We are pleased to present this NACUANOTE on Retirement Plans: Compliance with the New 403(b) Regulations, authored by Tara Schulstad Sciscoe. NACUA members are authorized and encouraged to reproduce and distribute copies of NACUANOTES, in whole or in part, with or without attribution, to faculty, staff and students of their respective institutions. For further clarification please view the NACUANOTESCopyright and Disclaimer Notice.
RETIREMENT PLANS: COMPLIANCE WITH THE NEW 403(b) REGULATIONS
One of the more significant exclusions from the nondiscrimination rules for colleges and universities is the one for employees who normally work less than 20 hours a week. The new regulations interpret this as a 1,000 hour a year requirement. The new regulations provide that an institution may exclude an employee from participating in the 403(b) plan during his or her first twelve months of employment if the institution reasonably expects the employee to work less than 1,000 hours during that period. However, for subsequent years, the employee can be excluded from the 403(b) plan only if he or she did in fact work less than 1,000 hours during the prior twelve-month period. Private institutions sponsoring 403(b) plans subject to ERISA, however, are already subject to stricter rules. Such institutions can exclude employees from participating in the 403(b) plan only if they actually work less than 1,000 hours that year .
An institution will not be treated as giving all employees an effective opportunity to participate in its 403(b) plan unless it notifies all eligible employees at least once a year of their ability to make or change an election to contribute to the 403(b) plan. Additionally, although an institution may condition matching contributions to the 403(b) plan (or to a 401(a) plan) on a participant making elective deferrals under the 403(b) plan, no other rights or benefits may be conditioned on participation in the 403(b) plan.
If a college or university fails to give all employees (except those permissibly excluded) an effective opportunity to participate in the 403(b) plan, all participant contracts under the 403(b) plan become taxable. Although the IRS does permit employers to correct for universal availability failures short of taxing the entire plan, the correction method requires an employer contribution made on behalf of all impermissibly excluded employees. Because of the draconian penalties for noncompliance with the universal availability rule, institutions may want to consider permitting all employees to participate in the 403(b) plan immediately for purposes of making salary deferrals (not necessarily employer contributions) and providing meaningful notice rather than attempting to track hours.
3. Clarifications Regarding Salary Deferral and Post-Employment Plan Contributions.
How do the new regulations impact salary deferral contributions to a 403(b) plan?
The new 403(b) regulations clarify that a salary deferral under Code Section 402(g) does not include a contribution made as a condition of employment or a contribution made pursuant to a one-time irrevocable election made on or before an employee's first becoming eligible to participate in the plan. Nonetheless, under a new regulation issued November 1, 2007, FICA taxes do apply to salary deferral contributions regardless of whether mandatory or elective.
The new regulations confirm that 403(b) plans can allow after-tax Roth contributions beginning in 2007. Roth contributions are treated the same as traditional pre-tax salary deferral contributions for most purposes under the 403(b) plan, and are counted toward the salary deferral contribution limits. Roth contributions are required to be held at least five years from the date that the first Roth contribution is made to the 403(b) plan in order to be tax-free at distribution.
The new regulations also set forth an "ordering rule" for application of catch-up contributions. There are two types of catch-ups available under 403(b) plans: the age 50 catch-up ($5,000 for 2008) and the 15 years of service catch-up (up to $3,000 per year, with a $15,000 maximum). The new regulations confirm that the age 50 catch-up applies only after the employee has contributed an amount equal to both the basic salary deferral limit ($15,500 for 2008) and the 15 years of service catch-up limit, if any. This rule is important in that employees can inadvertently use up their 15 years of service catch-up without realizing it. Additionally, the new regulations provide that part-time employment or full-time employment for less than the entire work period (e.g. academic year for faculty) must be aggregated, under a specific but complicated formula, to determine years of service under the 15 years of service catch-up.
What contributions are permitted to a 403(b) plan after termination of employment?
Post-retirement contributions to a 403(b) plan can generally take two forms. First, effective January 1, 2007, former employees can electively defer compensation that they receive from their employing institution up to the later of 2 ½ months after severance from employment or the end of the year in which they sever employment, but only to the extent that the compensation is either regular pay or accumulated unused sick or vacation pay and that the compensation has not been paid or made available to the employee at the time of the election. Any deferrals made under these provisions cannot exceed the contribution limits when aggregated with all other contributions to the 403(b) plan. Salary deferrals cannot be made from severance pay received after separation from service.
Second, employer contributions can be made for the five-year period beginning at the end of the taxable year of an employee's severance from employment. Contributions can be made each year up to the total contribution limit of the lesser either of 100% of compensation or $46,000 for 2008. The new regulations clarify that any contribution to a 403(b) plan under this rule on behalf of a former employee must be an employer contribution .
403(b) plans are unique in that they are the only type of retirement plan to which employer post-retirement contributions can be made. This can be a very valuable feature for institutions (particularly public institutions) that want to restructure existing unfunded-benefit promises, establish early-retirement incentives, or reward long service. Post-retirement contributions are subject to non-discrimination rules to the extent applicable, however, and private institutions should, therefore, exercise caution in designing a plan with post-retirement contributions.
4. In-Service Loans and Hardship Withdrawals from Plan Funds.
What changes have been made to the loan and hardship withdrawal provisions?
The new regulations require that plan loans and hardship distributions follow the same rules applicable to 401(k) plans. For example, hardship withdrawals can be made only if the institution (or the vendor, if appropriately delegated) verifies that there is a financial hardship and the amount of that hardship, the hardship withdrawal does not exceed certain amounts, and, if the safe harbor rules apply, salary deferrals are suspended for six months following the withdrawal . Note that in order to verify a financial hardship, the institution or vendor, as applicable, will need to request substantiation of the need - employee self-certification is no longer permissible. Likewise, loans cannot be made if the participant has a previous loan in default with a vendor or if the participant has an existing loan with a vendor that if combined with the second loan request would exceed certain dollar limits. Similarly, the new regulations do not permit employees to self-certify that the loan requirements are satisfied.
What distribution rules apply to employer contributions?
Salary deferral contributions to 403(b) annuity contracts generally cannot be distributed prior to age 59 ½, death, disability, severance from employment, and financial hardship. Employer and salary deferral contributions to 403(b) custodial accounts are subject to similar rules. However, employer contributions made to an annuity contract under a 403(b) plan have historically not been subject to any distribution restrictions. Under the new regulations, employer contributions to an annuity contract cannot be distributed prior to a fixed number of years (such as five years of participation), attainment of a stated age, or the occurrence of certain events (such as severance from employment or disability) . The regulations provide that a timely amendment to a 403(b) plan to comply with this new rule will not violate ERISA's anti-cut-back rule to the extent the amendment reduces a right to receive in-service distributions. This change applies to all 403(b) annuity contracts issued on or after January 1, 2009.
5. Non-Taxable Transfers and Exchanges.
What transfers are available under a 403(b) plan?
The new regulations recognize three types of transfers under a 403(b) plan that will not be treated as a taxable distribution:
The new regulations continue to permit participants to transfer their account or contract to another vendor (which the IRS refers to as "contract exchange") after September 24, 2007, however, so long as the following rules are satisfied:
What happens if the institution makes a mistake?
If an institution fails to timely adopt a written 403(b) plan document, the plan does not satisfy the applicable nondiscrimination rules, or the plan is not operated in accordance with its coverage provisions, all amounts under all participants' contracts under the 403(b) plan become taxable. However, most operational failures that occur within a participant's account or contract will result in the disqualification only of the contracts or accounts of that participant held under the 403(b) plan, and will not impact other participant accounts under the plan .
There is a special rule that applies if the contribution limits are exceeded. Any excess contribution must be held in a separate account that is not treated as covered by Code Section 403(b) in the year of the excess and each year thereafter, and is immediately taxable to the extent vested. If the excess is not timely held in a separate account, all of the affected participant's contracts or accounts under the 403(b) plan become taxable. Excess elective deferrals plus allocable net income should be distributed by April 15 of the year following the year the excess was made to avoid double taxation of the excess.
6. Timely Remittance of Plan Contributions.
When must contributions be paid to vendors?
The new 403(b) regulations require that both public and private institutions sponsoring 403(b) plans remit contributions to vendors within a period that is no longer than reasonable for proper plan administration. The new regulations give an example of a reasonable period for employee salary deferrals being within 15 business days following the end of the month in which the amounts would otherwise have been paid to the participants. However, private institutions sponsoring ERISA-covered 403(b) plans are already subject to a stricter remittance rule; they are required to transfer salary deferral contributions to the vendor within a period that is no longer than reasonable for the proper administration of the plan, but no longer than 15 business days following the month in which the amounts would otherwise have been paid to the participant. The DOL has interpreted the "no longer than reasonable" requirement as being significantly shorter than the 15 day standard. Employer contributions generally must be made in accordance with the plan document and the Code Section 415 rules.
7. Annuity Contract and Custodial Account Agreement Requirements.
What must be in the annuity contracts and/or custodial account agreements to comply with the new regulations?
Annuity contracts or custodial account agreements with vendors are required to contain specific provisions in order to comply with the 403(b) rules, including the nonforfeitability (for annuities) and nontransferability of accounts, the salary deferral contribution limits, and the direct rollover provisions. The new regulations also require that the annuity contracts and custodial account agreements contain the minimum distribution requirements and the limits on incidental benefits. Finally, the new regulations require that an annuity contract and/or custodial account agreement be issued under an employer 403(b) plan.
8. Rules Concerning Plan Terminations.
Can an institution terminate its 403(b) plan and establish another type of retirement plan?
Historically, there has been no statutory basis for terminating a 403(b) plan. The new regulations specifically provide that 403(b) plans can be terminated . Plan assets must be distributed as soon as reasonably practicable after termination and can be rolled over by participants to another retirement plan or an IRA. Distributions can also be made in the form of a deferred but vested annuity. A 403(b) plan can be terminated before January 1, 2009, without having to adopt a plan document, so long as the plan satisfies all other requirements of the new regulations.
The new regulations state that 403(b) plans cannot be merged with, nor can their assets be transferred to, a 401(k), 457(b), or 401(a) plan. Therefore, an institution sponsoring a 403(b) plan cannot establish a new 401(k) plan, terminate the 403(b) plan and transfer all 403(b) assets to the 401(k) plan, nor can it merge the two plans into a single plan. Instead, the assets of the 403(b) plan would have to be distributed to participants at termination, which (unless paid in the form of a deferred vested annuity) the participant could then choose to roll over to the new plan or to another retirement plan or IRA, or take as a taxable distribution.
9. The Controlled Group Rules.
What are the new controlled group rules?
Although the Internal Revenue Code contains controlled group rules for determining when different employer plans should be aggregated for various purposes, these rules do not apply to tax-exempt and governmental entities. In conjunction with the new 403(b) regulations, the IRS issued new regulations under Code Section 414(c), effective January 1, 2009, that apply for determining when tax-exempt organizations are treated as a single employer for employee benefit purposes. The new regulations provide that common control exists if 80% or more of the directors or trustees of one entity are either representatives of, or directly or indirectly controlled by, the other organization. The rules can apply so that two tax-exempt entities are treated as a single employer or a tax-exempt entity and another type of entity are treated as a single employer. If common control exists, then the organizations are treated as a single employer for purposes of applying the 403(b) nondiscrimination rules, contribution limits, vesting, 15 years of service catch-up contributions, and minimum distribution rules. The controlled group rules are not limited to 403(b) plans, however, but also apply for many other purposes relating to qualified retirement plans, health plans, cafeteria plans, and fringe benefits.
The new regulations also permit tax-exempt organizations to permissively aggregate if they maintain a single plan covering one or more employees from each organization and the organizations regularly coordinate their day-to-day exempt activities, so long as aggregated for all purposes. However, permissive aggregation is subject to an anti-abuse rule if the purpose of aggregation is to avoid requirements under Code Sections 401(a), 403(b) or 457(b) .
10. Steps to Achieve Compliance.
What steps should my institution take to ensure timely compliance with the new regulations?
For most institutions, all requirements under the new 403(b) regulations must be satisfied both in form (e.g., written plan document) and operation (e.g., timely remittance of contributions) no later than January 1, 2009. The institution is legally responsible for its 403(b) plan under the new regulations, so although delegation of responsibility is permitted and anticipated, institutions should ensure that they are partnering with capable vendors and are protected by well-drafted vendor agreements. In order to ensure timely compliance and risk management, institutions should consider undertaking the following steps:
Department of Labor Rules and Guidance:
Internal Revenue Service Rules and Guidance:
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