The IRS has issued new regulations under Section 403(b) of the Internal Revenue Code of 1986, as amended (the “Code”), which will, effective January 1, 2009, impose significant new burdens on tax-exempt employers that offer a tax-sheltered annuity plan for their employees. The new regulations make employers responsible for the plan’s compliance with all the tax rules under Code section 403(b) — even for those plans that are purely voluntary and have no employer contributions. The new rules are complex and burdensome and will create new exposures for employers.
Among other new demands, the regulations will require that all 403(b) plans have a written plan document that accurately sets forth all key plan provisions and reflects all applicable legal requirements. Even plans that are not subject to ERISA will be required to have accurate and complete written plan documents. Those plan sponsors that do not have written plan documents will find this development to be a demanding task. Those plan sponsors with plan documents will also have significant challenges, including updating their documents to comply with all of the requirements of the new regulations, to reflect accurately the terms and operation of the plan, and to avoid conflicts with the annuity contracts and custodial account agreements that fund plan benefits.
The new regulations require plan sponsors to assume primary responsibility for ensuring that their plans comply in form and operation with all applicable legal requirements. Gone are the days when an exempt organization could simply rely on vendors to address compliance with such matters as contribution limits, distribution and withdrawal rules, and loan requirements. Ensuring compliance will require employers to compile, maintain, and coordinate scores of data for which they were not previously responsible. The new regulations will require employers to play such a key role in plan administration and compliance that virtually no 403(b) plans (other than governmental and church plans) will be able to qualify as exempt from ERISA — even if the only contributions to those plans are voluntary employee contributions.
The new regulations also require that the plan sponsor have either service agreements or “information sharing agreements” with any vendor that will hold or receive plan assets. Many exempt organization employers are already inundated with demands by 403(b) vendors to sign vendor-drafted information sharing agreements. With regard to the information sharing agreements, we recommend caution — particularly before the employer has made all of the critical design decisions required to bring its plan into compliance. While vendors often present these agreements as mere formalities required to continue plans, they are binding legal contracts that may include terms that can put employers and their plans at a disadvantage. Additionally, there are some circumstances under which these agreements are not even necessary. A plan sponsor should read any proposed agreement very carefully and consult with qualified counsel before signing it.