• Publications
• Events
• Blogs & Social Media Sites
• Sign-up for Publications

If You Payroll Deduct Contributions for Employees to Send to 403(b) Providers, You Have New Requirements to Address Before the End of 2008!

Last summer, the Internal Revenue Service published final regulations for Section 403(b) of the Internal Revenue Code, the first updating of the regulations for 403(b) arrangements in 43 years. In its comments on the final regulations, the Service said its intention was to reduce the differences between 403(b) arrangements and other salary reduction arrangements such as 401(k) plans.

The result is a profound change in the rules governing
403(b) arrangements.
The final regulations are generally effective January 1, 2009.

Here are some highlights of the final regulations:

• Written Plan Requirement. Beginning January 1, 2009 all 403(b) arrangements must be maintained under a written plan document, which contains all the material terms and conditions for:
  
  • Eligibility and Benefits
  • Limitations on Contributions
  • Funding
    • Annuity Contracts
    • Custodial Accounts
  • Time and Form of Benefit Payments
  • Optional Features
    • Hardship Withdrawals
    • Plan Loans
    • Plan-to-Plan Transfers
    • Contract Exchanges

These terms need not be found in a single document – for instance, the written plan requirement may be satisfied by combining an annuity contract with a "wrap document" which together contain all the required provisions.

This requirement applies to an employer even if it doesn't consider its arrangement to be one it "sponsors." If the employer provides the assistance of payroll deduction to remit money to any providers, this written plan requirement must be met in order to continue to justify withholding the monies pre-income-tax.

• Changes to the Universal Availability Rule. All 403(b) arrangements are subject to the "universal availability" rule which provides that, generally, all employees of the employer sponsor must have the opportunity to make salary deferrals under the 403(b) arrangement (subject to a $200 minimum, if the plan so states). Certain employee categories can be excluded:
  
  • employees who are eligible to make salary deferrals under another 403(b) arrangement, 401(k) plan, or 457(b) plan of the same employer
  • employees who are nonresident aliens with no U.S.-source income from the employer
  • student employees performing services to a school, college, or university
  • employees who normally work fewer than 20 hours per week.

In determining whether an employee meets the "fewer than 20 hours per week" requirement, the final regulations provide that the employer, at date of hire, must reasonably expect the employee to work fewer than 1000 hours for the ensuing 12 month period and the employee must actually work fewer than 1000 hours for every subsequent plan year or 12 month period.

However, certain employees who could be excluded under prior guidance may no longer be excluded under the final regulations:

• Collectively bargained employees
• Visiting professors
• Employees who have taken a vow of poverty
• Employees who make a one-time election to participate in a governmental plan instead of the 403(b) arrangement
  
  
• Contribution Issues. The final regulations address a number of issues related to contributions. For example, contribution amounts must now be transferred to the annuity contract issuer or custodial account custodian no later than 15 business days following the month in which the amounts would otherwise be paid to the participant.
  
  Note: for 403(b) plans subject to ERISA [any plan to which the employer makes contributions, and any plan under which the employer "endorses" the provider(s) involved], the applicable standard for participant deferrals is the earliest reasonable date that such deferrals can be segregated from the employer's general assets.
  
• Distribution Restrictions. Under the final regulations, benefits generally may be distributed from a 403(b) arrangement only:
  
  • After severance from employment (including severance on account of death)
  • Upon the occurrence of an event named in the plan (such as a fixed number of years)
  • At the attainment of an age stated in the plan
  • For disability
    
• New Transfer Regime. Annuity to annuity transfers by participants with no employer involvement used to be a staple of 403(b) arrangements. No longer. The final regulations permit only two kinds of transfers: exchanges within the same plan and plan-to-plan transfers.
  
  • Exchanges between investment vendors within the same plan can be made if:
    
    
    • They are permitted by the plan document
    • The participant's benefit is not diminished in the course of the exchange
    • The same distribution restrictions apply as before the exchange
    • The employer enters into an information sharing agreement with the issuers of the annuity contracts or the custodians of the custodial accounts involved
      
  • Plan-to-plan transfers can be made if:
    
    • The participant involved is an employee or former employee of the sponsor of the receiving plan
    • Both the transferor and receiving plans permit such transfers
    • The participant's benefit is not diminished in the course of the transfer
    • The same distribution restrictions apply as before the exchange
      
      
• Plan Terminations. Prior to the final regulations, there was no authority allowing a 403(b) arrangement to be terminated by the employer sponsor. Under the final regulations, a 403(b) arrangement can be terminated, under the following conditions:
  
  • The plan document specifically allows for the plan to be terminated
  • No other entity in the same controlled group as the employer sponsor makes contributions to another 403(b) arrangement in which 2% or more of the employees in the terminated plan participate within 12 months before and after the date of termination
  • If any amounts in the terminated plan are subject to vesting, those amounts must be 100% vested as of the date of plan termination
  • All benefits are distributed upon plan termination (and will generally be eligible for rollover treatment)
    
    
• The Department of Labor Weighs In. Many 403(b) arrangements which have only employee salary deferral contributions, often called tax-deferred annuity programs, are not subject to ERISA if the involvement of the employer is limited to comply with a safe harbor contained in the Department of Labor (DOL) regulations.
  
  At about the same time the final IRS regulations were issued, the DOL released a Field Assistance Bulletin (2007-02) addressing the problems employers perceived arose with the status of their 403(b) arrangements as non-ERISA plans if they also had to comply with the plan document requirement under the final IRS regulations. The DOL said that whether the exemption still applies would be determined on a case-by-case basis, but that compliance with the final regulations will not necessarily cause a tax-deferred annuity program to be subject to ERISA.
  
  
  • The mere fact that an employer is now required to adopt a written plan document for the 403(b) arrangement will not take the arrangement out of the safe harbor exemption;
  • This is true even if the document coordinates administration among different issuers and addresses applicable tax compliance matters, such as the universal availability rule;
  • Even the employer's performance of certain administrative functions required for tax compliance, such as testing for compliance with nondiscrimination rules and contribution limitations, will not violate the safe harbor; but
  • If the employer exercises discretionary authority over such areas as authorizing plan-to-plan transfers, processing distributions, satisfying applicable qualified joint and survivor annuity requirements, and making determinations regarding hardship withdrawals, qualified domestic relations orders, and plan loans, that involvement would not be consistent with the safe harbor and would cause the arrangement to be subject to ERISA

Thus, in theory it is still possible for a 403(b) arrangement or tax-sheltered annuity program to be exempt from ERISA. In practice, however, the extensive list of administrative areas that will cause a 403(b) arrangement to fall outside of the safe harbor means that only a bare-bones arrangement can still be outside of ERISA's regulatory scheme.

The Clock Is Ticking:

In Fewer Than 6 Months, You Need A Plan Document
Significant Changes Must Be Implemented By Year-End

These are only some of the changes affecting 403(b) arrangements made in the final regulations. Careful study of your 403(b) arrangement will have to be done and any necessary changes (including, in many cases, the creation of a plan document for the first time) must be made before the final regulations become effective January 1, 2009.

Contact one of FBT's Employee Benefits/Executive Compensation Practice Group members to start the review and update of your 403(b) arrangement.

Attorneys

Practices