Section 403(b) plans operate much like their cousins, 401(k) plans. But, there are some key differences.
In December the IRS issued Notice 2018-95. The Notice provides very specific and targeted relief for retirement plans under Code Section 403(b). Specifically, the Notice provides relief to 403(b) sponsors who failed to properly administer certain 403(b) eligibility rules. However, equally valuable to 403(b) sponsors, is the clarification contained in the Notice on how these eligibility rules are supposed to be administered.
Section 403(b) plans operate much like their cousins, 401(k) plans. But, there are some key differences. One such key difference is the fact that 403(b) plans are not required to pass the Actual Deferral Percentage (or ADP test), which limits deferrals by highly compensated employees (“HCEs”) based on the deferral rate of non-highly compensated employees (“NHCEs”). However, in exempting 403(b) plans from the ADP test Congress imposed a “universal availability” requirement on 403(b) plans. Under universal availability, virtually all employees must be given the opportunity to defer into 403(b) plans, so the exclusions available to 401(k) plans (such as employees who have not met minimum service requirements or collectively bargained employees) cannot be utilized by 403(b) plans.
There is one major exception to universal availability: employers can exclude certain part-time employees. Here’s where things start getting tricky-the part time exclusion is identified as applicable to an employee who “normally works fewer than 20 hours per week” but is not actually based on employees’ regular work schedule. As detailed in Notice 2018-95 employees can be excluded under this part-time rule if, and only if:
(i) During the employee’s initial year of employment, the employee can be excluded from deferring into the 403(b) plan if the employer “reasonably” expects the employee to work fewer than 1,000 hours of service;
(ii) After the employee’s initial year of employment, the employee can continue to be excluded from deferrals if the employee in fact works fewer than 1,000 hours in the prior year; and
(iii) Once the employee does complete 1,000 hours of service in a year, the employee cannot be excluded using this part-time exclusion, even if the employee’s annual hours drops below 1,000 hours (the once-In-always-in or OIAI rule).
Notice 2018-95: Relief Granted
Notice 2018 has only one purpose: to grant relief for employers who inadvertently failed the OIAI rule by “re-excluding” employees who
• completed 1,000 hours of service in a year, and
• whose hours dropped below 1,000/year and were excluded from future deferrals as a result of that decrease in hours.
What Else Does Notice 2018-95 Teach Us?
Although the purpose of Notice 2018-95 is to grant the relief described above, there are a number of other key takeaways for 403(b) plan sponsors:
• Regularly scheduled hours are irrelevant; total hours are the name of the game. Although the part-time exclusion is identified as affecting employees who “normally work” fewer than 20 hours per week, Notice 2018-95 (and the 403(b) regulations) only measure whether the employee is expected to (or does) complete 1,000 hours of service in a year. Accordingly, employees on a 6-month contract for 35 hours/week can be excluded from a 403(b) plan under the part-time rule. After all, such an employee is “reasonably expected” to work fewer than 1,000 hours over the next year (35 hours*26 weeks + 0 hours*26 weeks=810 hours).
And, if the employee does indeed work fewer than 1,000 hours of service in year, the part-time exclusion remains available with respect to this employee.
• These rules apply to deferrals and only deferrals. Some employers are under the mistaken impression that the inability to exclude part-time employees affects their entire 403(b) program (including matching and employer contributions). However, Notice 2018-95 provides a clear reminder that these rules apply only to the right to make employee deferrals. So, subject to general plan coverage requirements (under Code section 410(b)), an employer can exclude entire classes of employees from receiving employer contributions, as long as these employees can make 403(b) deferrals. For example, many colleges and universities will gladly allow adjunct faculty to defer into the 403(b) plan, as long as these employees can be excluded from matching or employer contributions.
• Acceptable ways to reintroduce minimum employment requirements. There are ways that 403(b) sponsors can “reintroduce” minimum employment requirements. For example, an employer can include a provision in a 403(b) plan specifying that the employer contribution for a year will be allocated only to employees who meet certain criteria–such as a requirement that the employee must be employed on the last day of the plan year or must complete 1,000 hours of service in the year. Making eligibility for an annual employer contribution contingent on one of these employment requirements is not the same as excluding the employee from the plan.
An employer seeking to apply such a condition needs to assess the administrative, employee relations and compliance implications of imposing the condition. But, imposing such conditions in order to receive the employer contribution can prove to be a helpful strategy for employers facing budget constraints.
Notice 2018-95 offers welcome relief to 403(b) sponsors who have run afoul of certain nuances in the 403(b) rules. It also offers a reminder of other potentially helpful planning opportunities to all 403(b) sponsors.