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Tip of the Week: How Are Employers Using Employer 403(b) Contributions?

Editor’s Note: This is an occasional feature in the NTSA Advisor. It is drawn from The Source, a book that covers technical, compliance, administrative and marketing aspects of the 403(b) and 457(b) markets. More information about The Source is available here.

This is Part I of a two-part series.

There are many situations in which employers find the flexibility of employer 403(b) contributions to be beneficial.

Superintendent/Key Employee Plans. School districts are making employer contributions on behalf of the superintendent to recruit and/or retain that key individual. The “key” employee type of plan has also been used to recruit and retain others such as highly regarded professors in colleges and college football or basketball coaches. It is also common to see 401(a) plans used for this purpose by governmental or religious organizations when the 403(b) limit (with the combination of employer contributions and elective deferrals) is not sufficient to meet the benefit need. However, when the 403(b) limits are sufficient, most districts may prefer to use 403(b) plans since the 403(b) arrangement is generally already in place.

Recruitment of Hard to Find Teachers. In some areas of the country, there are teacher shortages, especially for math, science, bi-lingual and special education teachers. Where collective bargaining agreements do not prohibit, employer contributions to 403(b) plans can be used to attract those specialty teachers.

Insufficient State Pension Benefits. In some states, the pension provided to retiring educators is not enough to provide sufficient income for retirement. This is particularly true in states that have also “opted out” of Social Security. Employer contributions to 403(b) accounts for senior staff often provide incentive income to encourage these individuals to retire.

Reducing Unfunded Liabilities. Many districts are faced with large accrued liabilities for unused sick leave and vacation pay. School board members are aware that those unfunded liabilities will have to be paid at some point. However, those amounts are generally not budgeted or funded, leaving school districts at risk. For example, a large school district was faced with over $1.3 million in unused sick leave and vacation pay obligations due to an unanticipated number of retirees in one year. A solution would be to develop a strategy in which unused sick leave and vacation pay is capped with employer 403(b) contributions made to replace that portion of the accruals no longer permitted.

Example: School District has permitted 10 days of unused sick leave or vacation pay to
be carried over each year up to a maximum of 200 days which are then paid in compensation
at the time of retirement.

Change this to a new “plan” under which the District will permit the accrual of five days each year to a maximum of 100 days. For all affected employees, the District will make an employer contribution at the end of each year equivalent to a portion of the unused days that are no longer accrued.

Replacing Final Year Pay with Employer Contributions. Many districts have established policies under which terminating employees receive employer contributions in lieu of unused sick leave or vacation pay. In years before 2002, such employers generally made contributions only in the final year of service up to the contribution limits. However, after EGTRRA, the Code clearly permits employer contributions to 403(b) plans for up to five tax years after employees have retired or otherwise terminated their employment.

This provision is helpful when the amount of the entitlement exceeds the contribution limit applicable to the final year of service as covered in the next section.

Post-Employment Contributions to a 403(b) Plan. For years after 2001, EGTRRA amended IRC §403(b)(3) to include a provision that permits employers to make contributions for employees who have terminated their employment with the employer.

The amount of each year’s post-employment contribution is based on the employee’s includible compensation during the period that counts as the most recent one-year period of full time service, measured from the employee’s final date of service. Employers may contribute up to 100 percent of each employee’s includible compensation earned that period, subject to a maximum of the applicable dollar limit under Section 415(c) ($55,000 in 2018) per year for up to five  calendar years following the year in which the employee terminated employment. Both employers and employees benefit from this provision by extending the payouts over several tax years and budget years.

It is possible to design plans to satisfy the unique needs of each employer. For example, employees who retire with small amounts of accumulated sick and vacation days who are not receiving a substantial amount of final year pay can be excluded from the plan. For instance, the administrative language could provide that post retirement contributions will be made for all retiring employees who have accumulated more than $10,000 or more than 20 days of unused sick leave or vacation pay. Excluded employees receive a cash payout of their accumulated leave. No individual employee can be given an option on whether to receive compensation or a nonelective contributi