1981 in the section 415 regulations. Instead, the preamble to the regulations directs plan sponsors to use the Employee Plans Compliance Resolution System (EPCRS) program for correction of excess contributions. The IRS is considering further guidance on this issue. Until then, the corrective methods available under the 1981 regulations can be used for EPCRS correction, but only if all the rules of EPCRS are satisfied.
Learn more about EPCRS in GuideStone’s 403(b)(9) Self-Audit Manual (pdf).
Aggregation for 403(b) plans
These regulations clarify a special aggregation rule that applies to Code section 403(b) plans, other plans of the employer and plans of related employers. Generally, a section 403(b) plan is not aggregated with qualified plans that are maintained by the participant’s employer or with 403(b) plans of other employers because the section 403(b) annuity contract is considered to be maintained by the participant and not the employer for purposes of section 415. However, if a participant with a 403(b) plan is in control (i.e., owns a significant portion) of any employer for a limitation year, the section 403(b) plan must be aggregated with all other defined contribution plans maintained by the participant controlled employer. In addition, it appears that 403(b) plans of other employers may need to be aggregated as well in the case where a participant is in control of an employer. Accordingly, the employer that contributes to the section 403(b) plan must obtain information from participants regarding employers controlled by those participants and plans maintained by those controlled employers (and possibly other 403(b) plans) to monitor compliance with applicable limitations. GuideStone can help with this because GuideStone’s contribution limit calculation services request information from participants regarding employers for which the participant owns a controlling interest.
The general information in this publication is not intended to be nor should it be treated as tax, legal, or accounting advice. Additional issues could exist that would affect the tax treatment of a specific transaction and, therefore, taxpayers should seek advice from an independent tax advisor based on their particular circumstances before acting on any information presented. This information is not intended to be nor can it be used by any taxpayer for the purpose of avoiding tax penalties.
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