What's New
Permissive service credit. The definition of permissive service credit has been expanded to include:
Service credit for periods where there is no performance of service, and
Service credited to provide an increased benefit for service previously credited under the plan.
Qualified reservist distribution. The additional 10% tax on early distributions does not apply to distributions from your 403(b) after September 11, 2001, if you were a qualified reservist called to active duty for 180 days or more. A qualified reservist is an individual who is a reservist or national guardsman and who was ordered or called to active duty for a period in excess of 179 days or for an indefinite period.
What's New for 2006
Roth contribution program. For tax years beginning after December 31, 2005, your 403(b) plan may allow you to contribute to a Roth contribution program. Under this program, you can designate all or a portion of your elective deferrals as Roth contributions. Elective deferrals designated as Roth contributions must be maintained in a separate Roth account. Contributions to a designated Roth account are not excluded from your gross income, however, qualified distributions from a Roth account are excluded from your gross income. For more information on the Roth contribution program, see Publication 560, Retirement Plans for Small Business.
Limit on elective deferrals. For 2006, the limit on elective deferrals has been increased from $14,000 to $15,000.
Limit on annual additions. For 2006, the limit on annual additions has been increased from $42,000 to $44,000.
Catch-up contributions for persons age 50 or over. If you will be age 50 or over by the end of 2006, you may be permitted to make additional catch-up contributions of up to $5,000 to your 403(b) plan. See chapter 6.
What's New for 2007
Rollovers by nonspouse beneficiaries. For tax years beginning after December 31, 2006, a nonspouse beneficiary may make a direct rollover of a distribution from an eligible retirement plan of a deceased participant if the rollover is a direct transfer to an inherited IRA established to receive the distribution. The transfer will be treated as an eligible rollover distribution and the receiving individual retirement plan will be treated as an inherited retirement account or annuity.
Rollover of after-tax contributions. For tax years beginning after December 31, 2006, participants in a 403(b) plan can roll over after-tax contributions to an eligible retirement plan, and receive rollover after-tax contributions from an eligible retirement plan, if the rollover is made through a direct trustee-to-trustee transfer.
Retired public safety officers. For tax years beginning after December 31, 2006, if you are an eligible retired public safety officer, distributions of up to $3,000, made directly from your 403(b) plan to pay accident, health, or long-term care insurance are not included in your taxable income. The premiums can be for you, your spouse or your dependents. A public safety officer is a law enforcement officer, fire fighter, chaplain, or member of a rescue squad or ambulance crew. For additional information, see Publication 575.
Limit on elective deferrals. For 2007, the limit on elective deferrals has been increased from $15,000 to $15,500.
Limit on annual additions. For 2007, the limit on annual additions has been increased from $44,000 to $45,000.
Proposed Regulations
Proposed Income Tax Regulations pertaining to tax-sheltered annuities within the meaning of section 403(b) of the Internal Revenue Code were issued on November 16, 2004. Generally, when finalized, these regulations will be effective for taxable years beginning after December 31, 2007. The Proposed Regulations, REG-155608-02, 2004-49 I.R.B. 924 are available at www.irs.gov.
Introduction
This publication can help you better understand the tax rules that apply to your 403(b) (tax-sheltered annuity) plan.
In this publication, you will find information to help you:
Determine the maximum amount that can be contributed to your 403(b) account in 2007.
Determine the maximum amount that could have been contributed to your 403(b) account in 2006.
Identify excess contributions.
Understand the basic rules for claiming the retirement savings contributions credit.
Understand the basic rules for distributions and rollovers from 403(b) accounts.
This publication does not provide specific information on the following topics.
Distributions from 403(b) accounts. This is covered in Publication 575, Pension and Annuity Income.
Rollovers. This is covered in Publication 590, Individual Retirement Arrangements (IRAs).
Withdrawals, repayments, and loans from 403(b) annuity contracts for taxpayers who suffered economic losses as a result of Hurricane Katrina, Rita, or Wilma. This is covered in Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma.
How to use this publication
This publication is organized into chapters to help you find information easily. Chapter 1 answers questions frequently asked by 403(b) plan participants. Chapters 2 through 6 explain the rules and terms you need to know to figure the maximum amount that could have been contributed to your 403(b) account for 2006 and the maximum amount that can be contributed to your 403(b) account in 2007. Chapter 7 provides general information on the prevention and correction of excess contributions to your 403(b) account. Chapter 8 provides general information on distributions, and transfers and rollovers. Chapter 9 provides blank worksheets that you will need to accurately and actively participate in your 403(b) plan. Filled-in samples of most of these worksheets can be found throughout this publication. Chapter 10 explains the rules for claiming the retirement savings contributions credit.
Useful Items - You may want to see:
Publication
- 517 Social Security and Other Information for Members of the Clergy and Religious Workers
- 575 Pension and Annuity Income
- 590 Individual Retirement Arrangements (IRAs)
Form (and Instructions)
W-2
Wage and Tax Statement1099-R
Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.5329
Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts5330
Return of Excise Taxes Related to Employee Benefit Plans8915
Qualified Hurricane Retirement Plan Distributions and Repayments
1. 403(b) Plan Basics
This chapter introduces you to 403(b) plans and accounts. Specifically, the chapter answers the following questions.
What is a 403(b) plan?
Who can participate in a 403(b) plan?
Who can set up a 403(b) account?
How can contributions be made to my 403(b) account?
Do I report contributions on my tax return?
How much can be contributed to my 403(b) account?
What is a 403(b) Plan?
A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.
Individual accounts in a 403(b) plan can be any of the following types.
An annuity contract, which is a contract provided through an insurance company,
A custodial account, which is an account invested in mutual funds, or
A retirement income account set up for church employees. Generally, retirement income accounts can invest in either annuities or mutual funds.
Throughout this publication, wherever the term “403(b) account” is used, it refers to any one of these funding arrangements, unless otherwise specified.
What are the Benefits of Contributing to a 403(b) Plan?
There are three benefits to contributing to a 403(b) plan.
The first benefit is that you do not pay tax on allowable contributions in the year they are made. You do not pay tax on allowable contributions until you begin making withdrawals from the plan, usually after you retire. Allowable contributions to a 403(b) plan are either excluded or deducted from your income. However, if your contributions are made to a Roth contribution program, this benefit does not apply. Instead, you pay tax on the contributions to the plan but distributions from the plan (if certain requirements are met) are tax free.
The second benefit is that earnings and gains on amounts in your 403(b) account are not taxed until you withdraw them. Earnings and gains on amounts in a Roth contribution program are not taxed if your withdrawals are qualified distributions. Otherwise, they are taxed when you withdraw them.
The third benefit is that you may be eligible to take a credit for elective deferrals contributed to your 403(b) account. See chapter 10.
Excluded
If an amount is excluded from your income, it is not included in your total wages on your Form W-2. This means that you do not report the excluded amount on your tax return.
Deducted
If an amount is deducted from your income, it is included with your other wages on your Form W-2. You report this amount on your tax return, but you are allowed to subtract it when figuring the amount of income on which you must pay tax.
Who Can Participate in a 403(b) Plan?
Any eligible employee can participate in a 403(b) plan.
Eligible employees
The following employees are eligible to participate in a 403(b) plan.
Employees of tax-exempt organizations established under section 501(c)(3) of the Internal Revenue Code. These organizations are usually referred to as section 501(c)(3) organizations or simply 501(c)(3) organizations.
Employees of public school systems who are involved in the day-to-day operations of a school.
Employees of cooperative hospital service organizations.
Civilian faculty and staff of the Uniformed Services University of the Health Sciences (USUHS).
Employees of public school systems organized by Indian tribal governments.
Certain ministers (explained next).
Ministers
The following ministers are eligible employees for whom a 403(b) account can be established.
Ministers employed by section 501(c)(3) organizations.
Self-employed ministers. A self-employed minister is treated as employed by a tax-exempt organization that is a qualified employer.
Ministers (chaplains) who meet both of the following requirements.
They are employed by organizations that are not section 501(c)(3) organizations.
They function as ministers in their day-to-day professional responsibilities with their employers.
Example —
A minister employed as a chaplain by a state-run prison and a chaplain in the United States Armed Forces are eligible employees because their employers are not section 501(c)(3) organizations and they are employed as ministers.
Who Can Set Up a 403(b) Account?
You cannot set up your own 403(b) account. Only employers can set up 403(b) accounts. A self-employed minister cannot set up a 403(b) account for his or her benefit. If you are a self-employed minister, only the organization (denomination) with which you are associated can set up an account for your benefit.
How Can Contributions Be Made to My 403(b) Account?
Generally, only your employer can make contributions to your 403(b) account. However, some plans will allow you to make after-tax contributions (defined later).
The following types of contributions can be made to 403(b) accounts.
Elective deferrals . These are contributions made under a salary reduction agreement. This agreement allows your employer to withhold money from your paycheck to be contributed directly into a 403(b) account for your benefit. Except for Roth contributions, you do not pay tax on these contributions until you withdraw them from the account. If your contributions are Roth contributions, you pay taxes on your contributions but any qualified distributions from your Roth account are tax free.
Nonelective contributions . These are employer contributions that are not made under a salary reduction agreement. Nonelective contributions include matching contributions, discretionary contributions, and mandatory contributions from your employer. You do not pay tax on these contributions until you withdraw them from the account.
After-tax contributions . These are contributions (that are not Roth contributions) you make with funds that you must include in income on your tax return. A salary payment on which income tax has been withheld is a source of these contributions. If your plan allows you to make after-tax contributions, they are not excluded from income and you cannot deduct them on your tax return.
A combination of any of the three contribution types listed above.
Do I Report Contributions on My Tax Return?
Generally, you do not report contributions to your 403(b) account (except Roth contributions) on your tax return. Your employer will report contributions on your Form W-2. Elective deferrals will be shown in box 12 and the Retirement plan box will be checked. If you are a self-employed minister or chaplain, see the discussions below.
Self-employed ministers. If you are a self-employed minister, you must report the total contributions as a deduction on your tax return. Deduct your contributions on line 28 of Form 1040.Chaplains
If you are a chaplain and your employer does not exclude contributions made to your 403(b) account from your earned income, you may be able to take a deduction for those contributions on your tax return. However, if your employer has agreed to exclude the contributions from your earned income, you will not be allowed a deduction on your tax return. If you can take a deduction, include your contributions on line 36 of Form 1040. Enter the amount of your deduction and write “403(b)” on the dotted line next to line 36.
How Much Can Be Contributed to My 403(b) Account?
There are limits on the amount of contributions that can be made to your 403(b) account each year. If contributions made to your 403(b) account are more than these contribution limits, penalties may apply.
Chapters 2 through 6 provide information on how to determine the amount that can be contributed to your 403(b) account.
Worksheets are provided in chapter 9 to help you determine the maximum amount that can be contributed to your 403(b) account each year. Chapter 7, Excess Contributions, describes steps you can take to prevent excess contributions and to get an excess contribution corrected.
2. Maximum Amount Contributable (MAC)
Throughout this publication, the limit on the amount that can be contributed to your 403(b) account for any year is referred to as your maximum amount contributable (MAC). This chapter:
Introduces the components of your MAC,
Tells you how to figure your MAC, and
Tells you when to figure your MAC.
Components of Your MAC
Generally, before you can determine your MAC, you must first figure the components of your MAC. The components of your MAC are:
The limit on annual additions (chapter 3), and
The limit on elective deferrals (chapter 4).
How Do I Figure My MAC?
Generally, contributions to your 403(b) account are limited to the lesser of:
The limit on annual additions, or
The limit on elective deferrals.
Depending upon the type of contributions made to your 403(b) account, only one of the limits may apply to you.
Which limit applies
Whether you must apply one or both of the limits depends on the type of contributions made to your 403(b) account during the year.
Elective deferrals only
If the only contributions made to your 403(b) account during the year were elective deferrals made under a salary reduction agreement, you will need to figure both of the limits. Your MAC is the lesser of the two limits. Nonelective contributions only. If the only contributions made to your 403(b) account during the year were nonelective contributions (employer contributions not made under a salary reduction agreement), you will only need to figure the limit on annual additions. Your MAC is the limit on annual additions.
Elective deferrals and nonelective contributions
If the contributions made to your 403(b) account were a combination of both elective deferrals made under a salary reduction agreement and nonelective contributions (employer contributions not made under a salary reduction agreement), you will need to figure both limits. Your MAC is the limit on the annual additions. You need to figure the limit on elective deferrals to determine if you have excess elective deferrals, which are explained in chapter 7.
Worksheets
Worksheets are available in chapter 9 to help you figure your MAC.
When Should I Figure My MAC?
At the beginning of 2007, you should refigure your 2006 MAC based on your actual compensation for 2006. This will allow you to determine if the amount that has been contributed to your 403(b) account for 2006 has exceeded the allowable limits. In some cases, this will allow you to avoid penalties and additional taxes. See chapter 7.
Generally, you should figure your MAC for the current year at the beginning of each tax year using a conservative estimate of your compensation. If your compensation changes during the year, you should refigure your MAC based on a revised conservative estimate. By doing this, you will be able to determine if contributions to your 403(b) account can be increased or should be decreased for the year.
3. Limit on Annual Additions
The first component of MAC is the limit on annual additions. This is a limit on the total contributions (elective deferrals, nonelective contributions, and after-tax contributions) that can be made to your 403(b) account. The limit on annual additions generally is the lesser of:
$44,000 ($45,000 for 2007), or
100% of your includible compensation for your most recent year of service.
Participation in a qualified plan. If you participated in a 403(b) plan and a qualified plan, you must combine contributions made to your 403(b) account with contributions to a qualified plan and simplified employee pensions of all corporations, partnerships, and sole proprietorships in which you have more than 50% control.
You can use Part I of Worksheet 1 in chapter 9 to figure your limit on annual additions.
Ministers and church employees
If you are a minister or a church employee, you may be able to increase your limit on annual additions or use different rules when figuring your limit on annual additions. For more information, see chapter 5.
Includible Compensation for Your Most Recent Year of Service
Definition
Generally, includible compensation for your most recent year of service is the amount of taxable wages and benefits you received from the employer that maintained a 403(b) account for your benefit during your most recent year of service.
When figuring your includible compensation for your most recent year of service, keep in mind that your most recent year of service may not be the same as your employer's most recent annual work period. This can happen if your tax year is not the same as your employer's annual work period.
When figuring includible compensation for your most recent year of service, do not mix compensation or service of one employer with compensation or service of another employer.
Most Recent Year of Service
Your most recent year of service is your last full year of service, ending on the last day of your tax year that you worked for the employer that maintains a 403(b) account on your behalf.
Tax year different from employer's annual work period. If your tax year is not the same as your employer's annual work period, your most recent year of service is made up of parts of at least two of your employer's annual work periods.Example —
A professor who reports her income on a calendar-year basis is employed on a full-time basis by a university that operates on an academic year (October through May). For purposes of figuring her includible compensation for her most recent year of service for 2006, the professor's most recent year of service consists of her service performed during January through May of 2006 and her service performed during October through December of 2006.
Figuring Your Most Recent Year of Service
To figure your most recent year of service, begin by determining what constitutes a full year of service for your position. A full year of service is equal to full-time employment for your employer's annual work period.After identifying a full year of service, begin counting the service you have provided for your employer starting with the service provided in the current year.
Part-time or employed only part of year. If you are a part-time employee, or a full-time employee who is employed for only part of the year, your most recent year of service consists of your service this year and your service for as many previous years as is necessary to total one full year of service. You add up your most recent periods of service to determine your most recent year of service. First, take into account your service during the year for which you are figuring the limit on annual additions. Then, add your service during your next preceding tax year, and years before that, until either your total service equals 1 year of service or you have taken into account all of your service with the employer.Example —
You were employed on a full-time basis during the months July through December 2004 (1/2 year of service), July through December 2005 (1/2 year of service), and October through December 2006 (1/4 year of service). Your most recent year of service for purposes of computing your limit on annual additions for 2006 is the total of your service during 2006 (1/4 year of service), your service during 2005 (1/2 year of service), and your service during the months October through December 2004 (1/4 year of service).
Not yet employed for 1 year
If, at the close of the year, you have not yet worked for your employer for 1 year (including time you worked for the same employer in all earlier years), use the period of time you have worked for the employer as your most recent year of service.
Includible Compensation
After identifying your most recent year of service, the next step is to identify the includible compensation associated with that full year of service.
Includible compensation is not the same as income included on your tax return. Compensation is a combination of income and benefits received in exchange for services provided to your employer.
Generally, includible compensation is the amount of income and benefits:
Received from the employer who maintains your 403(b) account, and
Must be included in your income.
Includible compensation does include the following amounts.
Elective deferrals (employer's contributions made on your behalf under a salary reduction agreement).
Amounts contributed or deferred by your employer under a section 125 cafeteria plan.
Amounts contributed or deferred, at the election of the employee, under an eligible section 457 nonqualified deferred compensation plan (state or local government or tax-exempt organization plan).
Wages, salaries, and fees for personal services earned with the employer maintaining your 403(b) account.
Income otherwise excluded under the foreign earned income exclusion.
The value of qualified transportation fringe benefits (including transit passes, certain parking, and transportation in a commuter highway vehicle between your home and work).
Includible compensation does not include the following items.
Your employer's contributions to your 403(b) account.
Compensation earned while your employer was not an eligible employer.
Your employer's contributions to a qualified plan that:
Are on your behalf, and
Are excludable from income.
The cost of incidental life insurance.
Contributions after retirement
Nonelective contributions may be made for an employee for up to 5 years after retirement. These contributions would be based on includible compensation for the last year of service before retirement.
Cost of Incidental Life Insurance
Includible compensation does not include the cost of incidental life insurance.
If all of your 403(b) accounts invest only in mutual funds, then you have no incidental life insurance.If you have an annuity contract, a portion of the cost of that contract may be for incidental life insurance. If so, the cost of the insurance is taxable to you in the year contributed and is considered part of your basis when distributed. Your employer will include the cost of your insurance as taxable wages in box 1 of Form W-2.
Not all annuity contracts include life insurance. Contact your plan administrator to determine if your account includes incidental life insurance. If it does, you will need to figure the cost of life insurance each year the policy is in effect.
Figuring the cost of incidental life insurance. If you have determined that part of the cost of your annuity contract is for an incidental life insurance premium, you will need to determine the amount of the premium and subtract it from your includible compensation.To determine the amount of the life insurance premiums, you will need to know the following information.
The value of your life insurance contract, which is the amount payable upon your death.
The cash value of your life insurance contract at the end of the tax year.
Your age on your birthday nearest the beginning of the policy year.
Your current life insurance protection under an ordinary retirement income life insurance policy, which is the amount payable upon your death minus the cash value of the contract at the end of the year.
You can use Worksheet A, Cost of Incidental Life Insurance, in chapter 9 to determine the cost of your incidental life insurance.
Example —
Your new contract provides that your beneficiary will receive $10,000 if you should die anytime before retirement. Your cash value in the contract at the end of the first year is zero. Your current life insurance protection for the first year is $10,000 ($10,000 - 0).
The cash value in the contract at the end of year two is $1,000, and the current life insurance protection for the second year is $9,000 ($10,000 - $1,000).
The 1-year cost of the protection can be calculated by using Figure 3-1, Uniform One-Year Term Premiums for $1,000 Life Insurance Protection. The premium rate is determined according to your age on your birthday nearest the beginning of the policy year.
Figure 3-1. Uniform One-Year Term Premiums for $1,000 Life Insurance Protection
| Age | Cost | Age | Cost | |
| 15 | $1.27 | 49 | $8.53 | |
| 16 | 1.38 | 50 | 9.22 | |
| 17 | 1.48 | 51 | 9.97 | |
| 18 | 1.52 | 52 | 10.79 | |
| 19 | 1.56 | 53 | 11.69 | |
| 20 | 1.61 | 54 | 12.67 | |
| 21 | 1.67 | 55 | 13.74 | |
| 22 | 1.73 | 56 | 14.91 | |
| 23 | 1.79 | 57 | 16.18 | |
| 24 | 1.86 | 58 | 17.56 | |
| 25 | 1.93 | 59 | 19.08 | |
| 26 | 2.02 | 60 | 20.73 | |
| 27 | 2.11 | 61 | 22.53 | |
| 28 | 2.20 | 62 | 24.50 | |
| 29 | 2.31 | 63 | 26.63 | |
| 30 | 2.43 | 64 | 28.98 | |
| 31 | 2.57 | 65 | 31.51 | |
| 32 | 2.70 | 66 | 34.28 | |
| 33 | 2.86 | 67 | 37.31 | |
| 34 | 3.02 | 68 | 40.59 | |
| 35 | 3.21 | 69 | 44.17 | |
| 36 | 3.41 | 70 | 48.06 | |
| 37 | 3.63 | 71 | 52.29 | |
| 38 | 3.87 | 72 | 56.89 | |
| 39 | 4.14 | 73 | 61.89 | |
| 40 | 4.42 | 74 | 67.33 | |
| 41 | 4.73 | 75 | 73.23 | |
| 42 | 5.07 | 76 | 79.63 | |
| 43 | 5.44 | 77 | 86.57 | |
| 44 | 5.85 | 78 | 94.09 | |
| 45 | 6.30 | 79 | 102.23 | |
| 46 | 6.78 | 80 | 111.04 | |
| 47 | 7.32 | 81 | 120.57 | |
| 48 | 7.89 | |||
Example —
Lynne Green, age 44, and her employer enter into a 403(b) plan that will provide her with a $500 a month annuity upon retirement at age 65. The agreement also provides that if she should die before retirement, her beneficiary will receive the greater of $20,000 or the cash surrender value in the life insurance contract. Using the facts presented we can determine the cost of Lynne's life insurance protection as shown in Table 3-1.
Lynne's employer has included $117 for the cost of the life insurance protection in her current year's income. When figuring her includible compensation for this year, Lynne will subtract $117.
Table 3-1. Worksheet A. Cost of Incidental Life Insurance
Note. Use this worksheet to figure the cost of incidental life insurance included in your annuity contract. This amount will be used to figure includible compensation for your most recent year of service.
| 1. | Enter the value of the contract (amount payable upon your death) | 1. | $20,000.00 |
| 2. | Enter the cash value in the contract at the end of the year | 2. | 0.00 |
| 3. | Subtract line 2 from line 1. This is the value of your current life insurance protection | 3. | $20,000.00 |
| 4. | Enter your age on your birthday nearest the beginning of the policy year | 4. | 44 |
| 5. | Enter the 1-year term premium for $1,000 of life insurance based on your age. (From Figure 3-1) | 5. | $5.85 |
| 6. | Divide line 3 by $1,000 | 6. | 20 |
| 7. | Multiply line 6 by line 5. This is the cost of your incidental life insurance | 7. | $117.00 |
Example —
Lynne's cash value in the contract at the end of the second year is $1,000. In year two, the cost of Lynne's life insurance is calculated as shown in Table 3-2.
In year two, Lynne's employer will include $119.70 in her current year's income. Lynne will subtract this amount when figuring her includible compensation.
Table 3-2. Worksheet A. Cost of Incidental Life Insurance
Note. Use this worksheet to figure the cost of incidental life insurance included in your annuity contract. This amount will be used to figure includible compensation for your most recent year of service.
| 1. | Enter the value of the contract (amount payable upon your death) | 1. | $20,000.00 |
| 2. | Enter the cash value in the contract at the end of the year | 2. | $1,000.00 |
| 3. | Subtract line 2 from line 1. This is the value of your current life insurance protection | 3. | $19,000.00 |
| 4. | Enter your age on your birthday nearest the beginning of the policy year | 4. | 45 |
| 5. | Enter the 1-year term premium for $1,000 of life insurance based on your age. (From Figure 3-1) | 5. | $6.30 |
| 6. | Divide line 3 by $1,000 | 6. | 19 |
| 7. | Multiply line 6 by line 5. This is the cost of your incidental life insurance | 7. | $119.70 |
Figuring Includible Compensation for Your Most Recent Year of Service
You can use Worksheet B in chapter 9 to determine your includible compensation for your most recent year of service.Example —
Floyd has been periodically working full-time for a local hospital since September 2004. He needs to figure his limit on annual additions for 2007. The hospital's normal annual work period for employees in Floyd's general type of work runs from January to December.
During the periods that Floyd was employed with the hospital, the hospital has always been eligible to provide a 403(b) plan to employees. Additionally, the hospital has never provided the employees with a 457 deferred compensation plan, transportation benefits, or a cafeteria plan.
Floyd has never worked abroad and there is no life insurance provided under the plan.
Table 3-3 shows the service Floyd provided to his employer, his compensation for the periods worked, his elective deferrals, and his taxable wages.
Table 3-3. Floyd's Compensation
Note.This table shows information Floyd will use to figure includible compensation for his most recent year of service.
| Year | Years of Service | Taxable Wages | Elective Deferrals |
|---|---|---|---|
| 2007 | 6/12 of a year | $42,000 | $2,000 |
| 2006 | 4/12 of a year | $16,000 | $1,650 |
| 2005 | 4/12 of a year | $16,000 | $1,650 |
Before Floyd can figure his limit on annual additions, he must figure includible compensation for his most recent year of service.
Because Floyd is not planning to work the entire 2007 year, his most recent year of service will include the time he is planning to work in 2007 plus time he worked in the preceding 3 years until the time he worked for the hospital totals 1 year. If the total time he worked is less than 1 year, Floyd will treat it as if it were 1 year. He figures his most recent year of service shown in the following list.
Time he will work in 2007 is 6/12 of a year.
Time worked in 2006 is 4/12 of a year. All of this time will be used to determine Floyd's most recent year of service.
Time worked in 2005 is 4/12 of a year. Floyd only needs 2 months of the 4 months he worked in 2005 to have enough time to total 1 full year. Because he needs only one-half of the actual time he worked, Floyd will use only one-half of his income earned during that period to calculate wages that will be used in figuring his includible compensation.
Using the information provided in Table 3-3, wages for Floyd's most recent year of service are $66,000 ($42,000 + $16,000 + $8,000). His includible compensation for his most recent year of service is figured as shown in Table 3-4.
After figuring his includible compensation, Floyd determines his limit on annual additions for 2007 to be $45,000, the lesser of his includible compensation, $70,475 (Table 3-4), and the maximum amount of $45,000.
Table 3-4. Worksheet B. Includible Compensation for Your Most Recent Year of Service*
Note. Use this worksheet to figure includible compensation for your most recent year of service.
| 1. | Enter your includible wages from the employer maintaining your 403(b) account for your most recent year of service | 1. | $66,000 |
| 2. | Enter elective deferrals excluded from your gross income for your most recent year of service ** | 2. | 4,475 |
| 3. | Enter amounts contributed or deferred by your employer under a cafeteria plan for your most recent year of service | 3. | -0- |
| 4. | Enter amounts contributed or deferred by your employer to your 457 account (a nonqualified plan of a state or local government, or of a tax-exempt organization) for your most recent year of service | 4. | -0- |
| 5. | Enter the value of qualified transportation fringe benefits you received from your employer for your most recent year of service | 5. | -0- |
| 6. | Enter your foreign earned income exclusion for your most recent year of service | 6. | -0- |
| 7. | Add lines 1, 2, 3, 4, 5, and 6 | 7. | 70,475 |
| 8. | Enter the cost of incidental life insurance that is part of your annuity contract for your most recent year of service | 8. | -0- |
| 9. | Enter compensation that was both:
| 9. | -0- |
| 10. | Add lines 8 and 9 | 10. | -0- |
| 11. | Subtract line 10 from line 7. This is your includible compensation for your most recent year of service | 11. | 70,475 |
| * Use estimated amounts if figuring includible compensation before the end of the year. **Elective deferrals made to a designated Roth account are not excluded from your gross income and should not be included on this line. | |||
4. Limit on Elective Deferrals
The second, and final component of MAC is the limit on elective deferrals. This is a limit on the amount of contributions that can be made to your account through a salary reduction agreement.
A salary reduction agreement is an agreement between you and your employer allowing for a portion of your compensation to be directly invested in a 403(b) account on your behalf. You can enter into more than one salary reduction agreement during a year.
More than one 403(b) account. If, for any year, elective deferrals are contributed to more than one 403(b) account for you (whether or not with the same employer), you must combine all the elective deferrals to determine whether the total is more than the limit for that year.403(b) plan and another retirement plan. If, during the year, contributions in the form of elective deferrals are made to other retirement plans on your behalf, you must combine all of the elective deferrals to determine if they are more than your limit on elective deferrals. The limit on elective deferrals applies to amounts contributed to:
401(k) plans, to the extent excluded from income,
Section 501(c)(18) plans, to the extent excluded from income,
SIMPLE plans,
Simplified employee pension (SEP) plans, and
All 403(b) plans.
Roth contribution program
Your 403(b) plan may allow you to designate all or a portion of your elective deferrals as Roth contributions. Elective deferrals designated as Roth contributions must be maintained in a separate Roth account and are not excludable from your gross income. The maximum amount of contributions allowed under a Roth contribution program is your limit on elective deferrals, less your elective deferrals not designated as Roth contributions. For more information on the Roth contribution program, see Publication 560.
Excess elective deferrals
If the amount contributed is more than the allowable limit, you must include in your gross income for the year contributed, the excess that is not a Roth contribution.
General Limit
Under the general limit on elective deferrals, the most that can be contributed to your 403(b) account through a salary reduction agreement for 2006 is $15,000. The limit for 2007 is $15,500. This limit applies without regard to community property laws.
15-Year Rule
If you have at least 15 years of service with a public school system, hospital, home health service agency, health and welfare service agency, church, or convention or association of churches (or associated organization), the limit on elective deferrals to your 403(b) account is increased by the least of:
$3,000,
$15,000, reduced by the sum of:
The increases to the general limit you were allowed in earlier years because of this rule, plus
The aggregate amount of designated Roth contributions for prior tax years, or
$5,000 times the number of your years of service for the organization, minus the total elective deferrals made by your employer on your behalf for earlier years.
If you qualify for the 15-year rule, your elective deferrals under this limit can be as high as $18,000 for 2006 and $18,500 for 2007.
To determine whether you have 15 years of service with your employer, see Years of Service, next.
Years of Service
To determine if you are eligible for the increased limit on elective deferrals, you will first need to figure your years of service. How you figure your years of service depends on whether you were a full-time or a part-time employee, whether you worked for the full year or only part of the year, and whether you have worked for your employer for an entire year.
You must figure years of service for each year during which you worked for the employer who is maintaining your 403(b) account.
If more than one employer maintains a 403(b) account for you in the same year, you must figure years of service separately for each employer.
Definition
Your years of service are the total number of years you have worked for the employer maintaining your 403(b) account as of the end of the year.
Figuring Your Years of Service
Take the following rules into account when figuring your years of service.
Status of employer
Your years of service include only periods during which your employer was a qualified employer. Your plan administrator can tell you whether or not your employer was qualified during all your periods of service.
Service with one employer
Generally, you cannot count service for any employer other than the one who maintains your 403(b) account.
Church employee
If you are a church employee, treat all of your years of service with related church organizations as years of service with the same employer. For more information about church employees, see chapter 5. Self-employed ministers. If you are a self-employed minister, your years of service include full and part years in which you have been treated as employed by a tax-exempt organization that is a qualified employer.
Less than 1 year of total service
Your years of service cannot be less than 1 year. If at the end of your tax year, you have less than 1 year of service (including service in any previous years), figure your limit on annual additions as if you have 1 year.
Total years of service
When figuring years of service, figure each year individually and then add the individual years of service to determine your total years of service.
Example —
The annual work period for full-time teachers employed by ABC Public Schools is September through December and February through May. Marsha began working with ABC schools in September 2002. She has always worked full-time for each annual work period. At the end of 2006, Marsha had 4.5 years of service with ABC Public Schools, as shown in Table 4-1.
Table 4-1. Marsha's Years of Service
Note. This table shows how Marsha figures her years of service, as explained in the previous example.
| Year | Period Worked | Portion of Work Period | Years of Service |
|---|---|---|---|
| 2002 | Sept.-Dec. | .5 year | .5 year |
| 2003 | Feb.-May | .5 year | 1 year |
| Sept.-Dec. | .5 year | ||
| 2004 | Feb.-May | .5 year | 1 year |
| Sept.-Dec. | .5 year | ||
| 2005 | Feb.-May | .5 year | 1 year |
| Sept.-Dec. | .5 year | ||
| 2006 | Feb.-May | .5 year | 1 year |
| Sept.-Dec. | .5 year | ||
| Total years of service | 4.5 years | ||
Example —
All full-time teachers at ABC Public Schools are required to work both the September through December semester and the February through May semester. Therefore, the annual work period for full-time teachers employed by ABC Public Schools is September through December and February through May. Teachers at ABC Public Schools who work both semesters in the same calendar year are considered working a full year of service in that calendar year.
Full-Time Employee for the Full Year
Count each full year during which you were employed full time as 1 year of service. In determining whether you were employed full-time, compare the amount of work you were required to perform with the amount of work normally required of others who held the same position with the same employer and who generally received most of their pay from the position.
How to compare
You can use any method that reasonably and accurately reflects the amount of work required. For example, if you are a teacher, you can use the number of hours of classroom instruction as a measure of the amount of work required. In determining whether positions with the same employer are the same, consider all of the facts and circumstances concerning the positions, including the work performed, the methods by which pay is determined, and the descriptions (or titles) of the positions.
Example —
An assistant professor employed in the English department of a university will be considered a full-time employee if the amount of work that he or she is required to perform is the same as the amount of work normally required of assistant professors of English at that university who get most of their pay from that position.
Full year of service
A full year of service for a particular position means the usual annual work period of anyone employed full-time in that general type of work at that place of employment.
Example —
If a doctor works for a hospital 12 months of a year except for a 1- month vacation, the doctor will be considered as employed for a full year if the other doctors at that hospital also work 11 months of the year with a 1-month vacation. Similarly, if the usual annual work period at a university consists of the fall and spring semesters, an instructor at that university who teaches these semesters will be considered as working a full year.
Other Than Full-Time for the Full Year
If, during any year, you were employed full-time for only part of your employer's annual work period, part-time for the entire annual work period, or part-time for only part of the work period, your year of service for that year is a fraction of your employer's annual work period.
Full-time for part of the year. If, during a year, you were employed full-time for only part of your employer's annual work period, figure the fraction for that year as follows.The numerator (top number) is the number of weeks, months, or semesters you were a full-time employee.
The denominator (bottom number) is the number of weeks, months, or semesters considered the normal annual work period for the position.
Example —
Jason was employed as a full-time instructor by a local college for the 4 months of the 2006 spring semester (February 2006 through May 2006). The annual work period for the college is 8 months (February through May and July through October). Given these facts, Jason was employed full time for part of the annual work period and provided ½ of a year of service. Jason's years of service computation for 2006 is as follows.
| Number of months Jason worked | = | 4 | = | 1 |
| Number of months in annual work period | 8 | 2 |
The numerator (top number) is the number of hours or days you worked.
The denominator (bottom number) is the number of hours or days required of someone holding the same position who works full-time.
Example —
Vance teaches one course at a local medical school. He teaches 3 hours per week for two semesters. Other faculty members at the same school teach 9 hours per week for two semesters. The annual work period of the medical school is two semesters. An instructor teaching 9 hours a week for two semesters is considered a full-time employee. Given these facts, Vance has worked part-time for a full annual work period. Vance has completed 1/ of a year of service, figured as shown below.
| Number of hours per week Vance worked | = | 3 | = | 1 |
| Number of hours per week considered full-time | 9 | 3 |
The numerator (top number) is the number of weeks, months, or semesters you were a full-time employee.
The denominator (bottom number) is the number of weeks, months, or semesters considered the normal annual work period for the position.
The numerator (top number) is the number of hours or days you worked.
The denominator (bottom number) is the number of hours or days required of someone holding the same position who works full-time.
Example —
Maria, an attorney, teaches a course for one semester at a law school. She teaches 3 hours per week. The annual work period for teachers at the school is two semesters. All full-time instructors at the school are required to teach 12 hours per week. Based on these facts, Maria is employed part-time for part of the annual work period. Her year of service for this year is determined by multiplying two fractions. Her computation is as follows.
Maria's first fraction
| Number of semesters Maria worked | = | 1 |
| Number of semesters in annual work period | 2 |
Maria's second fraction
| Number of hours Maria worked per week | = | 3 | = | 1 |
| Number of hours per week considered full-time | 12 | 4 |
Maria would multiply these fractions to obtain the fractional year of service:
| 1 | x | 1 | = | 1 | ||||
| 2 | 4 | 8 |
Figuring the Limit on Elective Deferrals
You can use Part II of Worksheet 1 in chapter 9 to figure the limit on elective deferrals.
Example
Floyd has figured his limit on annual additions. The only other component needed before he can determine his MAC for 2007 is his limit on elective deferrals.
Figuring Floyd's limit on elective deferrals. Floyd has been employed with his current employer for less than 15 years. He is not eligible for the special 15-year increase. Therefore, his limit on elective deferrals for 2007 is $15,500, as shown in Table 4-2.Floyd's employer will not make any nonelective contributions to his 403(b) account and Floyd will not make any after-tax contributions. Additionally, Floyd's employer does not offer a Roth contribution program.
Figuring Floyd's MAC
Floyd has determined that his limit on annual additions for 2007 is $45,000 and his limit on elective deferrals is $15,500. Because elective deferrals are the only contributions made to Floyd's account, the maximum amount that can be contributed to a 403(b) account on Floyd's behalf in 2007 is $15,500, the lesser of both limits.
Table 4-2. Worksheet 1. Maximum Amount Contributable (MAC)
Note.Use this worksheet to figure your MAC.
| Part I. Limit on Annual Additions | |||
| 1. | Enter your includible compensation for your most recent year of service | 1. | $70,475 |
| 2. | Maximum
| 2. | 45,000 |
| 3. | Enter the lesser of line 1 or line 2. This is your limit on annual additions | 3. | 45,000 |
| Caution: If you had only nonelective contributions, skip Part II and enter the amount from line 3 on line 18. | |||
| Part II. Limit on Elective Deferrals | |||
| 4. | Maximum contribution
| 4. | 15,500 |
| Note. If you have at least 15 years of service with a qualifying organization, complete lines 5 through 17. If not, enter zero (-0-) on line 16 and go to line 17. | |||
| 5. | Amount per year of service | 5. | 5,000 |
| 6. | Enter your years of service | 6. | |
| 7. | Multiply line 5 by line 6 | 7. | |
| 8. | Enter the total of all elective deferrals for prior years made for you by qualifying organizations | 8. | |
| 9. | Subtract line 8 from line 7. If zero or less, enter zero (-0-) | 9. | |
| 10. | Maximum increase in limit for long service | 10. | 15,000 |
| 11. | Enter all prior year increases in the limit for long service | 11. | |
| 12. | Enter the total amount of all designated Roth contributions for prior years | 12. | |
| 13. | Add lines 11 and 12 | 13. | |
| 14. | Subtract line 13 from line 10 | 14. | |
| 15. | Maximum additional contributions | 15. | 3,000 |
| 16. | Enter the least of lines 9, 14, or 15. This is your increase in the limit for long service | 16. | -0- |
| 17. | Add lines 4 and 16. This is your limit on elective deferrals | 17. | 15,500 |
| Part III. Maximum Amount Contributable | |||
| 18. |
| 18. | $15,500 |
5. Ministers and Church Employees
Self-employed ministers and church employees who participate in 403(b) plans generally follow the same rules as other 403(b) plan participants.
This means that if you are a self-employed minister or a church employee, your MAC generally is the lesser of:
Your limit on annual additions, or
Your limit on elective deferrals.
For most ministers and church employees, the limit on annual additions is figured without any changes. This means that if you are a minister or church employee, your limit on annual additions generally is the lesser of:
$44,000 ($45,000 for 2007), or
Your includible compensation for your most recent year of service.
Although, in general, the same limit applies, church employees can choose an alternative limit and there are changes in how church employees, foreign missionaries, and self-employed ministers figure includible compensation for the most recent year of service. This chapter will explain the alternative limit and the changes.
Who is a church employee? A church employee is anyone who is an employee of a church or a convention or association of churches, including an employee of a tax-exempt organization controlled by or associated with a convention or association of churches.Alternative Limit for Church Employees
If you are a church employee, you can choose to use $10,000 a year as your limit on annual additions.
Total contributions over your lifetime under this choice cannot be more than $40,000.
Changes to Includible Compensation for Most Recent Year of Service
There are two types of changes in determining includible compensation for the most recent year of service. They are:
Changes in how the includible compensation of foreign missionaries and self-employed ministers is figured, and
A change to the years that are counted when figuring the most recent year of service for church employees and self-employed ministers.
Changes to Includible Compensation
Includible compensation is figured differently for foreign missionaries and self-employed ministers.
Foreign missionary
If you are a foreign missionary, your includible compensation does not include contributions made by the church during the year to your 403(b) account. If you are a foreign missionary, and your adjusted gross income is $17,000 or less, contributions to your 403(b) account will not be treated as exceeding the limit on annual additions if the contributions are not in excess of $3,000. You are a foreign missionary if you are either a layperson or a duly ordained, commissioned, or licensed minister of a church and you meet both of the following requirements.
You are an employee of a church or convention or association of churches.
You are performing services for the church outside the United States.
Changes to Years of Service
Generally, only service with the employer who maintains your 403(b) account can be counted when figuring your limit on annual additions.
Church employees
If you are a church employee, treat all of your years of service as an employee of a church or a convention or association of churches as years of service with one employer. Self-employed minister. If you are a self-employed minister, your years of service include full and part years during which you were self-employed.
6. Catch-Up Contributions
The most that can be contributed to your 403(b) account is the lesser of your limit on annual additions or your limit on elective deferrals.
If you will be age 50 or older by the end of the year, you may also be able to make additional catch-up contributions. These additional contributions cannot be made with after-tax employee contributions.
You are eligible to make catch-up contributions if:
You will have reached age 50 by the end of the year, and
The maximum amount of elective deferrals that can be made to your 403(b) account have been made for the plan year.
The maximum amount of catch-up contributions is the lesser of
$5,000, or
The excess of your compensation for the year, over the elective deferrals that are not catch-up contributions.
Qualified retirement plans. (To determine if your plan is a qualified plan, ask your plan administrator.)
403(b) plans.
Simplified employee pension (SEP) plans.
SIMPLE plans.
You can use Worksheet C in chapter 9 to figure your limit on catch-up contributions.
7. Excess Contributions
If your actual contributions are greater than your MAC, you have an excess contribution. Excess contributions can result in income tax, additional taxes, and penalties. The effect of excess contributions depends on the type of excess contribution. This chapter discusses excess contributions to your 403(b) account.
Preventing Excess Contributions
To prevent excess contributions, you should figure your MAC at the beginning of each year using a reasonable estimate of compensation. If, at any time during the year, your employment status or your compensation changes, you should refigure your MAC using a revised estimate of compensation.
How Do I Know If I Have Excess Contributions?
At the end of the year or the beginning of the next year, you should refigure your MAC based on your actual compensation and actual contributions made to your account.
If the actual contributions to your account are greater than your MAC, you have excess contributions.
What Happens If I Have Excess Contributions?
Certain excess contributions in a 403(b) account can be corrected. The effect of an excess 403(b) contribution will depend on the type of excess contribution.
Types of excess contributions
If, after checking your actual contributions, you determine that you have an excess, the first thing is to identify the type of excess that you have. Excess contributions to a 403(b) account are categorized as either an:
Excess annual addition, or
Excess elective deferral.
Excess Annual Addition
An excess annual addition is a contribution that is more than your limit on annual additions. To determine your limit on annual additions, see chapter 3 (chapter 5 for ministers or church employees).
In the year that your contributions are more than your limit on annual additions, the excess amount will be included in your income.
Amounts in excess of the limit on annual additions that are due to elective deferrals may be distributed if the excess contributions were made for any one of several reasons, including:
A reasonable error in determining the amount of elective deferrals that could be made under the limit on annual additions, or
A reasonable error in estimating your compensation.
Excise Tax
If your 403(b) account invests in mutual funds, and you exceed your limit on annual additions, you may be subject to a 6% excise tax on the excess contribution. The excise tax does not apply to funds in an annuity account or to excess deferrals.
You must pay the excise tax each year in which there are excess contributions in your account. Excess contributions can be corrected by contributing less than the applicable limit in later years or by making permissible distributions. See Chapter 8 for a discussion on permissible distributions.
You cannot deduct the excise tax.
Reporting requirement
You must file Form 5330 if there has been an excess contribution to a custodial account and that excess has not been corrected.
Excess Elective Deferral
An excess elective deferral is the amount that is more than your limit on elective deferrals. To determine your limit on elective deferrals, see chapter 4.
Your employer's 403(b) plan may contain language permitting it to distribute excess deferrals. If so, it may require that, in order to get a distribution of excess deferrals, you either notify the plan of the amount of excess deferrals or designate a distribution as an excess deferral. The plan may require that the notification or designation be in writing and may require that you certify or otherwise establish that the designated amount is an excess deferral. A plan is not required to permit distribution of excess deferrals.
Correction of excess deferrals during year
If you have excess deferrals for a year, a corrective distribution may be made only if both of the following conditions are satisfied.
You or your employer designate the distribution as an excess deferral to the extent you have excess deferrals for the year.
The correcting distribution is made after the date on which the excess deferral was made.
Correction of excess deferrals after the year
If you have excess deferrals for a year, you may receive a corrective distribution of the excess deferral no later than April 15 of the following year. The plan can distribute the excess deferral (and any income allocable to the excess) no later than April 15 of the year following the year the excess deferral was made. Tax treatment of excess deferrals (not attributable to Roth contributions). If the excess deferral is distributed by April 15, it is included in your income in the year contributed and the earnings on the excess deferral will be taxed in the year distributed.
Tax treatment of excess deferrals attributable to Roth contributions
For these rules, see the regulations under section 402(g).
8. Distributions and Rollovers
Distributions
Permissible distributions
Generally, a distribution cannot be made from a 403(b) account until the employee:
Reaches age 59½,
Has a severance from employment,
Dies,
Becomes disabled,
In the case of salary reduction contributions, encounters financial hardship, or
Has a qualified reservist distribution.
In most cases, the payments you receive or that are made available to you under your 403(b) account are taxable in full as ordinary income. In general, the same tax rules apply to distributions from 403(b) plans that apply to distributions from other retirement plans. These rules are explained in Publication 575. Publication 575 also discusses the additional tax on early distributions from retirement plans. For more information concerning public safety employees, see Publication 575.
Distribution for active reservist
The 10% penalty for early withdrawal will not apply to a qualified reservist distribution attributable to elective deferrals from a 403(b) plan. A qualified reservist distribution is a distribution that is made:
To an individual who is a reservist or national guardsman and who was ordered or called to active duty for a period in excess of 179 days or for an indefinite period; and
During the period beginning on the date of the order or call to duty and ending at the close of the active duty period.
Minimum Required Distributions
You must receive all, or at least a certain minimum, of your interest accruing after 1986 in the 403(b) plan by April 1 of the calendar year following the later of the calendar year in which you become age 70½ or the calendar year in which you retire.
Check with your employer, plan administrator, or provider to find out whether this rule also applies to pre-1987 accruals. If not, a minimum amount of these accruals must begin to be distributed by the later of the end of the calendar year in which you reach age 75 or April 1 of the calendar year following retirement, whichever is later. For each year thereafter, the minimum distribution must be made by the last day of the year. If you do not receive the required minimum distribution, you are subject to a nondeductible 50% excise tax on the difference between the required minimum distribution and the amount actually distributed.
For more information on minimum distribution requirements and the additional tax that applies if too little is distributed each year, see Publication 575.
No Special 10-Year Tax Option
A distribution from a 403(b) plan does not qualify as a lump-sum distribution. This means you cannot use the special 10-year tax option to calculate the taxable portion of a 403(b) distribution. For more information, see Publication 575.