Are You Ready for an IRS Audit of Your 457(b) Plan?

1. Are You Ready for an IRS Audit of Your 457(b) Plan? PenServ Plan Services, 2014

2. Today’s Agenda • General Characteristics of the Governmental 457(b) Plans • Top 10 Problems found by IRS in Audits • Specific Requirements for municipal 457 plans in the State of NJ • Your Questions

3. Section 457(b) Plans • Characteristics • Employee participation is voluntary, maximum deferral, lesser of 100 % of “includible” compensation or $17,500 for 2014 • Available to states, political subdivisions of states, (cities, counties, public school districts, etc.) and certain tax exempt organizations

4. Section 457(b) Plans Characteristics IRS requires that there must be a “plan document”. For governmental 457 plans, assets required to be held in trust (generally effective after 1998) for the exclusive benefit of participants/beneficiaries. Therefore must have a “bank” as trustee or custodian of assets or an issuer (insurance company)

5. Section 457(b) Plans • Characteristics • Deferrals are subject to FICA and FUTA when services are performed. Deferrals are subject to income taxes at the point of distribution. • Advantage - There is no 10% premature distribution tax on any distributions from a 457(b) governmental Plan.

6. Section 457(b) Plans Characteristics Since 2004 governmental 457(b) plans are permitted to invest in group trusts. IRS provided model amendments for use by plans to add group trusts as an investment also in 2004

7. Section 457(b) Plans • Characteristics • "Catch-up" contribution rule applies to 3 years immediately preceding the employee's normal retirement age which permits a potential deferral up to 2 X the normal deferral limit for the 3 year period. • Distributions permitted prior to separation from service in the event the employee incurs an "unforeseeable emergency“.

8. Section 457(b) Plans • Characteristics • Rollovers into IRAs and other employer plans are permitted for distributions from gov’t 457(b)s made after 2001. • Does not result in active participation status for IRA deduction purposes.

9. Section 457(b) Plans Disadvantages Favorable tax treatment is not available as is for a Qualified Plan, such as a 401(k) No Prototype available, however, IRS issued some sample model language during 2004 and will approve under a Private Letter Ruling…but cost is $19,000 to the IRS for their approval.

10. QDROs(Qualified Domestic Relations Orders) • QDRO rules apply to 457(b) plans for years after 2001. • Court order must still be followed for years prior to 2002 (referred to as a PDRO). • Taxation: Beginning in 2002, taxation rules work like a QP or a 403(b)

11. Section 402(g) Elective Deferrals • Includes deferrals made to the following Plans: • - 401(k) • - 403(b) • - Salary Reduction SEP (SARSEP) • - SIMPLE Plans

12. Section 402(g) Elective Deferrals 402(g) Limit Per Taxpayer Per Calendar Year for 2014 Regular Deferral = $17,500 Plus Age 50 Catch-up = $5,500

13. 457(b) Plan Deferrals • Not 402(g) Elective Deferrals • Pre-2002 Coordination Rule Repealed. The maximum deferral of $17,500 for 2014 can be made in addition to other 402(g) Deferrals.

14. 457(b) Plan Deferrals 457(b) Elective Deferrals include: 1. Employee Pre-tax deferrals 2. Employer Matching 3. Employer Nonelective Definition added by final regulations

15. 457(b) Plan Deferrals Example 1: John participates in a 403(b) program. For 2014 he defers $17,500 into the 403(b) plan. He can defer an additional $17,500 into a 457(b) plan.

16. 457(b) Plan Deferrals Example 2: John is going to retire in 2014. For 2011 he defers $16,500 into his 403(b), he may (assuming the limits work to his advantage) defer an additional $33,000 to his 457(b) plan.

17. 457(b) Allowable BenefitPayments 1. Attainment of Age 70½ 2. Separation from Service 3. Incurs an "Unforeseeable Emergency” Unforeseeable Emergency means a severe financial hardship to the participant resulting from sudden and unexpected illness or accident to the participant or to a dependent. Also includes loss of participant's property due to casualty.

18. 457(b) Allowable Benefit Payments • Emergency distributions may not be made if relief is available through insurance, other reimbursement; liquidation of the participant's other assets or ceasing deferrals to 457 plan. • Independent Contractors may only qualify for "retirement" payments when service contract ends. • Plan Termination (added under final regulations)

19. Minimum Required Distributions From 457 Plans • Rules "similar" to QP rules apply • RBD is the later of April 1st following 70½

20. In-Service Distributions • Effective for tax years after 12/31/96 • Plan must not contain provision, optional • Requirements: • total amount may not exceed $5,000 • no deferrals made for 2 years • no prior in-service distribution taken under this rule (available one-time) • Voluntary or Mandatory in-service options available

21. Miscellaneous 457 Rules • Loans permitted for gov’t plans after 1998 - rules "similar to" QP rules. • Reporting Distributions Before and After 2002.

22. Miscellaneous 457 Rule • Transfers to other 457 arrangements are permitted. • 15 day deposit rule does not apply to 457(b) plans (not ERISA Plans) but States typically have “quicker” deposit rules. • New Jersey has a 72 hour rule on deposits from salary deferrals.

23. Coordination of “Catch-up” Rules • The Participant may contribute the greater of: • Age 50 Catch-up limit; • OR • Special 3 year 457 Catch-up.

24. NOTICE 2003-20 Applies to Employees of Eligible 457(b) Plans Does not apply to 457(f) Plans Does not apply to Independent Contractors covered under 457(b) plans

25. NOTICE 2003-20 Effective Date • Applies to deferrals and distributions made after 12/31/01 • However, for def. and distrib. Made after 12/31/01 and before 1/1/04 may use reporting and w/h requirements under Notice 2000-38 (W-2 reporting except for death distrib on 1099-R)

26. Governmental 457(b) Responsibility for Withholding • Plan Administrator unless Plan Administrator directs the payor to withhold Distributions from Gov 457(b) Plans • Form 1099-R • Form 945

27. 457(b) errors

28. Most Common 457(b) Errors First – IRS reports that there is a 90% “change rate” for the plans that they have audited…that means 90% of all 457 plans audited have errors! Lets take a look at the most common errors found!

29. Most Common 457(b) Errors • Excess Deferrals contributed to the plan • Loans permitted but plan does not permit loans • Multiple 457(b) Plan Documents have been adopted with different provisions • Catch-up contributions not calculated properly – again excess deferrals • Plan Documents not updated, not in compliance with current regulations • Unforeseeable Emergency distributions do not have valid proof of distribution • Withholding on distributions/withholding notices not correct.

30. Most Common 457(b) Errors • Employer MUST offer a beneficiary the option to directly roll over into an IRA. Many employers not permitting this option. • If Employer has multiple types of plans – i.e. 457 and a 401(a), loans must be aggregated for the overall limit – loan limit is a per employer limits not a per plan limit. • Tax reporting errors – all distributions must be reported on a Form 1099-R

31. Correcting 457(b) errors • Governmental 457(b) plan will remain eligible if it corrects a plan inconsistency before the first day of the first plan year beginning more than 180 days after the date of IRS's written notification • Eligible for EPCRS on a “provisional” basis • No similar rule for tax exempt employer – 457(f) and 409A immediately applicable

32. NJ Specific 457(b) Rules • There is a limit of one SRA per employee per fiscal year. • Administrator - The employer has to designate one or a group of public officials, or the county’s or municipality’s governing body or an authority’s governing body as the fiduciary for the plan. • Contracts – Administrative or Investment providers – must be approved by the Director of the Division of Local Government Services. • Prior to amending a Plan the Employer must notify Participants in writing of the amendment. • Prior to implementation, the amendment must be submitted to the Director and provide a certified resolution (sample from NJ) from its board to the Director.

33. NJ Specific 457(b) Rules • Is a Private Letter Ruling from IRS required - Yes. The employer must seek and obtain the approval of the IRS via a Private Letter Ruling (“PLR”) demonstrating that the proper requirements under the Code are met, and by resolution certify the same to the Director. • Is There An Alternative To Obtaining A PLR From The IRS? Yes, the alternative is that the employer adopt a resolution that certifies that it is adopting a plan ‘substantially similar’ to one that has been issued a satisfactory PLR by the IRS and that it acknowledges that it cannot rely on the PLR issued to another entity as precedent. • Note: Plans approved prior to 2002 can not be used as a PLR approved Plan.

34. NJ Specific 457(b) Rules Allowable Investments (1) fixed or variable life insurance contracts; (2) individual or group, fixed or variable annuity contracts; (3) mutual fund shares; (4) interest bearing accounts or securities in which savings banks of this State are authorized to invest their funds; and (5) the State of New Jersey Cash Management Fund. .

35. NJ Specific 457(b) Rules The employer has the right to reject requests from providers. The investments under the plan must fulfill the requirements of Prudent Investment Law in NJ (P.L.1975, c.337, C. 3A:15-35 et seq.) Providers must certify the investments to the Director annually within 30 days of receiving the form. Monies must be invested within 72 hours (3 days) exclusive of Sundays and holidays.

36. ?QUESTIONS? Contact Information Susan D. Diehl 215-444-9812 X 5041 sdiehl@penserv.com