(b)lines Ask the Experts – 403(b) Treatment of Payment to Employee After Retirement

“The school has a contractual agreement to pay a former administrator who retired last year $15,000 in 2018. Is the payment considered to be ‘compensation’ for retirement plan purposes, and is the plan sponsor thus obligated to withhold elective deferrals from this amount (the administrator was making elective deferrals to a 403(b) plan) and make the plan’s matching contribution with respect to those deferrals? The employee is a highly compensated employee if that makes a difference.”

Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

Though the Experts have tackled this issue in the past, it is worth revisiting since plan sponsors are often confused as to what to do when such payments are made following termination of employment. The key to the treatment of the payment is the type of payment that it is and its timing. To address the first issue, if the type of pay is severance (i.e., payments to a former employee for NOT working) it is NOT compensation for purposes of a qualified retirement plan or a 403(b) plan. Thus, if the $15,000 in question here is severance, NO 403(b) salary deferrals would be withheld, and NO 403(b) matching contribution would be made, REGARDLESS of timing.

However, if the compensation is simply earnings that otherwise would have been paid to the employee had he/she continued employment, such as a back pay award or payment of unused sick/vacation/PTO, then the timing of the payment would generally determine whether the payment could be included as compensation for 403(b) plan purposes. If the amount is paid to the employee no later than the later of 2 ½ months following employment termination and the end of the limitation year (typically calendar year), then it is possible that such 403(b) deferrals could be made from such pay. In the case of your administrator’s $15,000, if this amount had been paid during the first 2 1/2 months of 2018 (if the plan’s limitation year is the calendar year), then it would be possible for 403(b) deferrals to be made. If not, then it is not possible for 403(b) deferrals to be made from this compensation.

Of course, whether 403(b) deferrals should be made from such a payment, as well as whether a matching contribution should be made, will be dependent on the plan document’s definition of compensation and whether it allows such deferrals post-termination at all (some do not). Is the category of pay which is represented by this $15,000 included in the plan document definition of compensation, or excluded?  If the payment is made within the required time period, the plan language will ultimately determine if non-severance pay such as this $15,000 is included for 403(b) plan purposes.

Note that it is irrelevant for this purpose whether the individual is a highly compensated employee, though any matching contribution would need to satisfy applicable nondiscrimination testing.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.