New 403b Regulations


Summary of Final Regulations Under Section 403(b)

Executive Summary

On Monday, July 23, the Treasury Department and the Internal Revenue Service (IRS) released the much anticipated final regulations under section 403(b). This memorandum provides a brief summary of the final regulations. Soon hereafter we will provide you with more detailed analysis and a listing of meeting and webinar dates where the Regulations will be discussed more thoroughly.

The following are a few highlights.

1. 403(b) regulations have been published.

2. Written Plan document required – IRS will provide model plan language for public schools to adopt in advance of effective date of regulations. Each employer must have a plan for the 403(b) contract to qualify. (Note, the employer may not be the school where the teacher teaches but the school district.) Plan administration can be by employer and/or other persons. Third Party Administrator’s are not required.

3. Information sharing by issuers of 403(b) contracts and employers is now a fundamental requirement. Self-certification by employees for eligibility to make contributions or take loans/withdrawals will not be allowed.

4. Tax-free transfers can continue but with new rules. Rev. Rule 90-24 revoked, revocation is to be effective 60 days after formal publication of Regulations (anticipated effective date September 26, 2007), new transfer rules in place. It is unclear when new transfer rules are effective.

5. Rollover to IRA or other eligible retirement plans not affected by rules.

6. 403(b) plans must be universally available to employees including ability to make Roth contributions.

7. General effective date is January 1, 2009, but several grandfather exceptions.

8. Department of Labor to issue Field Assistance Bulletin regarding ERISA and non-governmental employees seeking to comply with new 403(b) regulations.

9. Life insurance, endorsement, health or accident, property, casualty or liability policies are prohibited as Section 403(b) funding vehicles. Annuities may include death benefits if permitted under the incidental benefit rule.

10. Effect of plan and operational failures are addressed in regulations.1. Effective Date The final regulations are generally applicable for taxable years beginning after December 31, 2008. Like the proposed regulations, the final regulations include a number of special transition rules. Of particular note, transition rules apply with respect to (1) the new withdrawal restrictions on employer contributions to section 403(b) annuity contracts, (2) the prohibition on life insurance and other non-annuity contracts, and (3) the new rules for tax-free transfers (each of these provisions is discussed below). Taxpayers generally can rely upon the final regulations for periods following the date they are published in the Federal Register (which should be July 26, 2007) and before the applicable effective date. However, such reliance must be on a "consistent and reasonable basis," and a special rule applies in the case of plan terminations (requiring all contracts under the plan to comply with the final rules prior to a distribution of accumulated benefits).2. Plan Document Requirement The final regulations, like the proposed regulations, require that all 403(b) contracts be issued pursuant to a written plan, which, in both form and operation, satisfies the requirements of section 403(b). The final regulations make a number of significant changes to the plan requirement.

Among others, the final regulations confirm that the plan document need not be a single written instrument and note that the document may incorporate other documents, such as the annuity contract, by reference. The final regulations also confirm that it is permissible to allocate administrative responsibilities to issuers, but provide that the plan document must clearly reflect such allocations. The final regulations also provide that participants may not be tasked with any responsibility for 403(b) compliance, although presumably compliance responsibility is distinct from providing information that is relevant to compliance, employees with respect to loans and hardship distributions will not be allowed.

The preamble to the final regulations confirms that the IRS will soon release model plan language for governmental 403(b) plans such as school districts. The preamble also suggests that plans generally must have documents that satisfy the requirements of the final regulations in place by January 1,2009, subject to any special effective dates. e.g., participant's age, basis for a hardship distribution. Self certification by and as expected, the final regulations generally retain the rule described in the proposed regulations by revoking Rev. Rule 90-24 and substitute in its place new rules governing "transfers" and "exchanges." The rules set forth in the Final Regulations are not as restrictive as those originally proposed. Specifically, the final regulations provide for three types (situations) where nontaxable transfers of amounts in section 403(b) contracts may occur:

(1) "a mere change of investment within the same plan (contract exchange);" – an exchange of one annuity for another where the teacher/employee has not changed employers.

(2) a "plan-to-plan transfer, so that there is another employer plan receiving the exchange;" – a exchange of annuity contracts where the employees current 403(b) employer is different than the employer when the first contract was purchased.

(3) "a transfer to purchase permissive service credit. .. " The final regulations include a number of changes to the rules applicable to exchanges and transfers under the proposed regulations. With regard to exchanges, unlike the proposed regulations, the final regulations permit an exchange of one contract for another to constitute a mere change of investment within the same plan, but only if certain conditions are met, including that the employer must enter into an agreement with the issuer of the transferee contract for the sharing in the future of certain information. The information would include information with respect to the participant's employment occurred) and information with respect to other section 403(b) contracts owned by the participant (to facilitate compliance with rules such as the loan limits of section 72(p )). Also with regard to intra-plan exchanges, the final regulations include a limited grandfathering rule under which the new requirements a contract received in an exchange that occurred on or before [60 days after final regulations are published in the Federal Register] if the exchange (including the contract received in the exchange) satisfies such rules as the Commissioner has prescribed in guidance of general applicability at the time of the exchange.

Precisely how this grandfathering rule will be implemented is uncertain. For example, it is not entirely clear how exchanges that occur after the 60-day transition period but before the final regulations become effective (January 1, 2009) will be treated, given that the regulations generally are not effective until 2009, and that until then presumably Rev. Rul. 90-24 is not revoked. It also is not entirely clear whether the grandfathering applies to the contract itself, such that subsequent exchanges likewise would not be subject to the new rules. Also with regard to intra-plan exchanges, the final regulations authorize the IRS to issue guidance of general applicability allowing such exchanges in cases not otherwise described in the final regulations. The authority is limited to cases in which the IRS determines that sufficient procedures are in place to share information needed to ensure compliance, such as whether a severance from employment has occurred for purposes of the distribution restrictions. The preamble to the final regulations states that procedures that rely on representations from the participant generally will be insufficient. With regard to "transfers" of section 403(b) contracts between different "plans," the final regulations provide that both plans must provide for transfers and the participant must be an employee or former employee of the employer that sponsors the receiving plan. Both the "exchange" rules and the "transfer" rules also require that the "accumulated benefit" immediately after the exchange or transfer must at least equal the "accumulated benefit" of the participant or beneficiary immediately before the exchange or transfer. There was concern that the final regulations clarify this requirement to make it clear that the net cash amount that would be payable to a participant upon a liquidation or partial surrender of a section 403(b) contract may be exchanged or transferred to another section 403(b) contract. The final regulations provide that the "accumulated benefit" requirement would be satisfied" ... if the exchange would satisfy section 414(1)(1) if the exchange were a transfer of assets."

The preamble to the final regulations states that DOL has not changed its view, as described by the Treasury Department in the preamble to the proposed regulations, that tax-exempt employers can comply with the requirements of section 403(b) and also remain within the DOL's safe harbor exemption for taxsheltered annuity programs that are funded solely by salary deferrals. However, DOL noted that the final regulations offer employers "considerable flexibility" in shaping the extent and nature of their involvement in a 403(b) plan, and that in determining whether a tax-sheltered annuity program will be subject to Title I of ERISA, a case by case analysis should be conducted. In conjunction with the publication of the final regulations, DOL will also issue a Field Assistance Bulletin that will provide additional guidance on the interaction of the safe harbor requirements and the final regulations. The Field Assistance Bulletin will be made available on the DOL website, at (The bulletin is not yet available.) The final regulations generally reflect the statutory rules regarding when distributions can be made from a section 403(b) contract. Like the proposed regulations, the final regulations also create distribution restrictions for amounts attributable to employer contributions by importing the rules for tax-qualified plans. Specifically, the final regulations provide that, where the distribution restrictions of section 403(b )(11) do not apply, a section 403(b) annuity contract is permitted to distribute retirement benefits to the participant no earlier than upon the earliest of severance from employment or upon the prior occurrence of an event, such as after a fixed number of years, the attainment of a stated age, or disability.

The final regulations adopt the rule that the new withdrawal restrictions do not apply to after-tax employee contributions or the earnings on such contributions. The final regulations also provide a grandfathering rule under which the new withdrawal restrictions on employer contributions do not apply to contracts issued by an insurance company before January 1, 2009. (e.g., whether a severance had(e.g., information sharing) do not apply

6. Taxation of Distributions and Benefits

Like the proposed regulations, the final regulations include a number of rules regarding the taxation of distributions and benefits from section 403(b) contracts. These rules generally track the statutory requirements applicable to such contracts, distributed, that eligible rollover distributions are not taxed if directly rolled over or ansferred to an eligible retirement plan, that non-direct rollovers are subject to mandatory withholding, and that the payor must give proper written notice regarding eligible rollover distributions. e.g., that section 72 applies to tax only amounts actually

7. Failures to Satisfy Section 403(b)

The final regulations include a new discussion of the effect of 403 (b) plan failures. In this regard, the final regulations provide that, in the ordinary course, only the contracts to which a defect relates will be adversely affected by the defect. As a result, operational defects will typically only effect the contracts to which the defect relates. However, a failure to maintain a plan document, a nondiscrimination failure, or an employer eligibility failure will affect all contracts under the plan.8. Nondiscrimination Requirement for Employer Contributions The final regulations generally end a good faith noncompliance standard for 501(c)(3) employers and the administrative safe harbors that were provided under Notice 89-23. Instead, the final regulations apply the nondiscrimination rules that apply to 401(k) plans. For this purpose, the final regulations, like the proposed regulations, provide standards for aggregating affiliated employers.9. Universal Availability The final regulations include a number of clarifications related to the universal availability requirement. For the most part, these clarifications track the changes that were suggested under the proposed regulations. As a result, for example, the final regulations clarify that the universal availability requirement applies in the case of a 501 (c)(3) entity, on a common law entity basis, and, in the case of a governmental employer, on a common payroll basis. In addition, the final regulations repeal a number of the prior law administrative exemptions from the universal availability requirement that were in Notice 89-23, including the exemption of union employees. The final regulations also expand on the exemption from the universal availability requirement for part time employees. One new issue covered in the final regulations is a clarification that the right to make Roth salary reduction contributions is subject to the universal availability requirement. Significantly, the final regulations include a variety of delayed effective dates for changes related to the universal availability and nondiscrimination requirements.10. Funding, Including Life Insurance

The final regulations retain the requirement in the proposed regulations that contributions to a section 403(b) plan must be transferred to the insurance company issuing the annuity contract "within a period that is not longer than is reasonable for the proper administration of the plan." addition, the final regulations, like the proposed regulations, provide that a life insurance contract, an endowment contract, a health or accident insurance contact, or a property, casualty, or liability insurance contract does not meet the definition of an annuity contract for purposes of section 403(b). potentially significant new language, the final regulations provide that "death benefits" under an annuity contract are permitted, assuming that they do not cause the contract to fail to satisfy any requirement applicable to section 403(b) requirements, such as "the incidental benefit requirement" of Treas. Reg. section 1.401-1

(b)(1 )(i) and Treas. Reg. section 1.403(b)-6(g). The preamble notes that guidance concerning the application of the incidental benefit requirement to "permissible nonretirement benefits such as life, accident, or health benefits" is contained in revenue rulings. The extent to which this new provision of the regulations will require annuity death benefits that are not life insurance under state law or federal tax law to be limited by the incidental benefit test contained in these revenue rulings is unclear.11. Plan Terminations The final regulations retain the rule that was included in the proposed regulations officially acknowledging for the first time that an employer may terminate a section 403(b) arrangement that it sponsors.12. Required Minimum Distributions The final regulations, like the proposed regulations, state that a section 403(b) contract must meet the section 40 1 (a)(9) minimum distribution rules in both form and operation. The provisions in the final regulations relating to the section 40 1 (a)(9) minimum distribution rules generally are the same as those set forth in the proposed regulations. However, the final regulations provide that for any section 403(b) contract that is not part of a governmental plan or church plan, the "required beginning date" on which required minimum distributions must commence under section 401 (a )(9)( C) for a 5-percent owner is April 1 of the calendar year following the calendar year in which the individual attains age 70Yz. Under the proposed regulations, the required beginning date for a 5-percent owner was defined as the later of (1) the calendar year in which the individual attains age and (2) the calendar year in which the individual retires from employment with the employer maintaining the plan.

Like the proposed regulations, the final regulations provide that if an employee is eligible for both the age 50 catch-up contribution under section 414(v) and the special section 403(b) catch-up contribution for employees with at least 15 years of service, a catch-up contribution is treated first as a special section 403(b) catch-up contribution up to the extent such contribution is permitted, and then as an amount contributed as an age 50 catch-up contribution.

The proposed regulations provided that for purposes of the special section 403(b) catch-up contribution applicable to an employees of a qualified organization, the term "health and welfare service agency," is defined as either an organization whose primary activity is medical care or a section 501(c)(3) organization whose primary activity is the prevention of cruelty to individuals or animals, or which provides substantial personal services to the needy to needy individuals). The final regulations expand this definition to include an adoption agency and an agency that provides either home health services or assistance to individuals with substance abuse problems or that provides help to the disabled. The final regulations, like the proposed regulations, provide for the use of a separate account to track nonvested amounts and amounts attributable to contributions that exceed the section 415 limits ("excess contributions"). For excess contributions, to the extent that a separate account is maintained a participant's contract will not be adversely affected by the excess contributions, provided that the excess contributions are reported as taxable income. In both cases, the final regulations, like the proposed regulations, provide that the separate account will be considered pmt of a separate contract that is a section 403( c) contract, a non-qualified annuity contract. (e.g., a tax-exempt organization that provides meals

15. Unresolved Issues

While the Regulations attempted to be complete, please note we are aware of several important but unresolved issues, including:

a. the manner and form of agreement related to the required information sharing agreement between vendors and employers; and

b. the applicability of information sharing requirements as to contracts for which the vendor has no contact with the employer i.e., no flow or no transfer requests.

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