I agree with the others - this seems wrong. I even doubt the legality of such a contribution.
That's messed up. It doesn't scale. In theory if your gross pay was low enough and your contributions high enough they could be contributing $0!
Because of this implication, that would mean that they would be giving higher salaried people a much greater percentage match than those who make far less. I believe that would fail discrimination testing - I don't think it's legal to give people a different percent match. You either give them the same match or none at all.
I recently read all of the US statutes on retirement schemes. Suffice it to say that they are very complicated and contain many exceptions and exceptions to the exceptions. However, fully digesting all those statutes did give me a much more advanced understanding of these plans. For example, did you know that there's no such thing as a 401(k) plan? The plan is actually authorised by § 401(a), and § 401(k) just provides that a 401(a) plan can have certain characteristics and still remain a 401(a) plan.
As for this topic, the starting point is the statute authorising the plan in question, 26 USC § 403(b). The nondiscrimination requirement is initially found in 26 USC § 403(b)(1)(D), which provides that, except for a plan purchased by a church, the 403(b) plan must meet certain nondiscrimination requirements found in 26 USC § 403(b)(12). Note that churches (as defined in the statute) are exempt from the nondiscrimination requirements, so if the OP's employer is a church, he can stop reading here.
Assuming the employer is not a church, 26 USC § 403(b)(12) sets out the nondiscrimination requirements for the plan. This section contains another exemption in 26 USC § 403(b)(12)(C), which provides that a governmental plan maintained by a state or local government or political subdivision thereof or agency or instrumentality thereof, is exempt from almost all of the nondiscrimination requirements (including all requirements that might be relevant to this thread). So, if OP's plan is operated by such a governmental entity, OP can again stop reading.
If we cleared those possible exemptions, there is yet another exemption found in the "flush language" of 26 USC § 403(b)(12), which exempts from the nondiscrimination requirements an employee who is a participant in another form of retirement plan offered by the employer (including, say, a 401(k) plan). There are some other possible exemptions from the nondiscrimination requirements, including nonresident aliens with no income from sources within the US, people who normally work less than 20 hours per week, and certain students. If OP falls into any of these various exemption categories, none of the potentially relevant nondiscrimination requirements apply.
If OP managed to clear all
those exceptions, then we get to the substantive nondiscrimination requirements described principally in 26 USC § 403(b)(12)(A)(i). This paragraph first exempts from the nondiscrimination requirements any contributions "made pursuant to a salary reduction agreement". The statute does not define the term "salary reduction agreement", but 26 CFR 1.403(b)-5(2) says that the nondiscrimination requirements do not apply to elective deferrals. So now we have narrowed down the possible application of the nondiscrimination rules to the employer contributions, and only if all of these other exemptions have been cleared.
As for the employer contributions to which the nondiscrimination requirements apply, they have to meet basically four separate tests.
The first test is found in 26 USC § 401(a)(4) (and 26 CFR 1.403(b)-5(1)(i)), which says that the "the contributions or benefits provided under the plan [cannot] discriminate in favor of highly compensated employees". However, that paragraph is subject to 26 USC § 401(a)(5)(B), which says that a plan is not discriminatory for the purpose of this test merely because contributions made by the employer "bear a uniform relationship to the compensation" within the meaning of 26 USC § 414(s). Finally, we get to the kicker, which is that 26 USC § 414(s)(2) says that for the purpose of the exception that contributions can be proportional to compensation without being discrimination, the employer does not need to consider the portion of salary which was deferred as part of compensation. In other words, the scheme described by the OP is
not discrimination within the meaning of 26 USC § 401(a)(4). However, that is just the first test; I mentioned there were four.
The second test is found in 26 USC § 401(a)(17) (and 26 CFR 1.403(b)-5(1)(ii)), which provides that compensation taken into account by the plan cannot exceed $200,000 per employee, adjusted for inflation for each year after 2001. That test does not appear relevant to this thread.
The third test is found in 26 USC § 401(m) (and 26 CFR 1.403(b)-5(1)(iii)), which places an upper limit on the amount of employer contribution. Given that the complaint in this thread is with the employer not matching enough (rather than matching too much), this test is also irrelevant for our purposes. (Note that for 401(a) plans (and thus, 401(k) plans), this provision also limits the amount of employee contributions. However, this part of the test does not apply for 403(b) plans.)
The fourth and final test is found in 26 USC § 410(b) (and 26 CFR 1.403(b)-5(1)(iv)), which provides that the plan must meet one of three subtests. It only has to meet one, not all three. The three alternative subtests are the following:
- "The plan benefits at least 70 percent of employees who are not highly compensated employees." [26 USC § 410(b)(1)(A)]; or
- At least (x*0.7)% of non-highly-compensated employees benefit from the plan, where x is the percentage of highly compensated employees who benefit from the plan [26 USC § 410(b)(1)(B)]; or
- Among other things, "the plan benefits such employees as qualify under a classification set up by the employer and found by the Secretary not to be discriminatory in favor of highly compensated employees" [26 USC § 410(b)(1)(C)].
So, if the plan already satisfies subtest (1) or (2) above -- and it might very well -- then it's game over, and the plan is legal. However, if the plan fails subtests (1) and (2), then subtest (3) appears the most hopeful ground for making an argument against the legality of the plan, as it's very vague. Under this third alternative subtest, you would merely have to argue that the scheme outlined in OP is a classification scheme that is discriminatory in favor of highly compensated employees. The term "highly compensated employee" is a technical term defined in
26 USC § 414(q).
Given the language "found by the Secretary" in the third alternative subtest, if your employer is intending to rely on this subtest, they may have already obtained a private letter ruling from the IRS that rules that the plan is not discriminatory. Pursuant to 26 USC § 6110, such written determinations are open for public inspection and the IRS
publishes them on its website, but it often redacts company names and other identifying information so even if such a ruling exists, you may not be able to find it.