Since the summer of 2007 when the Internal Revenue Service (IRS) published final regulations under Section 403(b) of the Internal Revenue Code, not-for-profit employers have been faced with various challenges and compliance deadlines with respect to their 403(b) arrangements, including (i) identifying orphaned contracts and entering into information sharing agreements, (ii) clarifying the allocation of responsibilities under the contracts with the issuers, (iii) drafting and adopting plan documents, and most recently, (iv) completing the first full Form 5500 with an audit.
Each of these tasks has helped employers define what is within (and what falls outside of) their 403(b) plans, whether or not the plan is subject to ERISA. An employer’s understanding of the scope of its 403(b) plan will be necessary if and when the employer desires to terminate the plan, as described in the most recent phase of IRS guidance. IRS Revenue Ruling 2011-7, published earlier this month, discusses the steps required to terminate a 403(b) plan.
Employer’s Steps in Terminating a 403(b) Plan
As a threshold matter, a significant impediment for many employers wanting to terminate a 403(b) plan may be the 24-month prohibition, reiterated in Revenue Ruling 2011-7, from contributing to another 403(b) contract 12 months before and 12 months after distribution of all of the assets under the terminated plan. There is a limited exception if fewer than 2% of the employees who were eligible under the terminating plan are eligible under another 403(b) plan. However, assuming the employer clears this hurdle and the 403(b) plan document allows for termination of the plan, the employer first must select a termination date and adopt a binding resolution to:
- cease future purchases of annuity contracts under the plan and terminate the plan effective on the selected termination date,
- provide for 100% vesting of any employer contributions as of the termination date, and
- direct all benefits to be distributed as soon as practicable after the termination date.
Two notices must then be distributed in connection with the termination of a 403(b) plan. First, all participants and beneficiaries in the plan must be notified of the plan termination, which may raise the challenge of locating missing participants that exists in any plan termination. Second, when the assets are distributed, as described below, employees must be notified of their rollover rights. (Former employees received a rollover notice when they terminated employment). Finally, the employer must file a final Form 5500 if the plan is subject to ERISA.
The assets in a 403(b) plan funded through individual contracts, a group contract, and/or custodial account will remain sheltered from tax after the plan’s termination until withdrawn by the participant or beneficiary if they are distributed in the following forms:
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Insurer’s and Regulated Investment Company’s Role in Termination of a 403(b) Plan
The insurance carriers and custodial account providers also have a role in 403(b) plan terminations, e.g., permitting rollover distributions and ensuring the contracts following termination remain in compliance with Code Section 403(b) as it existed on the date of the plan’s termination. However, ongoing administration of the contracts as terminated will not involve the same responsibilities required under an active plan, as no further contributions will be made to the contracts. This will eliminate the need to monitor contribution limits or sign new information sharing agreements to verify employment status or coordinate loan applications.
A Few Remaining Questions
An outstanding question remains how Revenue Ruling 2011-7 applies to plans that are exempt from ERISA under Department of Labor’s exemption for voluntary, salary deferral only contracts. An employer may have difficulty directing a distribution under an individual contract, particularly a voluntary non-ERISA contract under which the employer has no authority or role beyond remitting salary deferrals. However, as noted above, delivery of a fully-paid individual annuity contract suffices as a “distribution” for a plan funded by individual 403(b) contracts and thus would appear to accommodate an employer’s desire to terminate a non-ERISA plan within the bounds of the individual’s contract rights.
Additionally, when a plan funded with a group annuity contract is terminated and each participant receives a certificate evidencing his or her fully-paid benefit under the group contract, is the employer still the contract-holder after termination? If so, does it have any residual responsibilities under the contract following the plan’s termination?
We look forward to the continued development of this next phase of 403(b) guidance.