There are two kinds of post-employment contributions that can be made to a 403(b) plan—post-employment nonelective (employer) contributions and post-employment employee elective deferrals. There are different rules for each type of contribution, so we will cover each one separately here.
Advantages of a Post-Employment 403(b) Employer Contribution Plan Through WEA Member Benefits
No FICA or other payroll taxes on contributions.
Contribution schedule is flexible for up to five years.
Plan design flexibility.
WEA Member Benefits experience working with employer nonelective programs.
No FICA tax on contributions.
All 403(b) contributions are tax-deferred (reduce potential of moving into higher tax bracket).
Maintains personal income tax control—can withdraw money now or later.
Low fees and no surrender charges with WEA Member Benefits 403(b) program—we allow complete flexibility on withdrawals or transfers.
Post-employment 403(b) employer contributions
Setting up post-employment 403(b) employer contributions gives school districts flexibility in delivering retirement benefits and creativity in designing retirement incentives. Existing employer benefits such as early retirement stipends, accumulated sick and vacation pay, and other cash outs of unused benefits can be redesigned to fund a 403(b) account with employer contributions. Making post-employment 403(b) employer contributions is a smart option for deferring taxes on retirement benefits over an extended period of time (up to five years).
All public school employees are eligible. In fact, many of these expanded benefit rules are unique to 403(b) plans. Once adopted, all employees covered under the agreement must be included.
Here’s how it works
Example: A school district has 20 teachers retiring in the same year. In total, the district’s unused sick leave and vacation pay liability for the retiring teachers is $220,000. The impact on the district is a large budget burden in a single year plus FICA taxes payable on the amount of the liability. The impact on the employees is that the entire payment is taxable as ordinary income, and each employee will pay FICA taxes on the payment.
Post-employment 403(b) employer contributions can be the solution. Just amend the employment contract to direct unused leave into the 403(b) on behalf of the retiring employees over a five-year period. The result is this:
- The employer saves $11,000 in FICA taxes.
- The employer can spread the district’s large budget burden over five years, easing the budget strain.
- The employee saves 7.65% in FICA taxes on the amount due him or her.
- The employee gets to defer taxes on an otherwise taxable benefit, and potentially avoid a higher marginal tax bracket.
Here’s what you need to know
- A collective bargaining agreement, negotiated employment contract, employee handbook, or resolution of a governing board must be in place prior to nonelective contributions being made.
- Each employee can receive up to the lesser of 100% of the employee’s final year’s compensation or $53,000 (for 2015) each year for five years (limits can change each year).
- As in the past, employers can also make nonelective contributions during an employee’s final year of service, if a six-year payout is desired; the year of retirement contribution would be limited to $53,000 (for 2015) less any employee elective contributions (excluding age 50 catch-up contributions) in his or her last calendar year of employment.
- When selecting groups of employees to receive these contributions, the employer cannot discriminate on the basis of age, race, or gender.
- The employee must not have the option to take the contributions as cash or in any other form of payment.
- The participant is immediately 100% vested and has full access as contributions are made to his or her account (check individual account for surrender fees); all of these post-employment contributions are tax deferred until withdrawn voluntarily or as required by IRS required minimum distribution rules beginning at age 70½.
A public school teacher has an employment agreement that states the school district will contribute 10% of compensation per year for five years starting after the year in which the teacher retires. The plan provides that if the teacher dies during the first five years after the year of retirement, a contribution is made that is equal to the lesser of:
- The excess of the individual’s includible compensation for that year over the contributions previously made for the individual for that year; or
- The total contributions that would have been made on the individual’s behalf thereafter if he or she had survived to the end of the five-year period.
The teacher retires in March 2015 and has annual includible compensation for the period from March 1, 2014, through February 28, 2015 (the most recent one year of service), of $60,000 or $5,000 monthly. A $500 contribution is made for the teacher in January 2016 (10% of monthly includible compensation of $5,000). The teacher dies in February 2016. The school district makes a contribution for the teacher for February equal to $9,500 (the teacher’s monthly includible compensation for January and February reduced by $500).
The school district need not make any further post-employment nonelective contributions for this teacher, as no contributions may be made on behalf of a deceased participant.
Post-Employment Elective Deferrals
Post-employment elective deferrals should not be confused with nonelective (employer) post-employment contributions. Post-employment elective deferrals are employee deferrals that are based on amounts that represent pay an employee would have received, or leave that could have been taken, were he or she still employed (such as sick/vacation leave and back pay), but with some limits. In order for an employee to defer post-employment compensation, the regulations require that:
- The post-employment elective deferral must represent pay that employees would have received, or leave that could have been taken, if they had continued to work.
- The agreement to defer must be initiated prior to compensation being paid or made available.
- Post-employment elective deferrals must be made by the later of 2½ months following employment from employment or the end of the year in which the employment occurs.
- The total amount of elective deferrals for the calendar year (normal payroll deferrals plus post-employment deferral) cannot exceed the annual maximum limit (as indexed for inflation).
- Elective deferrals are always subject to FICA tax, which must be deducted from these amounts before deferring into the plan.
- An employee should complete a Salary Reduction Agreement to indicate the amount to be deposited to the 403(b) account as a post-employment elective contribution.
Let’s apply the above to the following example
Assume a teacher will retire on May 31, 2015, with six months of accumulated sick and vacation leave that will be paid to him or her. Pay for the most recent period ending on the close of the employee’s tax year is $40,000. The school district’s sick leave policy provides that $8,000 will be paid in cash to the employee, and the balance will be made as a nonelective contribution to the 403(b) plan for five years, up to the IRS limits.
The employee may elect by May 31, 2014, to make an elective deferral contribution of all or part of the $8,000 cash payment based on the accumulated sick and vacation leave received by the later of 2½ months following employment from employment or the end of the year in which employment occurs, subject to the IRS elective deferral limits.
The IRS points out if an individual left employment on November 30, 2014, they would have 2½ months after November 30, 2014, or February 15, 2015, to receive these funds and make a deferral from them. In 2015, they would pick up an entirely new elective deferral limit not to exceed $24,000—these limits are indexed each year, so you will need to adjust for years after 2015. With proper planning, an employee would be able to optimize the ability to continue tax deferral of those funds into the following year when they pick up a brand new limit. It’s important to remember that these elective deferrals are only for:
- Regular pay paid after one terminates employment;
- Accumulated sick pay; and/or
- Accumulated vacation pay.
To learn more about post-employment 403(b) plan contributions, contact a WEA Member Benefits retirement consultant at 1-800-279-4030.
This brochure is for informational purposes only and not intended to be legal or tax advice. Consult your tax advisor or attorney before taking any action.
TSA 2936-280-0415 (W)