IRS Issues Final 403(b) Regulations

Section 403(b) regulations were first issued in 1964. New regulations were proposed in November 2004, and on July 26, 2007 the IRS issued new final Section 403(b) regulations. These new regulations encompass the numerous major pieces of legislation affecting 403(b) plans that have been passed over the past 43 years and provide clarification for plan operation and compliance. One of the main purposes of these new regulations is to put the rules for 403(b), 401(k) and eligible 457(b) plans on the same footing and make administration and compliance of the rules simpler.

The final regulations are generally effective for tax years beginning after December 31, 2008.

Below are some highlights of the new final regulations:

403(b) Plans now need a written plan

All terms and conditions must be in the plan. This does not mean there must be a "plan document". A written plan could be accomplished by bundling the salary reduction agreement, summary plan description, custodial agreement, annuity arrangement, etc.

The plan must contain all the material terms and conditions for eligibility, benefits, applicable limitations, the time and form under which distributions will be made, and the annuity contracts or mutual funds available under the plan. It is expected, however, that a single document will be adopted for any program involving multiple investment providers.

In addition to the written plan requirement, the funding contract, i.e. the annuity arrangement or custodial agreement must have language satisfying 401(a)(9) RMD rules and the incidental benefit requirements.

A written plan will not subject a non-ERISA 403(b) to Title 1 ERISA requirements. Generally, a deferral-only plan sponsored by a 501(c)(3) is exempt from ERISA and governmental plans and non-electing church plans are also exempt from ERISA. See U.S. DOL Field Assistance Bulletin No. 2007-02 for more information.

Rev. Rul. 90-24 is repealed

Unlike the 2004 proposed regulations, the final regulations permit a tax-free exchange of one contract for another in order to change investments within the plan. The plan must permit the exchange, and the new contract must include distribution restrictions that are not less stringent than those in the contract being exchanged.

Transfers to investment providers both within and outside the approved vendor group will still be permitted, but only if the employer and the investment provider receiving the transfer enter a written "information sharing agreement." Information to be shared includes, but is not limited to, employee information pertaining to severance from employment and plan information pertaining to eligibility, loans and hardship distributions.

Unlike the 2004 proposed regulations, there is no need to add the vendor who receives the transfer to the list of current vendors receiving salary reduction contributions.

Rev. Rul. 90-24 tax-free exchanges that allowed participants to move 403(b) assets among various investment providers without the knowledge of the plan sponsor will no longer be permitted after September 24, 2007.

Plan Termination

The final regulations permit an employer to terminate a Section 403(b) plan and distribute plan assets to participants. Participants have the right to roll the plan termination distribution to an eligible retirement plan, such as an IRA.

In order for a 403(b) plan to be considered terminated, all accumulated benefits under the plan must be distributed to all participants and beneficiaries as soon as administratively practicable after termination of the plan.

Miscellaneous Issues

Life insurance contracts, endowment contracts, health or accident insurance or property, casualty or liability insurance contracts are prohibited as Section 403(b) funding vehicles.

Hardship distributions will generally follow the same rules as 401(k) plans.

Pre-1989 pretax deferrals (excluding earnings) and after-tax employee contributions may be distributed without the occurrence of a distribution triggering event.

Qualified domestic relations order (QDRO) procedures apply to Section 403(b) plans.