Unexpected way employees exceed 403(b) plan limit

Ensuring that employees don’t exceed the contribution limits for retirement plans may involve more steps than you realize.

Each year, IRS announces the defined contribution plan limit for total employer and employee contributions. For 2021, IRS has the dollar amount for 403(b) plans set at the lesser of:

• $58,000, or
• 100% of the employee’s annual compensation.

Here’s what catches some employers by surprise. A 403(b) plan is an annuity contract, over which the employee maintains control. Therefore, you’d aggregate contributions differently than for other defined contribution retirement plans that employers may offer such as 401(k) plans.

In fact, to ensure you don’t exceed the plan limit, you’d aggregate a 403(b) plan with other defined contribution plans over which the employee maintains control.

So said IRS in Issue Snapshot – 403(b) Plan.

Caution for hospitals, universities

As explained in the Issue Snapshot, an employer that offers a 403(b) plan will need to find out whether employees have taken on outside jobs. It doesn’t matter whether your organization actively permits outside work or is silent on the matter.

Hospitals and universities will want to pay special attention to this IRS guidance. After all, medical doctors or professors, in addition to working at hospitals or universities, sometimes run their own consulting businesses.

Here’s how outside work can lead to excess contributions to a 403(b) plan.

Let’s say an employee elected to defer $19,500 – the 403(b) salary deferral limit for 2021. Meanwhile, your organization made a non-elective employer contribution of $35,000 to the 403(b) plan on behalf of the employee.

So far, so good. Contributions haven’t exceeded $58,000.

In addition to that, the employee controls her own separate business. Furthermore, that business sponsors a defined contribution plan to which she contributes $24,000.

Now you have a compliance problem. Specifically, the combined amount of $78,500 exceeds the 2021 defined contribution plan limit of $58,000.

The excess annual addition would be attributed to the 403(b) annuity contract that your organization provides, according to IRS.

Complying with the plan limit

You can avoid the costly impact of exceeding contribution limits. IRS says you should:

1. Inform employees about the aggregation rule.
2. Tell employees what info to provide on outside employment and plan contributions.

Good communication can make or break compliance efforts.