On July 26, 2007, the Treasury Department, in conjunction with the IRS, released a finalized set of 403(b) regulations. With a history dating back to the 1950's, this rulemaking effort was nearly 50 years in the making, and provides 403(b) participants with some long-awaited guidance.
In this article, we're going to run through the important changes to section 403(b) plans. We'll provide a brief history of these retirement programs, as well as an overview of the changes in various plan provisions. We're going to discuss the final rules dealing with plan documentation, transfers or contract exchanges, contributions (including Roth contributions), and severance policies. Finally, we'll provide a concise timeline that outlines when all of these new rules and regulations became effective.
The 403(b) plan is a retirement savings program that is made available to employees of Section 501(c)(3) organizations (nonprofit) and public schools (primarily teachers). Originally dating back to 1958, the first set of comprehensive regulations for these plans appeared in 1964 under section 403(b) of the tax code.
Through the years, these regulations were updated by the Employee Retirement Income Security Act of 1974 (ERISA), the Tax Reform Act of 1986, the Small Business Job Protection Act of 1996 (SBJPA), the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), and the Pension Protection Act of 2006 (PPA).
Even though the operating rules of these plans had been modified through the years, the final rules were never passed until July of 2007. The primary impact of these final rules is the better alignment of 403(b) plans with section 401(k) plans, and governmental plans under section 457(b) of the tax code.
Even though it is accurate to describe these rules as "final," many of these features we're about to outline already appear in today's plans. The rules we'll talk about in the following sections include:
All 403(b) plans are required to have a written document which describes the sharing of plan responsibilities among the employer / issuer, employee, and any other party involved with the plan (such as a financial institution or insurance company). Ideally, this written plan would be one document, however, the final rules allow for "incorporation by reference."
If an issuer or employer fails to have a written plan, any contract purchased through that same employer would not be considered a valid 403(b) contract.
The final regulations, similar to the existing 403(b) rollover rules, provide for three specific kinds of non-taxable exchanges or transfers:
If an accountholder chooses to transfer all, or part of, their interest from one 403(b) account to another, then the transfer is tax free. This type of transaction is known as a 90-24 transfer.
The transfer can be made on a tax-free basis only if the transferred interest is subject to the same, or stricter, distribution restrictions. After September 24, 2007, the accountholder cannot make a 90-24 transfer without their employer's involvement.
The final 403(b) rules confirm prior guidance for 403(b) contribution limits, with one important change. In addition to the catch-up contribution for employees that are 50 years and older by the end of the calendar year, plans may now offer an employee of a qualified organization who has at least 15 years of service a special catch-up limit.
If a plan participant is eligible for both the catch-up contribution and the special 15 years of service catch-up contribution, then the special catch-up contribution limit is applied first to their accounts.
The final regulations made a number of changes to the existing 403(b) distribution rules including:
A program participant is eligible to receive a distribution from their 403(b) account if they experience a "severance from employment." A severance from employment can occur when a participant no longer works for an employer that is eligible to sponsor a 403(b) program. This can happen even if the participant chooses to work for another related employer that is still part of the controlled group.
If two or more employers are linked by 80% or greater common ownership, then they are treated as a single employer. The final 403(b) regulations specify that the 80% board-control test is to be used to identify members of the controlled group.
Under prior law, an employer that chooses to stop offering a 403(b) program to its employees can only freeze the program; thereby stopping all additional contributions. Program administrators were not allowed to distribute assets of the plan unless a participant also had a distributable event.
Under the new regulations, a 403(b) program can be amended to contain a provision that allows the employers to terminate their programs. If a company chooses to terminate their program, then the distribution of assets can occur. Employee and employer contributions can be distributed to custodial accounts only if the employer does not make contributions to an alternative program 12 months following the termination of an existing program.
A program is considered terminated when, following the announcement of program termination, all benefits have been distributed to participants and beneficiaries.
Before allowing employee contributions, also known as elective deferrals, the program must satisfy a universal availability requirement. This rule states that all employees of an employer offering a 403(b) plan must be allowed to make an elective deferral if any employee is allowed to make an elective deferral.
There are exceptions to this rule, for example the following classes of employees are excluded from this rule:
In addition, IRS Notice 89-23 also permits exclusions including:
The final regulations also clarify that any employees with the ability to make elective deferrals also have the ability to designate section 403(b) elective deferrals as designated Roth contributions.
The new 403(b) regulations generally apply to taxable years beginning after December 31, 2008. Since most individual's tax year is on a calendar year, these regulations began on January 1, 2009. However, there are a couple of exceptions worth noting.
If a section 403(b) plan is part of a collective bargaining agreement that was ratified, and in effect on July 26, 2007, then the regulations do not apply until the earlier of:
If the 403(b) plan was maintained by a church-related organization, under which the authority to change or amend the plan is conducted by a church convention, then the final regulations started on the first plan year following December 31, 2009.
If a plan excludes any of the three classes of employees from eligibility to make elective deferrals on July 26, 2007, as permitted by Notice 89-23, then the 403(b) plan was permitted to continue that exclusion until taxable years beginning on or after January 1, 2010.
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