On July 20, 2009, the Department of Labor issued limited relief for Section 403(b) arrangements that are now required to file Form 5500 Annual Reports starting with the 2009 plan year. Field Assistance Bulletin No. 2009-02 (the "Bulletin") provides that annuity contracts and custodial accounts covering current or former employees will not need to be treated as part of the employer's Section 403(b) arrangement for purposes of the annual Form 5500 reporting requirements if the following conditions are met:

  • The contract or account was issued to a current or former employee before January 1, 2009;
  • The employer ceased to have any obligation to make contributions (including employer salary reduction contributions), and in fact ceased making contributions to the contract or account, before January 1, 2009;
  • All of the rights and benefits under the contract or account are legally enforceable against the insurer or custodian by the individual owner of the contract or account without any involvement by the employer; and
  • The individual owner of the contract or account is fully vested in the contract or account.

Contracts and custodial accounts that meet these conditions ("Pre-2009 Contracts") will not need to be reported on the Section 403(b) plan's Form 5500 Annual Report. In addition, current and former employees who hold only Pre-2009 Contracts will not need to be reported as plan "participants" on the 403(b) plan's Form 5500. Finally, the Bulletin provides that the Department of Labor will not reject a Form 5500 filed with respect to a Section 403(b) plan because the independent auditor for the plan issues a qualified, adverse or disclaimed opinion if the auditor expressly states that the sole reason for issuing such qualified, adverse or disclaimed opinion is because the audit did not cover the Pre-2009 Contracts or because the Pre-2009 Contracts were excluded from the plan's financial statements.

Background

Section 403(b) arrangements maintained by tax-exempt employers are generally subject to the requirements of the Employee Retirement Income Security Act of 1974 ("ERISA"). Governmental plans and certain church plans are exempt from ERISA. In addition, a separate exemption provides that a Section 403(b) arrangement maintained by a tax-exempt employer will not be considered a "plan" subject to ERISA if the employer does not make any contributions under the arrangement (other than employee elective deferrals) and has minimal involvement in the administration of the Section 403(b) arrangement.

Among other things, ERISA requires plan administrators to file an annual Form 5500 providing detailed information about the plan, including financial information respecting the assets of the plan. In addition, ERISA requires large plans (generally those covering more than 100 "participants") to be audited annually by an independent auditor. Until 2009, the Department of Labor exempted Section 403(b) tax-sheltered annuity arrangements from the Form 5500 filing requirement and the audit requirement.

New Form 5500 regulations going into effect for plan years beginning in 2009 remove the general exemption for Section 403(b) arrangements. Separately, new tax regulations governing Section 403(b) arrangements, also effective beginning in 2009, require a written plan document and other employer involvement with the arrangement that will make it harder for Section 403(b) arrangements of nongovernmental employers to avoid treatment as ERISA plans, even if there are no employer contributions.

The new reporting requirements pose a particular problem for Section 403(b) arrangements that might now need to obtain financial information on the annuity or custodial account balances of former employees. Former employees generally deal directly with the provider of the underlying annuity contract or custodial account on most matters without involving the employer. Thus, financial information on these contracts or custodial accounts may not be readily available to the employer or plan administrator responsible for filing the Form 5500. The problem is exacerbated when the annuity or custodial account provider has been discontinued as a provider for the Section 403(b) arrangement and is no longer receiving contributions from the employer.

Determining Participant Status and Plan Assets Under Current Guidance

The need to supply (and pay for!) audited financial statements respecting assets in the annuity contracts or custodial accounts of former employees, and the underlying 100-participant threshold for the audit requirement, raise the question of whether terminated employees, who continue to hold annuity contracts (or custodial accounts) without having taken a full distribution from such contracts or accounts, are still "participants" in the plan.

Generally, ERISA treats any current or former employee who is or may become entitled to receive a benefit from the plan as a participant. However, Department of Labor regulations provide that an individual is not a participant if the entire benefit rights of the individual are:

  • Fully guaranteed by an insurance company, insurance service or insurance organization licensed to do business in a State, and are legally enforceable by the sole choice of the individual against the insurance company, insurance service or insurance organization; and
  • A contract, policy or certificate describing the benefits to which the individual is entitled under the plan has been issued to the individual.

These conditions would normally be met with respect to any former employee with a Section 403(b) annuity contract (though not a custodial account) from the former employer.

Therefore, a partial solution to the impact of the new Form 5500 requirements on tax-exempt employers would be to ensure that the annuity contracts held by former participants in the Section 403(b) arrangement meet these conditions. Some Section 403(b) arrangements expressly provide that any employee with an annuity contract that meets these conditions will cease to be a participant in the Section 403(b) arrangement upon termination of employment. Some commentators have urged the Department of Labor to issue guidance confirming this position formally.

The Bulletin The new Department of Labor guidance in Field Assistance Bulletin No. 2009-02 responds in part to some of the concerns raised by the new reporting and audit requirements imposed on Section 403(b) arrangements. Specifically, it provides that:

  • Pre-2009 Contracts (i.e., an annuity contract or custodial account that meets the four conditions described at the beginning of this alert) will not need to be treated as part of the employer's ERISA plan, or as plan assets, for purposes of ERISA's annual reporting requirements;
  • A current or former employee holding only Pre-2009 Contracts and who does not have any other annuity contract or custodial account under the plan will not need to be treated as a plan participant for purposes of ERISA's annual reporting requirements or for purposes of determining whether the plan is subject to the audit requirement; and
  • The Department of Labor will not reject a Form 5500 filed with respect to a Section 403(b) arrangement due to the issuance of a qualified, adverse or disclaimed opinion by an independent auditor if the auditor expressly provides that the sole reason for issuing such qualified, adverse or disclaimed opinion is that the Pre-2009 Contracts were not covered by the audit or included in the plan's financial statements.

The scope of the reporting relief is broad in some respects. It applies to custodial accounts, which would usually not be able to meet the requirement under the existing regulations that a benefit must be "guaranteed by an insurance company" in order for the employee to cease to be a participant. The reporting relief also applies to group annuity contracts where the participant has received only a certificate, but does not receive a separate individual policy.

The reporting relief also applies to Pre-2009 Contracts held by current employees who may continue to participate in the Section 403(b) arrangement albeit through a different annuity contract or custodial account.

Although the Bulletin addresses the challenges that administrators will face in complying with the annual reporting and audit requirements for the 2009 plan year, the reporting relief is not expressly limited to the 2009 plan year.

Limitations on the Reporting Relief

In other respects, however, the reporting relief is quite limited. First, it only excludes annuity contracts or custodial accounts if the employer ceased to have any obligation to make contributions (including salary reduction contributions) to the contract or account, and in fact ceased to make any contributions, before January 1, 2009. Therefore, the reporting relief does not apply to the annuity contract or custodial account of employees who terminated employment after January 1, 2009 if the employer made any contributions to the contract or account on or after January 1, 2009. Accordingly, former employees may need to be treated as plan participants (and their annuity contracts or custodial accounts may need to be treated as plan assets) in future years if the existing regulations on when an employee ceases to be a participant do not apply. Thus, employers currently benefiting from the reporting relief and the relaxed financial and audit requirements of the Form 5500 for plans with under 100 participants may "grow into" the full reporting mandates in future years even if the number of active participants does not change.

For this reason, employers, particularly those with Section 403(b) custodial account arrangements (which could not benefit from those existing regulations), must ensure that their arrangement with the issuer or custodian requires the issuer or custodian to supply the financial and/or other information required for the Form 5500, even if and after the employer terminates contributions to that issuer or custodian. Employers that might benefit from the existing regulations on cessation of participation should ensure that their plan documents (which are required by the tax regulations) make it clear that an employee will cease to be a participant in the Section 403(b) plan upon his or her termination of employment if the only annuity contracts held by the employee are those meeting the requirements of the existing regulations.

Second, the new relief only applies to Form 5500 reporting. The Bulletin takes no position on whether former employees with Pre-2009 Contracts may still be ERISA plan "participants" for other purposes, such as entitlement to summary plan descriptions and periodic account statements from the "plan administrator" (which will normally be the employer or its in-house personnel, not the insurer or custodian) or bringing an ERISA suit against the employer or plan fiduciary for breach of fiduciary duty or other violations of ERISA.

Third, the reporting relief does not address issues arising from the transition to Form 5500 reporting requirements that are unrelated to the existence of the Pre-2009 Contracts. With respect to pre-2009 recordkeeping, for instance, the Bulletin only notes that whether a plan (or employer) must incur the cost of reconstructing records, and the personal liability of plan fiduciaries for missing records, depends on all the facts and circumstances and that plans should discuss issues that materially increase a plan's audit expenses with the auditors.

Finally, the reporting relief is subject to the requirement that the administrator of the Section 403(b) plan make a "good faith effort" to ERISA's generally applicable reporting requirements.

Employers with Section 403(b) arrangements that have not already rethought the structure and features of those arrangements in light of the one-two punch of tax and ERISA regulation changes should do so soon, in order to ensure that their limited funds used for compensation and benefits are deployed in the most cost-effective manner, to minimize administrative and overhead expenses, and to remain in compliance with the ever-changing law.