Now it’s my turn, and today’s post is about complying with the 403(b) contribution limits. So let’s start with some background. One of the concerns that the IRS had in their audits over the last several years was cases in which the contribution limits were exceeded and corrections not being done.

Those contribution limits are governed by Section 402(g) of the Internal Revenue Code and are adjusted annually. For 2009:

• Elective deferrals are limited to the lesser of $16,500, or 100% of the participant’s includible compensation.
• Designated Roth contributions count toward the $16,500 402(g) limit.
• A catch-up contribution of $5,500 is available for participants age 50 and older.

In addition, there is a special life-time catch-up of $3,000 per year, not to exceed $15,000 for an employee of a qualified organization. If a plan participant is eligible for both types of catch-up contribution, then the special catch-up contribution limit is applied first to their accounts.

Sounds simple, doesn’t it, but it won’t be. The new regulations take the approach that the employer is generally responsible for compliance with the 402(g) limits and the correction of any excess that occur. This will be a big departure from the current 403(b) environment in which there is an individual relationship between the employee and the 403(b) investment provider.

Here’s two examples of potential problems for employers.

Monitoring Special Catch-Up Contributions. Pre-regulations, the employer could rely on the employee’s representations regarding his or her eligibility for and the amount of special catch-up contributions. It’s a complicated calculation based on the availability of extensive employee historical data. Many employers, I would think, would avoid this responsibility by not permitting the special catch-up.

Returning Excess Contributions. For those 403(b) plans in which there are individual contracts, the employer has no ability to direct the return of excess contributions. So what if the employee who must have contributions returns, simply doesn’t comply. That is, not notify the investment provider to return the excess funds. The answer, it would seem to me, would be for the employer to inform the provider who would then do the appropriate tax reporting to the IRS.

There are serious issues since the penalty for failure to comply with the contribution limits can be harsh – adverse tax consequences for both the employer and the employee.

The practical solution for those employers who decide not assume responsibility for this plan compliance is to do what 401(k) plan sponsors do - delegate the responsibility to a third party adviser or to the investment provider.

Coming Attractions: Bob will be back on Monday with with #3 in the 403(b) Crunch Time Series, Trouble in Terminating Tax Deferred Annuities.
 

During this series, I’ll be joined by Bob Toth as a guest blogger. Bob, a Partner in the Baker & Daniels law firm, has over 25 years experience advising 403(b) plans and service providers.

And since it all starts with the new plan document requirement, here’s Bob with his guest post, Avoiding Problems With 403(b) Custodial Accounts.

The 403(b) Custodial Agreement. You know, that piece of paper you use in a 403(b) implementation that no one ever reads or understands, and is just signed because the Tax Code requires it? Heck, they’ve been used for years by the 403(b) vendors, so they’ve got to be pretty standard by now. How can they cause my 403(b) plan ANY problems at all?

Well, they generally still won’t cause you any problems in plans funded individual 403(b) custodial accounts. The problems are arising when folks are trying to set up 403(b) plans on a “401(k)-like” investment platform using a “group” or “master” custodial arrangement. Here, the “forms” are anything but settled.

There are two common errors:

Using a 401(k) Trust Document. The first common error occurs when you try to take a standard 401(k) trust document, change the word “trust” to “custodian,” place some gratuitous 403(b) language in the document, and think you are done.

This is almost right. But you need to make sure that the rules under 403(b)1(B)-(E) are also included in the document and, if the custodial account is also going to hold an annuity contract, have language which defers to that group contract (including the fact that the custodian won’t control the assets in the contract).

It is probably best for the custodial account NOT to hold annuity contracts; though its OK for the employer to hold that group annuity contract outside of the custodial agreement. By the way, collective trusts (often referred to in these 401(k) trusts) can’t serve as the “cash” holding account for the plan unless its “registered” as a “registered investment company.”

Using an Individual Custodial Document as a Group Document. The second common error is the “jury-rigged” use of the individual custodial account form with some modifications to try to make it serve as a group contract. This actually can cause you serious problems. Those custodial contracts DO have the necessary language that you wont find in the 401(k) trust. The problem is that they have too much language.

The individual custodial document was designed to serve the purpose of a plan document/service agreement, so they often have much language you would never otherwise find in a group trust document. There will often be language related to loans, hardships, distributions and the like, so that they almost look like a “quasi” plan document. And that is what causes the problem.

Plans using a group custodial document almost invariably also have a separate plan document-usually from a different vendor than who wrote that custodial document. So you have dramatically increased the probability of inconsistent terms, which can disqualify the document. You no more want your custodian having to monitor plan compliance than you would want your 401(k) trustee having that monitoring duty.

Thanks, Bob. Look for #2 in our 403(b) Crunch Time Series on Thursday when I’ll be talking about Complying With Contribution Limits For 403(b) Plans. 

Crunch time is nothing new for 401(k) plans who have been dealing with compliance deadlines since the passage of the Employee Retirement Income Security Act of 1974 (ERISA). But it’s a first time challenge for 403(b) plans. The IRS has constructed this challenge by providing comprehensive guidance for 403(b) plans for the first time in over 40 years. 403(b) plans will now have to deal with such issues as:

• Requirement for a plan document
• Rigorous application of the non-discrimination rules
• Employer responsibility for complying with contribution limits
• Timing of contributions. 
• Transfers to other 403(b) contracts 
• Employer responsibility for coordinating and tracking loans
• Plan termination

So between now and year-end, I’m going to be posting a series of articles on how to get ready for the January 1, 2009 deadline. We’re calling them the 403(b) Crunch Time Series. I’ll be joined by Bob Toth as a guest blogger. Bob, a Partner in the Baker & Daniels law firm, has over 25 years experience advising 403(b) plans and service providers.

And since it all starts with a new plan document, Bob will kick off the series tomorrow with his guest post, Avoiding Problems with 403(b) Custodial Accounts.

Based on informal discussions with 403(b) providers.

It's something I've blogged about before, What's Old is New Again: Commuter Benefits Under Section 132 and The Next Generation of Tax Favored Commuter Benefits: Bicycle Commuting.

Under Section 132 of the Internal Revenue Code, employers can provide a program that allows employees to pay for commuter expenses, i.e., public transportation, parking, and now bicycle commuting on a tax-favored basis. Employers get a tax break since Social Security taxes are not imposed on the benefit - not available with 401(k) plans.

It's a benefit that continues to grow in popularity because of the economy and global warming. TransitCenter, a company specializing in commuter benefit programs, just released their 2008 Commuter Impact Survey that provides a number of key insights and implications regarding the impact of commuting on employers, employees, and strategies used to address these impacts. Here are the implications they found as a result of their survey:

The Survey indicates that employers are profoundly concerned about the impact that high fuel and commuting costs are having on their employees. Importantly, most employers see a need to help find viable solutions to soften this impact. Yet, while employers see raising salaries as a means of providing relief, they also cite concerns that they may not have the resources to do so in today’s economic climate.

Survey findings also show that commuter benefit programs, including flextime, telecommuting and tax-free commuter benefits, continue to be a viable solution for employers to help employees cope with high commuting expenses. In particular offering a tax-free commuter benefits program is viewed as having three key impacts: a highly relevant and cost-effective enhancement to a company’s overall benefits package; an effective way to attract and retain employees; and an easy solution to help reduce a company’s carbon footprint.

Factors that may prompt more companies to offer commuter benefits — and more employees to use them — include tax credits and increases to the IRS cap on monthly pretax salary deductions for commuter benefits.

 Here is a link to the full survey.

Hat tip to Kris Dunn and his HR Capitalist blog.

First, some additional background. Balance forward recordkeeping was the traditional method of accounting when only contributions were made by the employer and deposited once a year. As 401(k) features were added to existing profit sharing plans and daily valuation technology available to even the smaller plans, employers increased the valuation frequency, e.g., quarterly or monthly, or simply changed to a daily valuation system.

So it seems to me that the real issue is: Should daily valuation plans provide for interim valuations, and if so, how? And like all matters ERISA, there are both tax and fiduciary issues to consider. Here's Sungard Relius discussing, Interim Valuations: The Right Thing to Do?, in more detail.

So no easy answer here. But definitely one of those matter to discuss with ERISA counsel.

Balance forward is an industry term given to those defined contribution plans, e.g., 401(k) and profit sharing, in which participants’ accounts are valued monthly, quarterly or annually. And after all the accounting takes place, it can be 4-8 weeks after the valuation date before participants receive statements. Most defined contribution plans, however, value participants’ accounts daily right after the markets close.

And I hadn’t given much thought to them lately thinking they were an anachronism. But the topic came up a recent conference of pension people that I attended, and there’s more of them out there than I thought. My brief skimming of one of the Form 5500 databases indicated that there are at least 70,000 401(k) plan not counting the profit sharing plans that allow participants to self-direct their accounts.

So what’s the problem you might ask. My visual metaphor up top is the answer. Like chess, balance forward retirement plans are a zero-sum game. That’s what the economists and game theorists call a situation or interaction in which one participant’s gain results from another participant’s loss. And in the context of the recent huge swings in the stock market, balance forward plans are a bigger zero-sum game than ever before.

Here why? Assume a participant in a balance forward plan with a $50,000 account balance as of December 31. The participant receives a distribution for $50,000 on March 1. But between January 1 and the distribution date, the plan has lost 20%. Thus, the plan - which is to say - all the remaining participants eat the $10,000 loss.

But now let's assume that same participant receives the same $50,000 distribution. But instead of the plan suffering a market loss, it increased by 20%. Now all the remaining participants in the plan share in the $10,000 gain.

Now that's fair, isn't it?

Now here comes the next generation of tax-favored commuter benefits. Buried in the Emergency Economic Stabilization Act of 2008, a/k/a the "Bailout Bill", is a provision that allows employers to provide employees with a new tax-favored bicycle commuting reimbursement benefit.

Section 132(f) of the Internal Revenue Code was amended to allow employees starting January 1, 2009 to receive up to $20 per month tax-free for the reasonable expenses they incur during a calendar year for:

• The purchase of a bicycle and for bicycle improvements
• Repair and storage if the bicycle is regularly used for travel between the employee’s residence and place of employment

The bicycle commuter benefit is not available if the employee receives other Section 132 commuter benefits, i.e., transit or parking reimbursement.

Picture credit: Bike To Work, The Best Part of Your Day poster by daisy art studio of Seattle, Washington.

And here’s why the new administration should do more for “Joe The Plumber” and all the other small businesses than tax credits. They will be an important part of the changing nature of the American business landscape according to a recent research study by Intuit, the maker of QuickBooks, and the Institute for the Future, a non-profit research organization.

The study, the Intuit Future of Small Business Report, gives us a peek into our future, when it says that by 2017, small businesses will be formed and run by a new and more diverse group of entrepreneurs, with a new outlook based on the changing nature of the American business landscape. Here's a summary:

• The Changing Face of Small Business

Entrepreneurs in the next decade will be far more diverse than their predecessors in age, origin, and gender. These shifts in small business ownership will create new opportunities for many, and will change both the will become increasingly common and diverse, new forms of small and personal U.S. and the global economy.

A new breed of entrepreneurs will emerge. Entrepreneurs will no longer come predominantly from the middle of the age spectrum, but instead from the edges.People nearing retirement and their children just entering the job market will become the most entrepreneurial generation ever.

Entrepreneurship will reflect an upswing in the number of women. The glass ceiling that has limited women’s corporate career paths will send more women to the small business sector.

Immigrant entrepreneurs will help drive a new wave of globalization. U.S. immigration policy and the outcome of the current immigration debates will affect how this segment performs over the next decade.

• The Rise of Personal Businesses

Personal businesses—one person businesses with no employees—have become an important part of the U.S. economy and will increase in number over the next decade. The growth will be driven by shifts in larger company employment practices and changes in technology.

Contract workers and accidental and social entrepreneurs will fuel a proliferation of personal businesses. Economic, social, and technological change and an increased interest in flexible work schedules will produce a more independent workforce seeking a better work–life balance. 

 See?

• Requirement for a Plan Document. Both Non-ERISA and ERISA 403(b) plan sponsors must have a signed document in place by January 1, 2009.
• Non-Discrimination Rules. This requirement applies to both Non-ERISA and ERISA 403(b) plans.
• Contribution Limits. Plan sponsors will be responsible for the compliance of 403(b) contributions with the Internal Revenue Code including the correction of excess amount contributed.
• Timing of Contributions. Plan sponsors must deposit contributions to plan providers within a “reasonable period” of time.
• Transfers to Other 403(b) Contracts. New rules affect participants’ moving their assets to other 403(b) annuities or 403(b) custodial accounts.
• Plan Termination. The new rules permit 403(b) plan sponsors to terminate their plan and distribute the assets under specified conditions.

The IRS has constructed this "road" by providing comprehensive guidance for 403(b) plans for the first time in over 40 years. It doesn't have to be a Toll Road.

But taking Social Security sooner can also result in a reduction in benefits - for anyone - of approximately 25% if you're one of the Boomers. Here's a chart  published by the Women's Institute for a Secure Retirement (WISER) who also maintain a blog. The chart illustrates the percentage of reduction in benefits for those retiring at age 62 and the percentage increase in benefits for those working beyond full retirement age.

That is, if you can afford to do that.

Picture above, Waiting in Repose, by artist Dale Wicks.