IRS Ruling Enhances Participation in Secs. 403(b) and 457(b) Plans

The Service has approved automatic deferrals of a fixed percentage of employees' salaries to Sec. 403(b) annuity plans offered by exempt organizations, public schools and colleges, and to Sec. 457(b) eligible deferred compensation plans of state and local governments and exempt organizations. The new policy is intended to encourage increased participation levels in retirement plans and to boost savings levels. In view of the ease of implementing the automatic deferral approach and its positive impact, employers should find this new approach highly attractive.

In Rev. Rul. 2000-35, the IRS approved an arrangement for a Sec. 403(b) annuity plan similar to the one approved for qualified plans in Rev. Rul. 2000-8. The plan was amended to add an automatic compensation reduction of 4% for each employee. Employees could elect to receive cash or contribute a different percentage to the plan. For a newly hired employee, an election not to make contributions or to contribute a different percentage was effective for the first pay period, if filed when the employee was hired. An election not to make reduction contributions or to contribute a different percentage could be made at any time.

In Rev. Rul. 2000-33, the Service approved an amendment to a Sec. 457(b) eligible deferred compensation plan. Under the amendment, 2% of the employee's compensation was automatically contributed to the employee's account, if a newly hired or current employee had not affirmatively elected either to receive cash compensation or have less than 2% of compensation deferred under the plan. This provision satisfied the Sec. 457(b)(4) requirement that an agreement providing for deferral during a calendar month had to be entered into before the beginning of such month.

If a new employee filed an election to receive cash in lieu of making deferrals and the election was filed within a reasonable period ending before the beginning of the first month after the individual first became an employee, no deferrals for that (or any subsequent) month would be made. If an existing employee filed an election to receive cash in lieu of making deferrals and the election was filed during the reasonable period ending on the amendment's effective date, no deferrals for the period beginning on or after the effective date would be made.

Under both scenarios, employees were required to receive a notice explaining the automatic compensation reduction election and their right to elect not to contribute or change the election. Compensation reductions and matching contributions were invested in accordance with the employee's wishes. If no investment election was made by a participant, investments were to be determined by plan fiduciaries under an approach that would be protective of participants, yet also provide an opportunity for a reasonable return.

For Sec. 403(b) plans subject to ERISA, ERISA Section 404(c) generally may serve to relieve certain fiduciaries from liability when participants or beneficiaries exercise control over the assets in their individual accounts. However, the Department of Labor's position is that a participant or beneficiary will not be considered to have exercised control when he is merely apprised of investments that would be made on his behalf in the absence of instructions to the contrary.

An open issue involves state wage withholding laws that in some cases (e.g., California) do not permit withholding absent employee consent. While it is possible that ERISA may preempt those restrictions for ERISA-covered plans, the laws clearly apply in the non-ERISA context.

From Seth Tievsky, Washington, DC