This article discusses preapproved Internal Revenue Code (I.R.C.) § 403(b) plans (403(b) plans), including their advantages, legal pitfalls, and other issues that an eligible employer may consider when determining whether to convert its existing 403(b) plan into a preapproved plan. In March 2017, the Internal Revenue Service (IRS) began issuing advisory and opinion letters to the first preapproved retirement programs described in I.R.C. § 403(b).
This article discusses the following questions:
- What Is a 403(b) Plan?
- What Is a Preapproved 403(b) Plan?
- What Are the Advantages of a Preapproved 403(b) Plan?
- What Are the Legal Pitfalls of a Preapproved 403(b) Plan?
- What Operational Issues Can Arise for a Preapproved Plan?
- What Practical Issues Can Arise for a Preapproved Plan?
- When Should an Employer Adopt a Preapproved 403(b) Plan?
- Can the Employer Cure Past Plan Issues by Adopting a Preapproved 403(b) Plan?
- What Should an Employer Do If It Did Not Comply with the Written Plan Document Requirement in the Past?
For discussion of 403(b) plan requirements, design, and operation, see Section 403(b) Plan Design and Operation. For discussion of 403(b) plans in general, see Employee Compensation and Benefits Tax Guide P 502, 502.14.
What Is a 403(b) Plan?
A 403(b) plan is a type of retirement plan providing for deferred taxation on certain contributions and earnings made by specific kinds of tax-exempt organizations (primarily, public schools and I.R.C. § 501(c)(3) tax-exempt organizations) for their employees and by certain ministers. I.R.C. § 403(b)(1). 403(b) plans are defined contribution plans, with the exception of certain grandfathered church defined benefit plans. 26 C.F.R. § 1.403(b)-10(f)(1).
For the participant, a 403(b) plan appears much like a 401(k) plan in that it provides for an individual account for each participant (except in the case of grandfathered church defined benefit plans). However, 403(b) plans are funded by an annuity contract with an insurance company, a custodial account, or a retirement income account—as opposed to a trust—and investment options are more limited. In addition, 403(b) plans are subject to some but not all of the requirements that apply to 401(k) and other retirement plans qualified under I.R.C. § 401(a).
Public schools and universities and I.R.C. § 501(c)(3) nonprofit organizations have for many years maintained 403(b) plans, sometimes referred to as tax-deferred annuities or tax-sheltered annuities. When I.R.C. § 403(b) was enacted, its provisions were fairly simple. However, over time, 403(b) plans have become more complex, both in the types of plans available and in the legal requirements applicable to them. For example, prior to December 31, 2009, 403(b) plans were not subject to the plan document requirement, which was imposed by regulations issued in 2007. 72 Fed. Reg. 41,128 (July 26, 2007) (the effective date of which was delayed by I.R.S. Notice 2009-3, 2009-1 C.B. 250). Today, they resemble the better-known 401(k) plans.
For more information on the I.R.C. requirements applicable to 403(b) plans, see Section 403(b) Plan Design and Operation.
Requesting IRS Ruling Letters for 403(b) Plans
As the requirements for 403(b) plans have become more complex, employers have often sought assurances from the IRS that their plans meet the legal requirements. At one time, employers would typically obtain ruling letters from the IRS. However, in Rev. Proc. 2013-22, 2013-1 C.B. 985, the IRS announced that it would no longer issue such letters to individual employers. Instead, it would issue only advisory or opinion letters to sponsors of preapproved plans.
The guidance on requesting advisory or opinion letters on preapproved plans is contained in Rev. Proc. 2013-22, as modified by Rev. Proc. 2014-28, 2014-1 C.B. 944, and clarified by Rev. Proc. 2017-18, 2017-5 I.R.B. 743, and Rev. Proc. 2015-22, 2015-11 I.R.B. 754.
What Is a Preapproved 403(b) Plan?
A preapproved plan is a form plan document developed by a plan sponsor for use by at least 15 different employers, except that a church-related organization is eligible to sponsor a 403(b) prototype plan that is intended to be a retirement income account under I.R.C. § 403(b)(9) without regard to the number of eligible employers that are expected to adopt the plan. Rev. Proc. 2014-28, Section 3.02; Rev. Proc. 2013-22, Section 11.01. The plan document will include certain required provisions, but allow for an employer to choose various permissible options. Rev. Proc. 2013-22, Sections 8.04-8.10 and 4.01. A preapproved 403(b) plan may take one of three forms, and can generally be adopted by any eligible employer for any type of 403(b) plan, with certain exceptions, as discussed in the following sections.
What Types of Preapproved 403(b) Plans Are Available?
Employers may choose among three types of preapproved 403(b) plans. Preapproved 403(b) plans may take one of three forms:
- Standardized prototype plans
- Nonstandardized prototype plans
- Volume submitter plans
A prototype plan receives an opinion letter from the IRS if it is found to meet the 403(b) requirements. For a volume submitter plan, the letter is referred to as an advisory letter.
Standardized and Nonstandardized Prototype Plans
A prototype plan (standardized or nonstandardized) takes the form of a basic plan document and an adoption agreement. The basic plan document contains all provisions that are the same for all employers. The adoption agreement contains choices regarding certain plan features, and the employer checks boxes to indicate which features it wants to adopt. For example, the basic plan document might provide for the investment choices available, but the adoption agreement might allow the employer to choose to allow for employee pretax deferrals, employee after-tax contributions, Roth contributions, employer matches, employer mandatory contributions, employer discretionary contributions, or some combination of these.
In the case of a prototype plan, the employer may not make any changes to the plan or the plan will be treated as an individually designed plan. The employer would then lose the protection of the IRS opinion letter issued to the plan sponsor. In some instances, a plan sponsor chooses the prototype form specifically for this reason. For example, a firm that provides an investment platform for the plan may offer a prototype plan document specifying that only the investment options provided in that platform are permissible options for investment by the plan. As another example, a third-party administrator may find administration more efficient if all of its employer clients have the same plan document.
Difference between Standardized and Nonstandardized Plans
A standardized 403(b) prototype plan allows employee salary deferrals. If it allows other types of contributions, the plan must:
- State they will be made for all eligible employees
- Make all benefits, rights, and features of the plan available to all benefiting employees
- Have provisions for allocating employer nonelective contributions that meet I.R.C. § 401(a)(4) design-based safe harbor provisions
- Define compensation in a way permissible under:
- I.R.C. § 415(c)(3) (disregarding I.R.C. § 415(c)(3)(E) (i.e., elective deferrals under I.R.C. § 402(g)(3) and employer contributions not includible in the employee’s gross income by reason of I.R.C. §§ 125, 132(f)(4), or 457)) or
- 26 C.F.R. § 1.414(s)–1(c)
Rev. Proc. 2013-22, Section 6.01.
A nonstandardized 403(b) prototype plan is a plan that doesn’t meet the requirements to be a standardized plan. One example of such a plan would be a 403(b) prototype plan that allows the adopting employer to select (in the adoption agreement) a method for allocating nonelective employer contributions that isn’t an I.R.C. § 401(a)(4) design-based safe harbor, and therefore must meet the I.R.C.’s nondiscrimination testing rules (except in the case of the plan of a public school or university or a church, which are exempt from such testing).
Volume Submitter Plan
A volume submitter plan is based on a sample plan, known as a specimen plan, which can take the form of a basic plan document and an adoption agreement, as with prototype plans. In the alternative, it can take the form of a single plan document from which all provisions not selected by the employer are removed. The latter approach takes more work on the part of the plan sponsor but may be less confusing to the employer.
The major advantage of a volume submitter plan is that an employer is permitted to make changes to the plan, so long as they are not material, without having the plan lose its status as a volume submitter plan. In many instances, a law firm or consultant will offer a volume submitter plan in order to give adopting employers the most flexibility in individualizing the plan.
Employers must take care to ensure that any amendments are not material, so as not to jeopardize the plan’s preapproved status. An employer that makes minor changes to a volume submitter plan can request a determination letter on the modified plan.
Which Types of 403(b) Plans May Use a Preapproved Plan Document?
A 403(b) plan can be a preapproved plan unless it is one of the following types of grandfathered plans:
- Church 403(b) defined benefit plans. Section 251(e)(5) of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97¬248, permitted certain arrangements established by a church-related organization and in effect on September 3, 1982 (TEFRA church defined benefit plans) to be treated as I.R.C. § 403(b) contracts, even though they are defined benefit arrangements, though such arrangements cannot be preapproved plans.
- Self-insured state and local governmental 403(b) plans. Rev. Rul. 82-102, 1982-1 C.B. 62, reversed previous rulings that had permitted certain arrangements that were neither annuities nor custodial accounts to be treated as 403(b) plans. However, it provided that the revenue ruling would not be applied to an arrangement established by an employer on or before May 17, 1982, if (1) the contract(s) issued pursuant to the arrangement (including self-insured arrangements) would have met the requirements of I.R.C. § 403(b) except that the contract(s) was not purchased from an insurance company, and (2) the arrangement covered only current and future employees of that employer. Such arrangements can be individually designed 403(b) plans, but cannot be preapproved plans.
Rev. Proc. 2013-22, Section 13.04. In the case of self-insured state and local governmental 403(b) plans, the employer may wish to modify the plan to provide for investment in annuities or custodial accounts, at least going forward.
If a church wishes to continue to offer a 403(b) defined benefit plan, it will likely have to do so without an IRS approval letter. Even if it already has a ruling on its plan document, it will have to monitor carefully future changes in law, regulations, or administrative guidance to ensure that its plan does not go out of compliance.
What Organizations Sponsor Preapproved Plans?
A wide variety of organizations, ranging from law firms to church benefit boards, sponsor plans. A complete list of those plan sponsors that have applied for IRS opinion or advisory letters can be found here.
What Are the Advantages of a Preapproved 403(b) Plan?
The primary advantages of preapproved 403(b) plans over individually designed plans are:
- Cost. Drafting one plan document for 15 or more employers costs less per employer than drafting a plan just for one employer. The reduction in cost typically gets passed on to the adopting employers. In some instances, a plan sponsor may even offer the plan document free for those employers that use other bundled services (e.g., investment services or third-party administration services).
- Reliance. An advisory or opinion letter from the IRS provides assurances that a plan meets IRS requirements. Even if the IRS later changes its interpretation of a particular legal requirement, it will typically provide retroactive relief to plans that have obtained such letters. In contrast, there is no determination letter program for individually designed 403(b) plans.
- Ability to correct retroactively. If an employer amends its plan document to take the form of a preapproved 403(b) plan, the IRS will allow it to correct certain past errors without penalty. Rev. Proc. 2017-18, Section 3. Because there is no determination letter program for individually designed 403(b) plans, there is no provision for retroactive correction.
- Updates. A plan document must be revised to reflect new legislative, regulatory, and administrative requirements as they are created. As with the initial plan drafting, plan sponsors can amend preapproved plan documents at less cost per employer as compared to the cost associated with drafting amendments for many individual employers.
- Bundled third-party services. A preapproved plan is often part of “one-stop shopping” for the employer. The plan sponsor or an affiliate may also provide investment choices under the plan and third-party administrative services. This saves the employer from having to find different vendors for each of the functions under the plan. In addition, the vendors may be able to operate more efficiently if they need to become familiar with only one plan document, instead of a different one for each employer.
In many instances, employers adopting a preapproved plan assume that if the plan is issued by a well-established sponsor and has an IRS opinion or advisory letter, the employer need not obtain any kind of legal review of the plan. However, as discussed in the following sections, there are a number of legal and practical issues that may arise even if the plan document itself is preapproved.
What Are the Legal Pitfalls of a Preapproved 403(b) Plan?
There are legal pitfalls of a preapproved 403(b) plan. An advisory or opinion letter on a preapproved plan will not cover certain issues:
- The advisory or opinion letter will not cover whether investment agreements such as annuity or custodial account agreements meet all legal requirements, even if they are incorporated into the 403(b) plan document. This issue arose when participants in retirement plans for 12 major universities sued plan fiduciaries, asserting breaches of fiduciary duty arising from allegedly excessive fees for administrative and investment management services, imprudent selection and monitoring of recordkeepers and investment options, underperforming plan investment options, and the offering of too many investment options (leading to decision paralysis on the part of the participants). See Doe v. Columbia Univ. et al. (S.D.N.Y. filed Aug. 16, 2016).
- The advisory or opinion letter will not address whether the plan is subject to the Employee Retirement Income Security Act (ERISA) and, if so, whether it meets ERISA’s requirements
- The advisory or opinion letter will not cover whether the plan operates in such a way as to meet the I.R.C.’s requirements (as opposed to just the plan document meeting such requirements).
Moreover, the advisory or opinion letter merely ensures that the plan meets I.R.C. requirements. It does not ensure that the plan will meet a particular employer’s objectives or that the terms of the plan are understandable or easy to apply. In many instances, employers assume that if a plan is preapproved, they need not obtain any kind of review of the plan before adopting it. This can be risky if, for example, the terms of a plan are not what the employer intended or are so unclear that the employer unwittingly violates IRS or Department of Labor (DOL) rules in operating the plan.
What Operational Issues Can Arise for a Preapproved Plan?
The IRS has identified some common issues that may occur, even if the plan language meets legal requirements. These operational issues include:
- Adoption by an ineligible employer. Nonprofits other than those described in I.R.C. § 501(c)(3), such as unions or trade associations, cannot sponsor 403(b) plans. These failures sometimes occur because of a change in the employer, such as when a private nonprofit hospital that maintains a 403(b) plan is taken over by a government entity that is ineligible to maintain the 403(b) plan.
- Excess contributions, including:
- Violating the 15-year catchup rule under I.R.C. § 402(g)(7) (which permits certain additional 403(b) contributions by employees of an adopting employer who have at least 15 years of full-time service with the same employer if the employer is an educational organization, hospital, home health service agency, health and welfare service agency, church, or convention or association of churches) and
- Violating the maximum aggregate limit on employer and employee contributions (the annual additions limit) under I.R.C. § 415(c). Violation of these limits frequently occurs when an employee participates in more than one 403(b) plan and the employer fails to take account of contributions to one plan when determining the limits on contributions to the other(s).
- Excluding eligible employees from participation:
- Eligible employees include part-time employees who would qualify to participate. With very limited exceptions (e.g., employees who normally work fewer than 20 hours per week), all employees must be permitted to make pretax contributions to a 403(b) plan if any employee is permitted to make such contributions. I.R.C. § 403(b)(12)(i). This is known as the universal availability rule. Compliance with the universal availability rule is especially an issue with casual employees such as substitute teachers, as the hours they will work are impossible to know in advance.
- Contributions other than pretax (or Roth, if permitted) employee contributions must be tested to ensure the employer does not impermissibly discriminate in favor of highly compensated employees under the nondiscrimination rules. I.R.C. § 403(b)(12)(ii). If the employer excludes certain individuals from the calculation of the number of eligible employees under the plan, this will skew the nondiscrimination testing.
Churches are exempt from both the universal availability rule and the nondiscrimination rules by reason of I.R.C. § 403(b)(1)(D), and governmental employers are exempt from the nondiscrimination rules by reason of I.R.C. § 403(b) (12)(C).
Issues with either the universal availability rule or the nondiscrimination rules can arise, for example, if an employer excludes individuals it believes to be independent contractors from the plan and the IRS later determines that such individuals are employees.
- Plan loan issues. Plan loan issues arise when (1) participants fail to make required payments when due, resulting in default of the entire loan; (2) loans are poorly documented; and (3) loans from multiple vendors result in the aggregate of plan loans to one participant exceeding permissible limits. (I.R.C. § 72(p) provides limits on the maximum amount of loans, and I.R.C. § 72(p)(2)(D) provides that all plans of an employer and its controlled group are aggregated for purposes of applying the limits.
- Hardship withdrawal issues. These include failure to obtain documentation of the hardship or distributions from multiple vendors that exceed the amount necessary to relieve the hardship. (I.R.C. § 403(b) requires that distributions not begin before age 591/2, severance from employment, death, or disability, except in the case of hardship. 26 C.F.R. § 1.401(k)-1(d)(3) requires that the determination of the existence of an immediate and heavy financial need and of the amount necessary to meet the need must be made in accordance with nondiscriminatory and objective standards set forth in the plan, and that the amount cannot exceed the amount necessary to relieve the hardship.)
For further discussion of issues related to 403(b) and 457 plans, see Top Ten Issues For IRC 403(b) and 457 Plans.
What Practical Issues Can Arise for a Preapproved Plan?
Even if a 403(b) plan meets all IRS requirements, certain provisions may cause practical pitfalls for the employer. Counsel employers to be mindful of the following issues:
- Plan provider issues. These include issues with responsibilities, indemnification, and resolution of claims against the plan provider. For example, the plan may call for the provider to handle certain administrative requirements. However, if those requirements are not handled in an acceptable manner, participants may sue the employer, but the plan may not give the employer any recourse against the provider or indemnification against liability that the employer may have to participants. Or the plan may provide that such claims must be resolved through arbitration rather than lawsuits or those lawsuits must be filed in the plan sponsor or practitioner’s home state (which may be far from where the employer is located).
- Insufficiency of plan provisions to protect the employer. While the advisory or opinion letter on a plan will generally provide comfort that the plan is qualified in form, it may omit crucial protections for the employer. For example, if the plan document does not give the employer the right to interpret the terms of the plan, a court may hold that provisions have a meaning quite different from that which the employer assumed. In addition, the plan may either omit a statute of limitations on bringing claims for benefits or provide one that is shorter than the maximum statute of limitations available under state law.
- Poor plan communications. Many lawsuits are based on plan communications. An employer with a 403(b) plan subject to ERISA should ensure that the Summary Plan Description (SPD) and all other employee communications accurately describe the essential provisions of the preapproved plan. See, e.g., Burstein v. Retirement Account Plan for Employees of Allegheny Health Education and Research Foundation, 336 F.3d 365 (3d Cir. 2003), in which the court found that when an SPD conflicted with the terms of a plan, the terms of the SPD controlled. In the case of a plan of a public school, the formal SPD requirements do not apply, but the public school maintaining the plan typically uses some form of summary to communicate plan features to participants.
- Failure to correctly identify whether the plan is subject to ERISA and to adopt an appropriate document. Government plans (403(b) plans of public schools or universities) are exempt from ERISA. Church plans are exempt from ERISA unless they have made an election to be covered by it. ERISA § 4 (29 U.S.C. § 1003). The 403(b) plans of other nonprofits are subject to ERISA unless they provide only for employee deferrals and have minimal levels of employer involvement. 29 C.F.R. § 2510.3-2(f).
Use of a non-ERISA 403(b) plan document for an ERISA plan, or use of an ERISA plan document for a non-ERISA plan, can create problems for the employer. An ERISA 403(b) plan is subject to a variety of reporting, disclosure, fiduciary, and prohibited-transaction rules. If an employer adopts a plan document designed for a non-ERISA plan when its plan is subject to ERISA, it may not be aware of the ERISA requirements with which it needs to comply. Conversely, if an employer adopts a plan document designed for an ERISA plan when its plan is not subject to ERISA, it may contractually subject itself to requirements with which it would not otherwise be required to comply. This can be a particularly serious issue in the case of the prohibited transaction requirements of ERISA § 406 (29 U.S.C. § 1106). Prohibited transactions requirements prohibit certain transactions between a plan and certain closely related entities. A plan that is subject to such requirements under ERISA can apply for an exemption from the DOL, whereas a plan that is subject to them under contract may be unable to escape them at all.
For a checklist describing ERISA prohibited transactions, see Checklist—Identifying ERISA Prohibited Transactions and Parties In Interest.
When Should an Employer Adopt a Preapproved 403(b) Plan? The IRS issued the first opinion and advisory letters on preapproved plans in March 2017. Rev. Proc. 2017-18, 2017-05 I.R.B. 743, announced that employers have until March 31, 2020 to convert their 403(b) plans to preapproved form.
Best Practice Is to Adopt a Preapproved 403(b) Plan Early There are advantages to adopting early. A 403(b) plan is required to operate in accordance with IRS requirements, even if the plan document has not yet been amended to incorporate such requirements. To prevent the confusion that can result if the rules under which the plan must operate differ from what is stated in the plan document, an employer will typically want to use the preapproved document as soon as possible.
Can the Employer Cure Past Plan Issues by Adopting a Preapproved 403(b) Plan?
Rev. Proc. 2013-22, as clarified by Rev. Proc. 2017-18, announced relief for an employer that adopted a formal written document in order to satisfy the written plan requirements in the 403(b) regulations by the later of January 1, 2010, or the plan’s effective date. Such an employer can retroactively correct defects in the form of its plan by either adopting a 403(b) preapproved plan or otherwise amending its 403(b) plan on or before March 31, 2020.
What Should an Employer Do If It Did Not Comply with the Written Plan Document Requirement in the Past?
If the organization did not have a written plan document by the deadline, the IRS will permit the issue to be corrected using the principles of the Employee Plans Compliance Resolution System (EPCRS). The details of EPCRS can be found in Rev. Proc. 2016–51, 2016-42 I.R.B. 465.
For further discussion of correction of 403(b) plan errors under EPCRS, see Section 403(b) Plan Design and Operation — Correcting 403(b) Plan Errors.
Consult Legal Counsel to Avoid IRS and DOL Scrutiny
Preapproved 403(b) plans can provide significant advantages to nonprofit employers and public schools and universities. However, they do not provide complete assurances that once it is in operation, the plan will meet IRS requirements or that it will meet employer needs. Legal advice is still critical to avoid both IRS and DOL scrutiny and potential participant lawsuits.