By December 31, 2008, all Code Section 403(b) tax-sheltered annuity plans (also known as 403(b) annuities, or tax-deferred annuities, and referred to in this article as a “403(b) Plan”) must be reviewed and will likely need to be amended to ensure compliance with the final Code Section 403(b) regulations. If you have not already started this process, action to review and amend your 403(b) Plans must begin soon in order to meet the December 31, 2008, deadline (note that this article assumes a calendar year plan).
This advisory reminds employers eligible to offer a 403(b) Plan (including unwritten non-ERISA 403(b) arrangements) about action items that must be completed in 2008, and also provides some highlights from the final Code Section 403(b) regulations.
On July 26, 2007, the Internal Revenue Service published final regulations applicable to 403(b) Plans available to employees of public schools and Code Section 501(c)(3) tax-exempt organizations. The regulations finalize proposed regulations from 2004 and represent the first comprehensive guidance issued under Code Section 403(b) since 1964.
The final regulations are generally applicable for taxable years beginning after December 31, 2008. There are some delayed effective dates for 403(b) Plans offered under collective bargaining agreements, for governmental 403(b) Plans (i.e. school districts) and for 403(b) Plans offered by certain church organizations. Certain transition rules for some requirements may also be available.
What Must Be Done in 2008?
1. Review all 403(b) Plans, including annuity contracts and custodial agreements.
Plan sponsors and employers must identify all 403(b) Plans, including annuity contracts and custodial account agreements. Employers must review each plan for compliance with the final Section 403(b) regulations.
2. Draft 403(b) Plan documents or prepare amendments to existing 403(b) Plans to ensure compliance by 1/1/09.
As discussed in more detail below, all 403(b) Plans must have a written plan document as of January 1, 2009. All 403(b) Plans must be compliant with the requirements of the final regulations by January 1, 2009.
Based on our experience, we believe that many, if not all, 403(b) Plans will need to be amended for compliance with the final regulations. The process of reviewing 403(b) Plans and preparing the amendments or restated plans can take time. Employers must leave sufficient lead time to seek board approvals, where necessary, and to adopt the required plan documents and amendments.
3. Review administrative procedures with respect to existing 403(b) Plans to ensure that all 403(b) Plans will comply operationally with the final regulations effective 1/1/09.
In addition to ensuring 403(b) Plan documents comply with the final regulations, each 403(b) Plan must be operated and administered in compliance with the final regulations, effective January 1, 2009. Employers should review administrative procedures to update them for the requirements of the final Code Section 403(b) regulations.
Highlights of the Final Code Section 403(b) Regulations
- Written Plan Document Requirement
The final regulations require that all 403(b) Plans (including non-ERISA 403(b) Plans) be maintained pursuant to a written plan document. The written plan document must contain all material terms and conditions of the 403(b) Plan including provisions regarding eligibility, benefits, applicable limitations and distributions. The written document can incorporate other documents (such as the annuity contracts or custodial accounts) by reference. To assist employers with meeting this written plan requirement, the IRS has issued Revenue Procedure 2007-71, which contains a model Code Section 403(b) plan document applicable for public educational institutions.
The Department of Labor issued Field Assistance Bulletin 2007-02, confirming that a 403(b) Plan can comply with the new written plan requirements and still qualify as a non-ERISA 403(b) Plan. Generally, sponsors of non-ERISA 403(b) Plans must continue to disassociate themselves from the operation of the plan, but must also establish a plan document that satisfies the final regulations.
- Contract Exchanges and Transfers
Prior to the final regulations, exchanges of investment contracts in a Code Section 403(b) Plan were governed by Revenue Ruling 90-24. The final regulations eliminate exchanges under Revenue Ruling 90-24 after September 24, 2007.
The final regulations permit non-taxable transfers from one 403(b) Plan to a 403(b) Plan of a different employer, provided that certain requirements are met. The 403(b) Plans must each permit the transfer, the individual’s benefit after the transfer must be at least as great as before the transfer, and the new 403(b) Plan must contain distribution restrictions that are not less stringent than the former 403(b) Plan.
Contract exchanges within the same 403(b) Plan are also permitted under the final regulations, provided that requirements similar to those for plan-to-plan transfers are met. In addition, contract exchanges require that the employer must enter into an agreement with the issuer of the new contract to ensure the exchange of certain information related to tax compliance requirements.
- Universal Availability and Nondiscrimination Rules
403(b) Plans are generally subject to a “universal availability” requirement. This requirement, with a few exceptions, provides that all employees must be permitted to make salary deferral elections into a 403(b) Plan if any employee of the employer is permitted to do so. The final regulations make some changes to the universal availability requirements, including eliminating the ability to exclude from participation in a 403(b) Plan certain classes of employees who were previously excludable, such as (i) employees covered by a collective bargaining agreement, (ii) visiting professors, (iii) members of a religious order who have taken a vow of poverty and (iv) employees who elect to participate in a governmental plan described in Code Section 414(d), instead of in the 403(b) Plan. The elimination of these exclusions is phased in until 2010.
- Controlled Group Rules
The final 403(b) regulations also impose new controlled group rules on tax-exempt entities (other than churches and governmental agencies). In general, control by one organization of 80 percent or more of the board members of another organization will cause the organizations to be treated as a single employer for benefit plan purposes. This means that nondiscrimination tests and other code-imposed limits will have to be applied across both organizations as if the two organizations were a single employer. Additionally, vesting service and plan eligibility may need to be tracked across multiple organizations.
The final regulations also provide that if certain requirements regarding day-to-day coordination of an organization’s tax-exempt activities are met, the organizations, though not required to, may permissively aggregate themselves and treat themselves as a single employer for benefit plan purposes.
These requirements have important implications for all tax-exempt organizations that extend beyond the 403(b) arena. All tax-exempt organizations should review these controlled group or common control requirements to determine the impact, if any, on their benefit plans and employees.