Compliance August 19, 2021

IRS Updates Issue Snapshot Regarding 403(b) Universal Availability Requirements

The agency highlights a common error in applying the requirements and makes self-audit suggestions.

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In an updated Issue Snapshot on the IRS website, the agency notes that a 403(b) plan must satisfy the universal availability requirement with respect to elective deferrals.

All employees of the employer must be eligible to make elective deferrals if any employee has the right to do so, with certain limited exceptions. Certain part-time employees, for example, may be excluded from eligibility to make elective deferrals.

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As a reminder, the Issue Snapshot says certain employees may be excluded, including:

  • Employees who normally work less than 20 hours per week;
  • Students performing services described in Internal Revenue Code (IRC) Section 3121(b)(10);
  • Non-resident aliens described in IRC Section 410(b)(3)(C); and
  • Employees who are eligible to make elective deferrals under another 401(k), 403(b) or 457(b) plan sponsored by the same employer.

If any employee who falls under the exclusion for those working less than 20 hours per week or the student exclusion has the right to make elective deferrals, then no employee who falls under such exclusion may be prevented from making elective deferrals.

Unlike a plan that is subject to IRC Section 401(a), a 403(b) plan may not exclude employees based on a generic classification such as:

  • Part-time;
  • Temporary;
  • Seasonal;
  • Substitute teacher;
  • Adjunct professor; or
  • Collectively bargained employee.

However, if these employees fall under the “normally work less than 20 hours per week” criterion, then they may be excluded on that basis.

The IRS says a common error occurs when employees working less than full-time are automatically excluded from making elective deferrals to the 403(b) plan. A plan that wants to apply the statutory exclusion for part-time employment must determine eligibility for the 403(b) elective deferrals based on whether the employee is reasonably expected to normally work less than 20 hours per week and has actually never worked more than 1,000 hours in the applicable 12-month period.

The agency recommends that 403(b) plan sponsors review plan language for excluded employees, verify the plan provides an effective opportunity to participate for all non-excludible employees, and review whether the plan may be eligible for transition relief under IRS Notice 2018-95.

Notice 2018-95 provided transition relief from the “once-in-always-in” (OIAI) condition for excluding part-time employees from 403(b) plan eligibility under Section 1.403(b)-5(b)(4)(iii)(B) of the Treasury Regulations. Under the OIAI exclusion condition, for a 403(b) plan that excludes part-time employees from making elective deferrals, once an employee is eligible to make elective deferrals, the employee may not be excluded from making elective deferrals in any later exclusion year on the basis that the employee is a part-time employee.

The IRS offered a fresh-start opportunity to comply with the OIAI condition after the relief period ended. This timing can be taken into consideration when determining whether a plan has operated in compliance with the condition for the appropriate period.

Compliance August 18, 2021

Court Finds Board Approval Not Needed for Exec to Get SERP Benefits

Although it was a longstanding practice for the trustees of the Young Adult Institute to vote on executives’ entry into the plan, an appellate court found that practice went against the plain language of the plan document.

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An appellate court has ruled that the Young Adult Institute Inc. (YAI) and the trustees of its supplemental executive retirement plan (SERP) erred in denying an executive benefits under the plan.

A District Court had held that the trustees (referred to in court documents as “the board”) arbitrarily and capriciously denied the executive’s claim for benefits principally because its decision rested on an unreasonable interpretation of the SERP. The defendants argued on appeal that the District Court erred in declining to defer to the board’s interpretation of the SERP. However, citing prior case law, the 2nd U.S. Circuit Court of Appeals said where an administrator “imposes a standard not required by the plan’s provisions, or interprets the plan in a manner inconsistent with its plain words, its actions may well be found to be arbitrary and capricious.” It said that, for purposes of an Employee Retirement Income Security Act (ERISA) claim, it applies a federal common law of contract, informed both by general principles of contract law and by ERISA’s purposes as manifested in its specific provisions.

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According to the appellate court’s decision, the SERP’s “eligibility” provision provides:

“Each management employee who shall complete 15 years of service with [YAI] and whose compensation is not fully considered in the computation of federal Social Security benefits, shall be eligible to participate in the plan. Entry into the plan as a plan participant shall be on the July 1 coincident with or next following the employee’s compliance with the eligibility requirements.”

The 2nd Circuit notes that the board interpreted the phrase “eligible to participate” in this provision to mean that employees do not automatically become SERP participants upon satisfying the stated eligibility criteria, but that the SERP also requires employees to obtain board approval to participate. But the appellate court said this interpretation “imposed a standard not required by the [SERP’s] provisions” and was “inconsistent with [the SERP’s] plain words.” It added that the language of the SERP document “is mandatory.”

“Nowhere does the SERP purport to require board approval for an employee’s entry into the SERP or otherwise to give the board discretion to assess an employee’s entitlement to benefits based on criteria external to the SERP,” the court wrote in its decision.

The defendants also argued that the court should defer to their interpretation because the board had a longstanding practice of selecting and voting to approve participants in the SERP. But the appellate court said they failed to argue that was integrated into the SERP’s terms or that their practice introduced ambiguity into the meaning of the SERP—“arguments that at least one of our sister circuits has deemed appropriate in review of a top hat plan.”  

The court said that in the absence of such arguments, “we see no reason to disturb the SERP’s plain text based on extrinsic evidence of its meaning.”

Noting that the executive met the SERP’s eligibility requirements, and that the defendants do not dispute that she did, the 2nd Circuit affirmed the lower court’s decision.

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