In Practice July 1, 2014

Using 403(b) Employer Contributions as Compensation

Advisers who serve school districts can add value by sitting down with employees to make sure they appreciate the benefits they receive through a 403(b) plan.
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Public K-12 school systems that offer 403(b) plans have an extra tool for solving certain reward and budget issues. As their 403(b)s are not subject to the Employee Retirement Income Security Act (ERISA) and not subject to nondiscrimination testing for employer contributions, they have an opportunity to solve a number of problems using employer contributions as compensation, according to Ellie Lowder of TSA Consulting and Training Services in Tucson, Arizona. Non-electing churches and qualified church-controlled organizations (QCCOs) can use employer contributions in similar ways as well, she told attendees of the National Tax-Sheltered Savings Association’s (NTSA’s) 2014 403(b) Summit.

Lowder said advisers can add value to the school districts they serve by offering to personally sit down with employees to make sure they appreciate the benefits the school district is offering and make sure they manage the savings properly. In addition, an adviser can reach out to a school district looking for a superintendent to talk to the district about challenges in attracting or hiring a supervisor. For example, the tax-paying public may have a problem with offering a high salary, so an adviser can tell the district it can sweeten the pot for an incoming superintendent by making employer contributions to the 403(b).

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For public schools, employer contributions may be used to recruit hard-to-find teachers, enhance compensation for superintendents, reduce unfunded liabilities for unused leave pay, and retain the most experienced teachers (who usually are at the top of the salary schedule). By making contributions to 403(b)s rather than increasing salaries, they avoid payroll taxes and, in most states, Social Security and FICA taxes.

Lowder said she is seeing some districts attracting math and science teachers from other districts by telling them, “If you come work for us, we’ll make a contribution to your 403(b) account.” Similarly, 403(b) employer contributions are also being used to attract teachers to inner city schools for which it is hard to recruit teachers. To retain teachers, districts may promise an employer contribution for every year a teacher stays. This is especially helpful if a teacher has reached the top of a district’s pay scale and is no longer getting a bump in salary.

Some school districts may have a policy where teachers may accumulate unused leave pay—for example, 10 days a year up to 200 days—to be paid when the teacher leaves employment. Many districts find it’s a liability they cannot pay, so they negotiate with the teacher’s union an alternate benefit—instead of paying a lump sum from which taxes will be taken, they may reduce accumulated leave pay to five days per year up to 100 days, and make up the remainder with 403(b) contributions.

Considerations for Using Employer Contributions as a Reward

Lowder said if union members are impacted by employer-contributions-as-compensation offerings, school districts must first discuss the offerings with the union. They should also check state and local laws, but most states will permit employer contributions.

Employer contribution provisions must be added to a district’s plan document, or the appropriate option must be checked in the plan adoption agreement. Lowder noted the plan document language is general, permitting employer contributions, but language specific to the employee and the reward agreement will be in a separate administrative policy adopted by the school board. She suggested school districts make the reward discretionary so they are not locked in. If 403(b) employer contributions are part of a superintendent’s benefit, provisions should be put in, or added to, the superintendent’s employment contract.

Although there is no nondiscrimination testing required for employer contributions, they still cannot exceed annual statutory limits, so these rewards should be coordinated among plan providers or third-party administrators to ensure limits are adhered to.

Lowder reminded attendees that Internal Revenue Code Section 403(b)(3) says includable compensation can be counted for up to five full years following the year of severance of service, meaning a district can make employer contributions for up to five years following a teacher’s severance. She said the most common utilizations of post-employment contributions are to replace the payment of unused sick pay, to incent early retirement (sometimes used to save budget dollars by eliminating higher salaries and fringe benefits for teachers who take the incentive), and to buy out the contract of a departing superintendent (the district will save money on the lump-sum pay, and the superintendent will benefit because the lump sum could put him or her in a higher income tax bracket).

Lowder noted employees receiving post-employment contributions must establish a 403(b) account while still employed—no cash option can be given to the employee or group of employees receiving post-employment contributions—and benefit accruals will cease in the month of a recipient employee’s death.

The Markets July 1, 2014

Increasing Participation in 403(b) Plans

With some exceptions, sponsors of 403(b) retirement plans, especially school systems, have problems getting employees to participate in the plans.
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According to Stephen R. Banks, co-founder of TSA Consulting Group in Tucson, Arizona, only around 30% of eligible employees are participating in 403(b)s sponsored by school systems. Banks told attendees of the 2014 National Tax-Sheltered Savings Association (NTSA) 403(b) Summit one reason employees do not participate in 403(b) plans is the employer is not engaged.

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He suggests advisers meet with school administrators and superintendents to educate them about what they need to do to make the plan successful. “If you’re successful in getting them engaged, all at stake will rise with that tide,” he said.

Tom Hendershot, founder of Hendershot Financial Group, added that 403(b) plan sponsors need to know why it is important for their plans to be successful, and why it is important to supplement defined benefit (DB) plans. He said he’s seen that if educators have a solid financial plan, they have better attitudes and are better educators. “If you can help participants retire, the retiring party is happier, and the school system budget is not as stressed,” he stated.

The next step is to get participants engaged, according to Banks. He noted that vWise and iJoin are two companies that use technology to allow employees to take action easily. iJoin uses phones, tablets or laptops in employee meetings so employees can take action to join the plan or request to be contacted by someone. vWise presents employees with information online in short snippets, allowing them opportunities to take action regarding their retirement savings along the way.

Shorter communications are important for getting employees’ attention, said Teresa Ward, who is responsible for OppenheimerFunds’ 403(b), IRA and small business retirement programs in New York, as our attention spans have become shorter with the availability of quick access to information. However, Hendershot noted technology can be used to engage employees, but they need help once plan sponsors get their attention.

Hendershot suggested plan sponsors or advisers ask participants how much of their last year’s income they would like to have annually in retirement—the answer will probably be 100% or more. Then sponsors or advisers should ask them how their current retirement planning efforts are doing in making that goal a reality. “This moves them,” he said.

Ward said other things that may move employees to save for retirement are peer pressure (see "Peer Pressure Could Help Raise Deferral Rates") and seeing an image of themselves in old age. She cited a study that found people who saw age-enhanced images of themselves were more likely to save more for retirement compared to those who weren’t exposed to their future selves.

“We want to tell plan sponsors we have the silver bullet for increasing participation, but there isn’t one, because if we had one, increasing participation wouldn’t be such a hot topic,” Ward concluded.

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