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toby

Sick Leave Payouts

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I was told that one can transfer a sick leave payout or a lump sum payout of accumulated comp time directly to a 403 b either at retirement or upon termination of employment and thus defer taxes and avoid the employer and employee fica taxes. Is this true and if so what are the requirements and the IRS code section that authorizes it?

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Guest Chuck Yanikoski

What you were told is true, sometimes. It's more complicated and fuzzier than that, though.

 

The timing of the severance/sick pay is a key issue. If it is being spread over time, then the IRS will consider it to be deferred compensation, and you could NOT take elective deferrals from it. The pay needs to be made available to you "as soon as administratively possible" in order to be considered salary from which elective deferrals to a 403(b) can be made.

 

You also have to watch the contribution limits. You may contribute up to 100% of "includible compensation," but the latter equals an amount that includes ONLY your regular pay during your last full year of service (i.e., it may include your earnings during more than one calendar year if you worked part-time or only a partial year of service in the year you retired). This amount includes severance/sick pay only to the extent that those amounts are attributable to (were earned in) your final year of service as defined above. But that is just for purposes of calculating the total amount you can contribute in your last year of service. If while you were still working you contributed less than the maximum, you can use some or all of your severance/sick pay to make up the balance, even if most of the severance/sick money is not itself adding to the permissible total contribution. That is, it can be the source of the funds, even if it is not itself "includible income."

 

Another possibility is for the employer to contribute to your 403(b) IN PLACE OF severance/sick pay. But this is a more complicated arrangement, with other rules.

 

You will not find these things spelled out specifically in the tax code or the regulations. Some of it may be spelled out later this year in expected new regulations from the IRS, but for now, it is not a matter of doing what the rules specify as it is doing what the rules PERMIT, and doing it in a way that reflects current IRS practices.

 

Kristi Cook and Ellie Lowder are two people I know who deal with these questions a lot. If you want to pay for expert advice, I would suggest going to one of them.

 

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Chuck: Thanks for your reply. It confirmed my research that this is not a cut and dried issue. There may also be a problem with changing your contribution election during the plan year; I understand that this can only be changed at the beginning of the plan year.

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Guest Chuck Yanikoski
Chuck: Thanks for your reply. It confirmed my research that this is not a cut and dried issue. There may also be a problem with changing your contribution election during the plan year; I understand that this can only be changed at the beginning of the plan year.

There used to be a rule that only one election could be made in a year, but Congress changed that several years ago so that now, as far as the Federal Government is concerned, there is no limit to how many times you may change your elective deferral amount. However, your plan or your product vendor may have more restrictive rules.

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