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IRS Issues Final 403(b) Regulations
Courtesy of By Fritz Richter, III September 2007 On July 26, 2007, the Internal Revenue Service (IRS) issued final regulations providing long-needed guidance on 403(b) annuity plans offered to employees of public schools and certain tax-exempt organizations. The final regulations generally adopt the provisions of proposed regulations issued by the IRS on November 16, 2004 (see the January 2005 issue of Benefits & Compensation Law for Nonprofits), but also add and clarify rules applicable to 403(b) plans. The issuance of these final regulations is welcome news. The last time the IRS issued comprehensive 403(b) regulatory guidance was over 40 years ago in 1964. A key goal of the final regulations is to make 403(b) plans more like 401(k) plans, while maintaining the unique features and advantages available under 403(b) plans that are not available under 401(k) plans. This article discusses the highlights of the final regulations, as well as related Department of Labor (DOL) guidance and new IRS controlled group rules applicable to tax-exempt organizations. These highlights include the following:
Universal Availability Rule The universal availability rule generally requires 403(b) plans that permit employee salary deferral elections to make such elections available to all employees. Certain employees may be excluded, including students, employees who usually work less than 20 hours a week, and employees eligible to make elective deferrals under 401(k) and 457(b) plans. However, the final regulations eliminate the ability to exclude certain groups of employees, including employees covered by a collective bargaining agreement, visiting professors, and employees who have taken a vow of poverty. Written Plan Document The final regulations require a 403(b) plan to be maintained pursuant to a written document. Related documents, such as the annuity contract, may be incorporated by reference. The 403(b) plan document must contain all of the terms and conditions for eligibility, limitations, and benefits under the plan. The DOL issued guidance at the same time as the final regulations to alleviate any concern that this written plan document requirement would make 403(b) plans not previously subject to the Employee Retirement Income Security Act of 1974 (ERISA) subject to ERISA. To avoid ERISA, sponsors of non-ERISA 403(b) plans need to make sure that they continue to operate such plans in compliance with the special DOL safe harbor. Transfer of Investment Contracts Currently, transfers of 403(b) investment contracts are governed by IRS Revenue Ruling 90-24, which requires little or no employer involvement. The final regulations change this effective September 24, 2007. Under the final regulations, transfers of investment contracts within the same plan are permitted in the following circumstances:
Plan-to-plan transfers are permitted if the following conditions are satisfied:
Termination of 403(b) Plans The final regulations confirm that 403(b) plans may be terminated. This is a fundamental change from current law, which imposes significant restrictions on terminating such plans. An employer that terminates a 403(b) plan must distribute benefits as soon as administratively reasonable and generally cannot contribute to another 403(b) plan for the 12-month period before or the 12-month period following the date the plan is terminated. Incidental Life Insurance Under the final regulations, incidental life insurance may no longer be provided under a 403(b) plan. Certain existing life insurance benefits are grandfathered. Distribution Limits Currently, the tax code imposes limits on distributions of amounts attributable to salary deferral elections and amounts contributed to certain 403(b) custodial accounts. Distribution restrictions generally do not apply to other amounts, including matching contributions held in 403(b) plans. However, the final regulations impose new limits on the distribution of those amounts, allowing them only after severance of employment and the occurrence of a specified event such as the attainment of a certain age, the completion of a fixed number of years of service, or disability. Catch-Up Contributions A 403(b) plan may permit employees to make two types of special "catch-up" contributions. These are the special contributions available to employees who attain age 50 (similar to the 401(k) plan rule) and the special contributions available to employees who complete 15 years of service. The final regulations clarify that the 15 years of service contributions are applied first in the case of an employee eligible to make both types of contributions. Employer Contributions The final regulations provide that the nondiscrimination rules applicable to matching and other employer contributions made to 401(k) and other qualified plans apply in equal force to 403(b) plans. Sponsors of 403(b) plans may no longer rely on the safe harbors and other guidance provided under IRS Revenue Procedure 89-23. Controlled Group Rules In addition to the final 403(b) regulations, the IRS regulatory package included final regulations that confirm how the controlled group rules apply to tax-exempt entities. The final regulations adopt the "board control test." Under this test, control by one tax-exempt entity of at least 80 percent of the board members of another tax-exempt entity will result in the two entities being treated as a single employer. This has potentially significant ramifications under IRS nondiscrimination, eligibility and vesting service, and other rules applicable to all benefit plans (not just 403(b) plans) maintained by tax-exempt entities. Conclusion The final regulations provide welcome clarification of issues long encountered by employers and vendors in connection with their 403(b) plans. The regulations also make some important changes to the rules applicable to such plans to make them operate more like 401(k) and other qualified plans, including more employer involvement and administrative responsibility. To ensure compliance with the final regulations, employers will need to review their 403(b) plans, including document and operational requirements, and examine their relationships with vendors. The regulations are generally effective for tax years beginning after December 31, 2008. Later effective dates apply for certain church, public school, and collectively bargained 403(b) plans. There are also several transition and "grandfather" rules and some earlier effective dates. The final regulations may be relied on before the generally applicable effective dates in "good faith," if such reliance is consistent and reasonable. Advisory Board member Fritz Richter is a partner in the Employee Benefits and Executive Compensation Practice Groups of Bass, Berry & Sims PLC, a law firm with offices in Nashville (Downtown and Music Row), Knoxville, and Memphis, Tennessee. He can be reached at frichter@bassberry.com. Copyright © 2007 M. Lee Smith Publishers LLC. This article is an excerpt from Benefits and Compensation Law for Nonprofits (ISSN 1525-8025). Benefits and Compensation Law for Nonprofits is designed to provide accurate and authoritative information in regard to the subject matter covered. It is published with the understanding that neither the author(s) nor its publisher is engaged in rendering legal, accounting, or other professional services through its pages. If legal advice or other expert assistance is required, the services of a competent professional should be sought. (From a Declaration of Principles jointly adopted by a committee of the American Bar Association and a committee of Publishers and Associations.) Additional Resources Newsletters for people who really need to know about benefits: |
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