By: Carol McBeth, CFS, CRPS®, AIF®

Established in the 1950s, 403(b) plans were primarily designed to supplement defined benefit pension plans. At long last, the IRS has issued final 403(b) regulations to replace the regulations issued in 1964. Whether your clients currently have a 403(b) plan or are looking to establish one, the new information can help you answer for clients the question: To Be or Not to 403(b).

Why Was the Legislation Enacted?

Currently 403(b) plan vendors and participant activities are not monitored. However, the IRS intends for the new 403(b) plans to be regulated more like 401(k) plans, which call for more employer control and responsibility. The regulations with the biggest impact involve required 403(b) plan documents and new information-sharing agreements for 90-24 transfers between 403(b) accounts.

The 403(b) Plan Must Be In Writing

Under current law, only 403(b) plans that are subject to the Employee Retirement Income Security Act of 1974 (ERISA) are required to have a written plan. The final regulations require that all 403(b) plans maintain a written plan. For example, if a 403(b) plan offers loans, or even the ability to take a distribution on account of financial hardship, the ability to take a loan or financial hardship would have to be spelled out in the plan. The written plan must describe: the allocation of plan-related responsibilities among the employer, the entity offering the investment options and any other parties involved. The final regulation provides that a plan can incorporate, by reference, other related documents, such as an insurance policy or custodial accounts. Employers that currently treat existing 403(b) programs according to ERISA standards should have no problems complying with this new rule. However, many employers currently offer 403(b) plans that are not subject to ERISA requirements due to ERISA exceptions for government plans, church-related plans or plans with limited employer involvement by 501(c)(3) organizations. For these organizations, creating a written plan—even one that incorporates other documents by reference—could be challenging. The Department of Labor recently released Field Assistance Bulletin 2007-02 discussing how to coordinate this written plan requirement with the limited employer involvement exception under ERISA. The final regulations specifically provide that if “an employer fails to have a written plan, any contract purchased by that employer would not be a 403(b) contract.”

New Requirements of 90-24 Transfers

The 403(b) contract exchanges under 90-24 have not been eliminated, but new conditions have been added for making these transfers. After September 24, 2007, any contract exchanges under old 90-24 transfer rules will be subject to new rules: participants will no longer be able to transfer 403(b) assets freely among different vendors. Any transfer of funds should be requested by a current employee. In the past, these types of in-service transfers did not include employer involvement. However, employers will now be involved with 90-24 transfers and should review the new restrictions under the final regulations to determine if these transfers are still practical.

The issue that generated the most interest was the application of 90-24 rules to custodial accounts and church retirement income accounts, not just to annuities. The right to transfer was very important to participants because it kept them from becoming locked into an investment that they were unhappy with. Under the old Revenue Ruling 90-24, individuals were permitted to take their assets in the existing 403(b) and transfer them to a vendor of their choice, even if that vendor was not on the employer’s payroll slot. The problem was that the transfer was not a reportable event, so no one knew when it took place. The employer who would be charged with various responsibilities in regard to the 403(b) would not know where the money had been transferred. This arrangement was not acceptable to the IRS, so they changed the way individuals dealt with the transfer of funds. The new regulations include two types of 90-24 transfers: transfers within the plan and transfers between plans. Because written plans are required by the new regulations, the rules and the details of these transfers of funds need to be spelled out and outlined in the plans themselves.

Universal Availability Standard is Clarified and Narrowed

This rule provides that generally all employees of an employer that offers a 403(b) plan must be permitted to make salary deferrals. There is no requirement for discrimination testing, as there is in a 401(k) plan, but there is a standard called “Universal Availability” that permits certain employees to be excluded: non-resident aliens, employees eligible for 457(b) deferrals, and students and employees who normally work fewer than 20 hours per week. Notice 89-23 permitted additional exclusions: employees covered by a collective bargaining agreement, employees who make a one-time election to participate in a governmental plan instead of a 403(b) plan, certain visiting professors and employees of a religious order who have taken a vow of poverty. The final regulations eliminated the IRS Notice 89-23 exception to the Universal Availability rule and various transition periods will expire between now and 2010.

403(b) Plans Can Now be Terminated

Currently an employer that no longer wants to offer a 403(b) plan to its employees has only one real option: to freeze the 403(b) program and stop additional contributions. The final regulations confirm that it will now be possible to terminate a 403(b) plan. For a 403(b) plan to be considered terminated, all accumulated benefits need to be distributed to all participants and beneficiaries as soon as administratively feasible following the plan’s termination. This new provision is the first to allow an employer to amend its 403(b) plan to provide for plan termination. This may be beneficial for the employers who currently have frozen 403(b) plans, permitting the distribution of all program assets to employees either in cash or by rollover to another 403(b) plan, a 401(k) plan or an individual retirement account. There is a special Transition Effective Date rule stating that terminations can occur between July 27, 2007, and the actual effective date of the final regulations if the 403(b) arrangement satisfies all the requirements of the final regulations.

When Will These Regulations Take Effect?

These final 403(b) regulations are generally effective for taxable years beginning after December 31, 2008, with some exceptions. For certain church-related organizations that offer the 403(b) plan, the regulations will not be effective until plan years following December 31, 2009. The final regulations also confirmed that Roth contributions can be made to a 403(b) plan.

Next Step?

So, what should be your next step? You will want to review and understand how the 403(b) changes affect your business owner clients and participants in the 403(b) plan. Let your business owner clients know that the final 403(b) regulations are in force and that you are ready to help them navigate through the changes and inform them of the new 90-24 transfer rules. If you are not already, partner with an organization that can provide helpful resources and education on the final 403(b) regulations.