August 7, 2007

403(b) Plans: Are You Ready for Some Fun?

At long last, the IRS has issued final 403(b) regulations. These regulations have been in the making for quite some time. The good news is that these rules generally do not apply until January 1, 2009, with some exceptions. This gives employers a little bit of time to get prepared for these regulations.

Plan Documentation and Administration

One of the biggest requirements of these regulations is that 403(b) plans must have a plan document. Historically, 403(b) plans were not required to have a plan document, unless the plan was subject to ERISA. The plan document must describe eligibility, as well as describe the allocation of administrative responsibility between the employer and third party providers. The plan must specify who has responsibility for tax compliance; this responsibility must rest with the employer or with a third party.

The regulations make it clear that the plan document can be comprised of other documents that are incorporated by reference, though there must be one umbrella document. The IRS has indicated that it intends to issue model 403(b) plan provisions available for use by public schools. It is not clear when these model provisions will be issued.

The regulations clarify that if an employer sponsors multiple plans, the employer is responsible for making certain that the 402(g) elective deferral limits are not exceeded.

An employer is also responsible for making sure that contributions are invested within a reasonable time, following the time they are withheld from the employee’s pay, such as by the 15th of the month following the month in which they are withheld.

Discrimination and Universal Availability

The regulations make it clear that 403(b) plans are subject to nondiscrimination rules, similar to those applicable to 401(k) plans. These rules do not apply to state and local public schools.

The universal availability standards apply to elective deferrals. The universal availability standard requires that if the plan allows elective deferrals, this option must be made available to all participants, with limited exceptions:

  • Collective bargaining employees;

  • Visiting professors;

  • Government employees who make a one-time election to participate in a government plan that is not a 403(b) plan; and

  • Employees who work under a vow of poverty.

The regulations also clarify that elective deferrals can be designated as Roth contributions.

Catch-up Rules

The regulations clarify the order of determining catch-up contributions: contributions first go toward the special 15-years of service catch-up; and then, to the special aged-50 or older catch-up contribution.

Plan Termination

Historically, it has not been possible to terminate a 403(b) plan and distribute plan assets. The plan had to be frozen and treated accordingly. These regulations provide that a plan can be terminated, and distribution of plan assets can be made.

Determination of a Control Group

These regulations clarify how to determine "control" for purposes of determining single employer status. For purposes of not-for profit entities, the 80% control rule applies. This means that if one board controls at least 80% of another, the entities are considered to be a control group.

Distributions Upon Severance

The regulations clarify when a severance from employment occurs, warranting a distribution. For example, a severance from employment occurs when an individual no longer works for an employer who can sponsor a 403(b) plan, even if the individual moves to another member of a control group, such as a for-profit entity that cannot sponsor a 403(b) plan.

Post-termination Contributions

The regulations clarify that an employer can make post-termination contributions to a 403(b) plan without running afoul of the IRC Section 409A deferred compensation regulations. The employer can make these kinds of contributions during the tax year in which the termination occurs, plus the five following tax years. No contribution can be made after the death of the plan participant.

Contract Exchanges and Plan-to-Plan Transfers

The regulations delineate when a contract exchange will be considered a change of investment. The requirements for a contract exchange within the same plan are:

  1. The plan must provide for the exchange;

  2. The participant has an accumulated benefit following the exchange that is at least equal to the accumulated benefit prior to the exchange;

  3. The distribution restrictions in the other contract cannot be less stringent than those imposed on the current contract; and

  4. The employer must agree to provide the issuer pertinent information, such as whether severance from employment has occurred for purposes of distribution, or other information to satisfy tax requirements.

The regulations also permit, if certain conditions are satisfied, a plan-to-plan transfer from one 403(b) plan to another 403(b) plan. The requirements for a plan-to-plan transfer are:

  1. The participant is an employee, or former employee, of the employer for the receiving plan; or, in the event of a transfer for a beneficiary of a deceased participant, the participant was an employee or former employee of the employer for the receiving plan;

  2. Both plans include provisions allowing such transfers;

  3. The participant whose assets are being transferred has an accumulated benefit immediately following the transfer that is at least equal to the accumulated benefit prior to the transfer; and

  4. The receiving plan imposes distribution restrictions that are no less stringent than those imposed by the transferor plan.

These are just some of the highlights of copious pages of regulations. While 2009 might deem a bit far away, time for preparation is now.


The information contained in this Benefit Beat is not intended to be legal, accounting, or other professional advice, nor are these comments directed to specific situations.

As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this Benefit Beat is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.

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