4039 / What nondiscrimination requirements apply to tax sheltered annuity plans offering salary reduction contributions?

Tax sheltered annuity plans offering salary reduction contributions generally are subject to a single nondiscrimination rule (the “universal availability” rule) with respect to salary reduction contributions. The requirement does not apply to contracts purchased by certain churches or church-controlled¹ organizations.²

If any employee may elect to have the employer make contributions to a TSA under a salary reduction agreement, then all employees of the organization other than certain excludable employees generally must be allowed to elect to have the employer make contributions of more than $200 annually pursuant to a salary reduction agreement.³ Furthermore, the employee’s right to make elective deferrals also includes the right to designate 403(b) elective deferrals as Roth contributions, if Roth contributions are otherwise permitted under the plan.⁴

The final 403(b) regulations clarify that an employee is not treated as being permitted to have 403(b) elective deferrals unless the employee is provided with an effective opportunity that satisfies certain requirements (see Q 4040).

The general thrust of this rule is to require that all employees be eligible to make salary reduction contributions if the opportunity to make salary reduction contributions is offered to any employee, as a way to prevent discrimination in favor of the highly compensated employees. The employer may, however, require a minimum annual salary reduction contribution of more than $200, and may exclude from participation in a salary reduction agreement any employee who is not willing to reduce salary by more than $200 per year.⁵ The rule probably also prohibits employer efforts to cap an employee’s annual salary reduction contributions at $200 or less.

In addition, the nondiscrimination rule applicable to salary reduction contributions allows an employer to exclude certain other employees, including those who are participants in an IRC Section 457(b) deferred compensation plan of a governmental employer, a qualified cash or deferred IRC Section 401(k) arrangement of the employer, or another tax sheltered annuity.⁶ Certain ministers⁷ may be excluded as well.⁸

A contribution is considered not made pursuant to a salary reduction agreement if under the agreement it is made pursuant to a one time irrevocable election by the employee at the time of initial eligibility to participate.⁹ The legislative history provides that if an employee has a one-time election to participate in a program that requires an employee contribution, the contribution will not be considered an elective deferral to the extent that the employee is not permitted subsequently to modify the election in any manner.¹⁰

An employer that historically has treated one or more of its various geographically distinct units as separate for employee benefit purposes may treat each unit as a separate organization so long as the unit is operated independently on a day-to-day basis. Units located within the same Standard Metropolitan Statistical Area generally are not geographically distinct.¹¹

A plan will not be treated as violating the requirements under IRC Section 403(b)(12) merely on account of the making of, or the right to make, catch-up contributions ( Q 3761) by participants age 50 or over under the provisions of IRC Section 414(v), so long as a universal availability requirement is met.¹²