The IRS has made it clear: the effective date for the new 403(b) regulations will not change. Tax exempt organizations will need to have compliance programs underway by January 1, 2009. There is a lot of confusion in the 403(b) marketplace right now, so we thought we'd share with you a simple "to do" list to help you understand what needs to be done before the end of 2008. We're also providing a short, non-technical explanation of the potential risks of these new rules.
403(b) "To-Do" List
- Get a written plan document. The IRS has said that if a written plan document is not in place by January 1, 2009, employee contributions to your 403(b) plan will not be considered tax deductible. This is the case even if your plan is not covered by ERISA. There are also a few new design choices you need to make because of the new rules. The plan doesn't have to be complicated, but it has to be right. Be careful if you are using a plan provided by a vendor, as we are finding some problems with them.
- Select Vendors and Sign Service Agreements. The new rules require you to monitor compliance with the 403(b) regulations, including employee contributions. Many vendors offer this service, and you will need to enter into a service agreement to protect yourself. It's also not a bad time to weed through your vendors and see which ones you really want to use.
- Determine what contracts are in the plans and which are not. You will not be responsible for every old 403(b) contract that your employees may have bought while employed with you. Work with your vendor to figure out which contracts you will be responsible for, and which ones you will not.
- Review excluded classes of employees. The rules allowing you to exclude employees from your plan have changed. If you are excluding anyone from your plan, seek legal counsel or talk to your vendor to make sure you're not excluding improperly.
- Distributions and loans. The rules governing hardship withdrawals, withdrawals of employer contributions, and the taking of loans have all dramatically changed. They all now require a new level of employer involvement. You need to decide if you want to offer these features, and how.
- Deposit Rules. Under the old rules, only ERISA plans had a requirement that the employee payroll deductions be deposited into the plan by a certain time. Now the IRS says non-ERISA 403(b) plans must do the same, or risk the plan's 403(b) status.
New 403(b) Risks
The new 403(b) rules bring with them a whole host of mind-numbing technical details. Though the rules themselves may be hard to understand, the risks they bring are much clearer. Below we describe four key risks for which to be "on alert":
Risk 1: New compliance duties. Employers' new compliance functions include maintaining a written plan document which complies in form and operation with the new regulations; requires you to monitor contributions and distributions; and mandates you enter into, and maintain specific information sharing agreements with, a vendor. There are other specific compliance requirements as well.
Potential Risk: Improper execution of the compliance requirements may cause employees to become immediately taxed on their contributions to 403(b) products, which means that you will need to assess and manage potential liability arising from failed compliance activities. For example, the regulations require that you maintain a written plan document which complies in form and operation with the new rules. The IRS now has the right to immediately tax all of the amounts in the employee contracts if your plan document fails to comply.
Risk 2: Information sharing. The regulations require the sharing of large amounts of private employee data on a regular basis with your 403(b) vendor.
Potential Risk: Employers will now be exposed to potential liability related to the improper handling and transferring of massive amounts of confidential data. The data being transferred includes employee social security numbers, as well as financial, disability and employment information.
Risk 3: ERISA. Many tax exempt employer plans were not governed by ERISA, meaning they didn't have to file a Form 5500 or follow the fiduciary and disclosure rules. The responsibilities imposed by the new regulations may force many non-ERISA plans to become covered by ERISA (except that certain church organizations will only be covered by ERISA if they so elect).
Potential risk: ERISA coverage means incurring the expense of filing a Form 5500 annually (with audited financials for larger plans), fiduciary exposures in the selection of vendors, and new fiduciary obligations related to fee disclosures and vendor contracts. Failing these requirements can cause substantial monetary penalties.
Risk 4: Money Handling. For the first time, non-ERISA plans will need to transfer employee contributions to the 403(b) plan within strict time frames.
Potential risk: Employees may have a cause of action against employers who fail to deposit payroll deductions in a timely manner, and any such failure gives the IRS the right to cause all contributions to the plan to become immediately taxable.