Helping 403(b) Clients Understand Universal Availability Rules

A common category of errors found by the IRS, 403(b) plans need to understand all provisions of the universal availability rules.

Failure to comply with universal availability (UA) rules is still one of the most common errors the Internal Revenue Service (IRS) finds in examinations of 403(b) retirement plans.

In a webcast, Bob CreMeens, senior program analyst in the Office of Employee Plans and national 403/457 coordinator for the IRS, noted that the agency completed two compliance projects—one for K-12 public school 403(b) plans and one for higher education 403(b) plans—that found some plan sponsors were excluding employees based on classifications versus hours worked, not keeping track of hours, excluding from the plan employees that they are not allowed to exclude, failing to notify employees of the eligibility to participate in the plan, and/or not operating the plan according to the plan language.

The K-12 project found many schools excluded substitute and part-time teachers, janitors and bus drivers, and some allowed excludable employees that worked less than 20 hours a week to participate in the plan. Nearly one-fourth failed to demonstrate they had corrected errors in an IRS follow up, CreMeens said.

The higher education project found 40% of the 327 colleges and universities had one or more UA issues. Larger entities showed more compliance. The area with largest issues in compliance was communication of the effective opportunity to participate. CreMeens said small and medium-sized institutions, especially, need more communication.

The UA rule provides that if an employer permits one employee to defer salary into a 403(b) plan, the employer must extend this offer to all employees of the organization, with a few exceptions. Reese Scripture, senior Internal Revenue agent in the Office of Employee Plans and Great Lakes area 403/457 coordinator for the IRS also noted that eligible employees must be notified of and given an effective opportunity to participate in the plan at least once per year. “Employees must have a real chance each year to make deferrals,” she said. “There are lots of opportunities to do this, such as upon hire and during the annual benefits enrollment period. Employees must be given enough time to make a decision.”

NEXT: Who can and cannot be excluded

Scripture explained that 403(b) plans are subject to nondiscrimination rules to make sure plan does not favor one employee group over another; they must comply with statutory contribution limits and average contribution percentage (ACP) testing for employer contributions. Employee Retirement Income Security Act (ERISA) Section 403(b)(12) non-discrimination rules introduces universal availability, which applies to public schools and tax-exempt organizations, but not churches. She said since 403(b)s are not subject to actual deferral percentage (ADP) testing, UA shows nondiscrimination.

Scripture told webcast attendees the 403(b) written plan document must contain material terms and conditions for eligibility. It must clearly state who may elect to make salary deferrals and who is excluded.

According to final 403(b) regulations, excludable employees include:

  • Employees who are eligible to defer to a governmental 457(b) plan; 
  • Employees eligible to defer to a 401(k) or another 403(b) plan of the employer; 
  • Employees who are nonresident aliens with no U.S. earned income;
  • Employees who are students performing services described in section 3121(b)(10); and
  • Employees who normally work fewer than 20 hours per week.

Scripture explained that for employees who work less than 20 hours a week, for the first plan year, the plan sponsor must reasonably expect the employee will work less than 1,000 in 12-month period beginning with employment. After the initial plan year, the plan sponsor must keep track of hours to see if the employee worked less than 1,000 year. She noted that if an employee in this group becomes eligible to defer, he or she remains eligible from then on, regardless of hours worked.

403(b)s can no longer exclude:

  • Employees who make a one-time election to participate in a governmental plan instead of a section 403(b) plan;
  • Union employees;
  • Visiting professors for up to one year under certain circumstances; and
  • Employees affiliated with a religious order who have taken a vow of poverty.

However, plans can exclude individuals who have taken a vow of poverty if their compensation is not treated as wages for purposes of income tax withholding, and visiting professors who continue to receive compensation (and salary deferral opportunity) from their home university.

Scripture said if any employee in an excludable group is allowed to make salary deferrals into the plan, then all employees of that group must be allowed to defer. In addition, she noted that UA applies to each entity in a controlled group.

NEXT: Avoiding UA errors

Mary Lou Bailey-Funk, senior Internal Revenue agent in the Office of Employee Plans and Gulf States 403/457 coordinator for the IRS, said 403(b) plan sponsors should review regularly whether they are complying with universal availability rules and should make sure they keep track of hours worked for each employee.

Failure to comply with UA rules could cause the plan to lose favorable tax status, and the plan would no longer be treated as a 403(b) but as a 457(f) compensation arrangement.

She said for employees for which hours of service are difficult to determine—adjunct professors, substitute teachers, nurses who work on an on-call basis—some method must be put in place to determine hours worked. Any reasonable method applied to similarly placed employees is acceptable and it must be documented.

She also noted that a common error is to exclude these employees, as well as bus drivers and janitors, because they are not eligible for other benefits. If 403(b) plans exclude part-time, temporary or seasonable employees, the plan document must include language to include hours of service worked. “Employees cannot be excluded on classification alone,” Bailey-Funk said.

She also said mandatory deferrals do not count as elective deferrals for purposes of UA rules.

CreMeens noted that item 4 of the IRS’ 403(b) Plan Fix-It Guide includes useful information about UA.

NEXT: Fixing UA errors

If a 403(b) plan is chosen for examination by the IRS, it can expect the agency to review the plan document, employee handbook, employee orientation materials and company websites. In addition, Bailey-Funk said, the IRS will review procedures and internal controls and analyze excluded groups for only those permitted.

The agency will first send a document request to the plan sponsor, and may also request interviews with human resources, employee benefits and payroll staff; a census of plan employees; payroll information, to include position descriptions and job classification; and W-2 information. The IRS will also review communications to see if eligible employees were given a meaningful opportunity to defer at least once per year.

Most UA errors can be corrected through the IRS’ Employee Plans Compliance Resolution System (EPCRS), Bailey-Funk said. “The plan sponsor must restore the participant’s lost opportunity, and the missed deferral is deemed to be the greater of 3% or the maximum deferral matched 100% by the plan sponsor.”

She noted that when the pre-approved 403(b) plan documents become available, plan sponsors will be allowed a remedial amendment period to correct for operations that have not complied to the plan document.

However, she said, if the old plan excluded employees who work less than 20 hours a week, but the new plan allows all to defer, and the plan operates under the old rules, this is an operational error that cannot be retroactively fixed, and probably will not apply to the remedial amendment period under new pre-approved plan program. In this case, the plan sponsor must make missed opportunity contributions to employees and receive a closing agreement with the IRS.           

If the situation is the other way around, the operation of plan was more generous than what the new plan document provides, so the IRS would allow corrections during the remedial amendment period, she said.

Bailey-Funk told webcast attendees that guidance about the remedial amendment period will be coming soon.

More information about 403(b) plan rules is available on the IRS’ website.