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Executive and Deferred Compensation Options for Public School Employees. Presented by: Kristi Cook, JD for Kades-Margolis Corporation March 14, 2002. Why Enact Changes to Retirement Savings? . Congressional Recognition of Need for Additional Retirement Income Expect:

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Executive and Deferred Compensation Options for Public School Employees

Presented by:

Kristi Cook, JD


Kades-Margolis Corporation

March 14, 2002

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Why Enact Changes to Retirement Savings? School Employees

  • Congressional Recognition of Need for Additional Retirement Income

  • Expect:

    • Reduced Social Security benefits

    • Longer life expectancies

      • Compounded inflation rates diminish fixed benefits

    • Market fluctuations on investments

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Retirement Plan Changes School Employees

  • All individuals will be permitted to save more for their retirement

  • Easier calculations and contribution limits

  • Portability at retirement

  • Using pre-tax dollars to buy past service credit under PSERS

  • “Roth” type 403(b) contributions for estate planning and post retirement tax-free assets

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403(b) Plans Were Changed… School Employees

  • Easier contribution limits

  • Higher contribution limits

  • Contributions after retirement permitted

  • Coordination with 457 plans

  • Source for PSERS “buy back” dollars

  • Portability

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Higher Employee Deferral Limits School Employees

  • New 402(g) limit for employee salary reduction contributions will be $15,000

    • Effective in $1,000 increments

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Special Aged 50+ “Catch Up” School Employees

  • For any individual who is aged 50 or older during the calendar year, the deferral limit is increased by the following amounts:

  • Does NOT replace “15 Years of Service” catch up limit

    • Qualified individuals may use both “catch ups” in the same calendar year

  • Is not reduced by any other limit

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Review of New 403(b) School EmployeesDeferral Limits

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Employer Contribution Limits School Employees

  • MEA repealed after 2001

  • 415 limit applies to sum of employer and employee contributions

  • New 415(c) limit is lesser of 100% of compensation or $40,000

    • Thereafter automatically increase for cost of living increases in $1,000 increments (not $5,000)

  • $40,000 limit only applies if employer contributes to plan

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Special Note… School Employees

  • One definition of “includible compensation” for all 403(b) purposes

  • Very friendly definition of “compensation” for all 403(b) purposes

    • Compensation measured over most recent one-year period of service

      • Allows look backs

    • Excludes “termination pay” or other extraordinary compensation accrued over more than one year

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In 2002… School Employees

Employee contribution limit is $11,000

If aged 50+, deferral limit is increased by $1,000 to $12,000 total

If eligible for 15 years of service “catch up,” limit is increased by up to $3,000 for possible total of $15,000

Limit for employer and employee contributions is lesser of 100% of includible compensation or $40,000

In 2006…

Employee contribution limit is $15,000

If aged 50+, deferral limit is increased by $5,000 to $20,000 total

If eligible for 15 years of service “catch up,” limit is increased by up to $3,000 for possible total of $23,000

Limit for employer and employee contributions is lesser of 100% of includible compensation or $40,000

Review of 403(b) Limits

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457 Plans…More Deferral Opportunities School Employees

  • Because of changes under EGTRRA, 457 plans will become more attractive to school districts and other governmental employers

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What is a 457 Plan? School Employees

  • Considered “nonqualified deferred compensation” plan

    • NOT a “retirement” plan

  • Usually a payroll reduction but employer may contribute

  • No offsets against other plans

  • Salary reduction agreements are not effective until the 1st day of the month following the election to participate

  • Distribution timing restrictions

  • No 10% penalty for distributions before 59 ½

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New 457 Plan Limits School Employees

  • Total annual limit is same as deferral limit for 403(b) plans

    • $11,000 in 2002 increasing to $15,000 in 2006

    • Aged 50+ catch up

      • $1,000 in 2002 increasing to $5,000 in 2006

  • OR “Final 3 years” catch up equals 200% of normal limit

    • Cannot use in final year of service, only in last 3 full years before year of retirement

  • BUT, cannot use final 3 years of service “catch up” in same year as aged 50+ “catch up”

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Combined 403(b) and School Employees457(b) Limits

* In 457 plans,

cannot use

both “catch ups”

in same year

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Compliance Issues… School Employees

  • Some calculations are still necessary

    • 15 YOS catch up (in 403(b) plans) is still only available if employee has not averaged more than $5,000 per year in elective deferral contributions and has not previously used the full $15,000 limit

      • Contribution history

      • Service history

      • Available catch up dollars

  • Must still monitor deferrals and 415 dollar limit if employer contributes to plan

  • Must collect information on calendar year age

  • Includible compensation differences between 403(b) and 457 plans

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How to Install 457(b) Program School Employees

  • Employer must establish a “plan”

    • Need plan documentation to satisfy IRS requirements

    • Two Options

      • Employer adopts plan funded through trust, custodial account or annuity contract like a “traditional” retirement program, or

      • Investment products provide “document” through custodial accounts, annuities or contracts

        • Like current 403(b) relationships

    • Set up payroll process/procedure like 403(b) plans

      • Need separate tax reporting “slot”

      • FICA withholding issues

      • Will report 403(b) and 457(b) on W-2 as separate items

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How to Maximize Deferred Compensation School Employees

  • Multiple Plan Options

  • Employer may contribute to 403(b) and 457 plan for same employee

    • School district 457 plan is not subject to general eligibility requirements

    • Employer may contribute amounts into 457 or 403(b) plan for one, some or all employees

  • Employer may also contribute to other qualified plans in addition to 403(b) and 457 plans

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Multiple Plan Options School Employees

  • Multiple Plan Limits:

    • Separate 403(b) and 401(a) 415 limits

      • Employer contributions are not offset by contributions to other plan

        • Up to $40,000 in each plan!

    • PLUS 457(b) plan

      • Employer may fund all or any portion

        • $11,000 in 2002, $15,000 in 2006

      • Employee deferrals DO NOT offset 403(b) contributions

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New Employer Funding Opportunities… School Employees

  • Employers may make contributions into 403(b) plans for employees who have retired or otherwise severed their employment for a period of up to 5 years

    • No post employment contributions into 457(b), 401(k) or 401(a) plans

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How Much Can An Employer Contribute? School Employees

  • Up to 100% of final year’s “includible compensation,” capped at 415 dollar limit (currently $40,000)

    • In each of the 5 years following the year in which employee retired/terminated

    • Possible total of $200,000

      • Will increase as 415 dollar limit increases

  • Codifies previous private letter rulings

    • Effect is to increase annual limit from $15,000 to $40,000

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Possible Deferred School EmployeesCompensation Scenarios

  • Using 403(b) Plans…

    • Employer funds up to $40,000 per year

      • Employee may still contribute age 50+ catch up

    • Employer may fund $40,000 per year for up to 5 years after retirement

  • Add 457(b) plan…

    • Employer or Employer could fund up to deferral limitRESULT? For 2002 retiree, possible $253,000 For 2006 retiree, possible $265,000

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More possibilities School Employees

  • Using 457(f)

    • Unlimited dollar amounts, but all contributions are immediately taxed when they are no longer subject to a “substantial risk of forfeiture.”

      • NOT taxed when received

    • What is a substantial risk of forfeiture ?

      • Only “approved” risk is a fixed period of years

      • Perspective on attorneys vs. IRS

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Recommendations on Maximizing Deferred Income School Employees

  • Install 457(b) program to double deferral opportunities

    • Employees can defer up to $40,000 (in 2006) with no employer funding

  • Have employer make contributions into 403(b) accounts

    • Up to $40,000 per year while active employee

    • Employee could also contribute aged 50+ catch up amount

    • Employer or employee could also fund 457(b) plan

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Still More Deferred Compensation… School Employees

  • Employer should contribute to 403(b) plan for 5 years after retirement or severance

  • If more is needed, consider 457(f) with unlimited contributions

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Miscellaneous Changes School Employees

  • Past Service “Buy Backs” with 403(b)/457 Assets

    • School district employees could use 403(b) and 457 assets to buy past service credits under PSERS

  • Portability from all plans including 457(b) plans

  • “Roth” Type Contributions into 403(b) and 401(k) Plans, beginning in January 1, 2006

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Education Savings Programs School Employees

  • Education IRAs

    • Increased to $2,000/yr

    • May be used for K-12 expenses

  • 529 Tuition Savings Plans

    • After tax contributions deposited into “approved” 529 product

    • Proceeds are tax free if used for qualifying education expenses

    • Subject to 10% penalty if not used for education expenses

    • May change beneficiary to anyone within first cousin relationship to first named beneficiary

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Summary of New Opportunities School Employees

  • More opportunities for retirement savings

    • Compliance is easier for employers

    • More payroll issues

  • Post retirement funding of employer 403(b) contributions

  • Retirement planning is tax free benefit

    • Help will be needed to coordinate retirement options, portability issues and “Roth” viability

    • Integration of benefits with Social Security and state pension system

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Thank You School Employees

Any Questions?