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Final regulations recently released by the IRS provide the first comprehensive guidance on 403(b) tax-sheltered retirement arrangements in 43 years. Employers that sponsor 403(b) plans will have to address a number of compliance issues this year as the result of the release.
403(b) tax-sheltered arrangements are defined-contribution plans for employees of nonprofit organizations that are exempt from tax under Code Section 501(c)(3) and employees of public schools. Like 401(k) plans and 457(b) deferred-compensation plans, 403(b) plans offer participating employees important tax benefits, such as tax deferral of current income and tax deferral of earnings on investments.
Here are some key items to review:
A big change is the requirement that a 403(b) plan have a written plan document. The 403(b) plan document must outline all material plan provisions and allocate the responsibilities of the employer, the annuity contract issuer(s), other service providers, and participating employees regarding: eligibility, benefits, applicable contribution limits, available contract descriptions, loan procedures, hardship withdrawals, and the time and form under which distributions may be made.
The pension law – ERISA – imposes a number of fiduciary responsibilities on employers. While certain 403(b) programs are not covered by ERISA – and the new regulations will not necessarily cause a non-ERISA plan to become subject to ERISA – you should analyze your situation carefully. Going forward, employers may be required to assume monitoring the plans funding arrangements and developing an investment policy statement, among other things.
The final regulations replace previous safe harbor non-discrimination guidance. Under the new regulations, plans must satisfy specific requirements that prohibit discrimination in favor of highly compensated employees with respect to employer contributions and after-tax employee contributions. These nondiscrimination rules generally do not apply to plans offered by state and local public schools or to 403(b) contracts purchased by a church.
The new regulations address the application of the tax law’s contribution limits. For example, no employee’s elective deferrals can exceed the annual limit ($15,500 in 2007), no matter how many 403(b) plans you offer, and that includes designated Roth contributions.
The 403(b) regulations allow three types of nontaxable exchanges or transfers. First, an employee can move money from one employer-sponsored vendor to another employer-sponsored vendor. A transfer to an outside-of-plan vendor (formerly called a “90-24” transfer) is also permitted, but only if there is a written agreement between the vendor and the employer that ensures eligibility and distribution rules will be applied properly. Second, a 403(b) plan can transfer assets to a 403(b) plan of a different qualified employer, if the new employer’s plan accepts transfers. Third, 403(b) assets can be transferred to purchase permissive service credits in a defined-benefit pension plan maintained by a government.
The new rules for 403(b) distributions are similar to the 401(k) distribution rules. Amounts attributable to deferrals can be distributed only when the employee has a “severance from employment,” has a hardship, becomes disabled, or reaches age 59-1/2. The 403(b) regulations also require 20 percent federal income-tax withholding on any eligible rollover distribution that is not directly rolled over to another 403(b) plan or to a rollover IRA.
Here are some steps you can take now to help ensure that your 403(b) plan is in full compliance by 2009:
· Adopt a plan document if you do not currently have one. If you do, review the document for compliance.
· Check excluded employees to make sure they meet the new exclusion rules.
· Create a list of existing service providers and set a uniform standard for services.
· If your plan is subject to ERISA, develop an investment policy statement that sets guidelines for selecting investments and investment managers and for regularly monitoring investments and service providers.
· Form a plan or investment committee to manage your plan and make sure that you are meeting all of your fiduciary duties.
The final regulations generally are effective for tax years beginning after Dec. 31, 2008, with delayed effective dates for plans offered under certain collective bargaining agreements and plans sponsored by certain church organizations. There are also transition rules for some of the new requirements.
However, you may operate your 403(b) plan under the new regulations before the effective date as long as you apply the rules on a consistent and reasonable basis. •
Bernie Kaplan, J.D., LLM (BKaplan@tofias.com) is a shareholder and managing director of the Retirement Plan Services Group at Tofias PC. For more information, visit www.tofias.com or call (401) 626.3200.