IRS Updates Info on Correction of Excess Deferrals in 457(b) Plans

The IRS has updated the information on its website concerning correction of excess deferrals under Code Section 457(b). 

Specifically, in the Issue Snapshot the IRS discusses correction of excess deferrals under a 457(b) plan maintained by a tax-exempt entity and a government.

Annual Limitations on Annual Deferrals

A 457(b) plan must provide that annual deferrals can't exceed the lesser of the applicable dollar amount in effect for the participant’s taxable year or 100% of includible compensation. The applicable dollar amount equals $15,000, as adjusted for cost-of-living increases under Code Section 415(d). For 2020, the applicable dollar amount equals $19,500.

The basic annual limit may be increased by amounts available under the special 457 catch-up or the age 50 catch-up. 

The age 50 catch-up applies to governmental 457(b) plans, but not tax exempt 457(b) plans. The age 50 catch-up equals the lesser of: 

1. the applicable dollar amount as defined in Code Section 414(v)(2); or 
2. the excess of the participant's compensation under Code Section 415(c)(3) for the year over any other elective deferrals of the participant for such year that are made without regard to Code Section 414(v). 

For purposes of governmental 457(b) plans, the applicable dollar amount equals $5,000 as adjusted for cost-of-living increases. For 2020, the applicable dollar limitation for catch-up contributions to a governmental 457(b) plan for individuals age 50 or over equals $6,500. Under a governmental 457(b) plan that permits contributions under the age 50 catch-up and the special 457 catch-up, the catch-up that yields the larger amount applies.

Excess Deferrals

Excess deferrals made to an eligible deferred compensation plan may result in the plan losing its eligible status under Section 457(b) unless the excess deferrals are corrected in a timely fashion. 

All excess deferrals are includible in gross income in the taxable year of the excess deferral. An eligible plan may be written to provide that an excess deferral that results solely from a failure to comply with the individual limitation for a taxable year may be distributed to the participant, with allocable net income, as soon as administratively practicable after the plan determines that the amount is an excess deferral. Such a distribution of excess deferrals will not cause a plan to fail to comply with Code Section 457(b). When excess deferrals caused by application of the individual limitation aren’t distributed, a plan will still maintain eligible status; however, the participant must include the excess deferrals in income. 

Corrections

The requirements for timely correction of deferrals are different for an eligible 457(b) plan maintained by a non-governmental tax-exempt organization and one maintained by a governmental entity. 

Annual deferrals in excess of the plan limitation that are made to a tax-exempt 457(b) plan must be corrected by April 15 of the taxable year following the close of the taxable year of the excess. If the plan distributes the excess deferrals, plus allocable earnings by April 15, the plan will continue to be treated as an eligible plan. If the plan deferrals aren't corrected by such a distribution, the plan will be considered ineligible under Code Section 457(f). 

In a governmental 457(b) plan, excess deferrals arising from application of the plan limitation must be distributed, along with allocable net income, as soon as administratively practicable after the plan determines there is an excess deferral. Failure to correct the excess deferral as soon as administratively practicable causes the plan to become ineligible and benefits under the plan are taxable as Treas. Reg. §1.457-11 requires. 

Audit Tips

The IRS offers tips to help 457(b) plans and their sponsors and administrators stay in compliance: 

• Review the Box 12 of the Form W-2 to determine if deferrals exceed the Section 457(b) dollar limit in effect for the year. Verify if these excess amounts were due to allowable catch-up contributions. Annual deferrals made to eligible 457(b) plans are reported in Box 12 using Codes G and EE (Roth contributions).
• Request documentation to verify timely distribution of excess deferrals.
• Review Forms W-2 and 1099-R for proper reporting of distributions.