Overview

Under a §403(b) plan, a participant may elect the following types of elective deferrals:

• Pre-tax deferrals subject to the dollar limits of §402(g).  For 2008, that limit is $15,500.
• Pre-tax long-service catch-up deferrals for qualified individuals credited with 15-years of service with the Employer.  The maximum contribution under the long-service catch-up is the lesser of $3,000, $15,000 minus all long-service catch-up deferrals or $5,000 times the number of years of service minus the total of all elective deferrals for all prior years.
• Pre-tax catch-up contributions for employees who attain age 50 on or before December 31 of the applicable year.  The 2008 dollar limit is $5,000.

Applying Contributions to the Plan

Contributions to a §403(b) plan must be transferred to the investment provider within the “safe-harbor” timeframe defined in the §403(b) regulations.  Under these guidelines, the funds must be deposited to participant accounts within 15 business days following the month during which the deferrals would otherwise have been paid to the employee. 

When applying deferrals to the plan, regulations require that contributions be applied in a specific sequence.  Regular annual deferrals under the 402(g) limits are applied first to all employees.  If the participant is eligible for additional deferrals, the 15-year catch-up is applied next to the plan.  If the individual qualifies for the age-50 catch-up, those funds are applied last to the employee’s account.

Contributions

Many employers are making several changes to their plans that may impact employee deferrals to the plan:

• Investment Provider Changes.  In some cases, investment providers will not agree to provide information to the employer or recordkeeper for the plan.  While this may not be an immediate problem for the employee, at some time in the future when the individual or beneficiary requests a distribution, certain information will need to be confirmed by the plan and the investment provider will be required to provide certain information to the Plan.

Roth Contributions. As employers are modifying their plans, many are adding the ability of participants to make Roth contributions to their accounts.  If the employee chooses to make Roth deferrals, a new Salary Deferral Form will need to be completed, indicating the amount to be allocated under the Roth election.

Overview

90-24 Transfers
   
The first implication was the elimination of 90-24 transfers as they existed since 1990.  Under the new regulations, three types of non-taxable transfers will be permitted.  This includes:

• Plan-to-Plan Transfers.  Transfers that occur between separate 403(b) plans of the employer.

• Exchanges.  Transfers made between investment providers within the same plan.

• Purchases of Permissive Service Credits.  Transfers made between the §403(b) plan and a governmental defined benefit plan for the purchase of permissive service credits.

The distribution requirements depend on the type of plan and the type of monies being distributed.  This is a distinct change that will affect primarily annuity companies.  The distributable events are classified in the following manner:

• All elective deferrals;
• Employer monies distributed from custodial accounts; and
• Employer monies distributed from annuity contracts.

Distributable Events for all Elective Deferrals

The following events will make all elective deferrals available for distribution:

• Attainment of age 50 ½
• Severance from Employment
• Death
• Disability (under §72(m)(7))
• Financial Hardship (will follow the §401(k) rules in the future)

Distributable Events for Employer Contributions in a §403(b)(7) Custodial Account

• Attainment of age 59 ½
• Severance from Employment
• Death
• Disability (under §72(m)(7))
• Plan Termination

These distributable events also apply to amounts transferred to the §403(b)(7) custodial account including earnings thereon, when the source or the monies is not known.

Distributable Events for Employer Contributions in a §403(b)(1) Annuity Contract

• Attainment of a stated age or an event, for example, after a fixed number of years
• Severance from Employment
• Death
• Disability (under §72(m)(7))
• Financial Hardship (will follow the §401(k) rules in the future)

These distributable events also apply to amounts transferred to the §403(b)(1) annuity contract  including earnings thereon, when the source or the monies is not known.

Among the approved distributable events, payments upon attainment of age 59 ½ and hardship distributions are permitted while the participant is employed. If the investments are held in a 403(b)(1) annuity contract, attainment of a specific age or after a fixed number of years, an in-service distribution is also permitted.

Attainment of Age 59 1/2

This provision has been a provision of most annuity contracts and custodial accounts.  Funds distributed upon attainment of age 59 ½ are not subject to the 10% early withdrawal penalty and is eligible to rolled over to an IRA or other eligible plan.

Hardship Distributions

Hardship distributions may only include the principal amount of elective deferrals, not including earnings thereon.  However, the exception for pre-1989 monies, excluding earnings will still apply.  Also, the Employer must have a written hardship policy.

The final 401(k) regulations regarding the safe harbor for complying with the financial hardship distribution requirements, which will apply to §403(b) plans in the future, were written to make it more difficult to get a hardship distribution.  These rules now apply to both §401(k) and 403(b) plans.

The new rules would require an employee to sign a much more elaborate certification as to their immediate and heavy financial need. This is not the same as the former “self-certification” that was commonly used by investment providers under §403(b) plans prior to the new regulations.

Required Minimum Distribution Rules

The regulations require that in order for a taxpayer to utilize the pre-87 account balance rule and not begin distributions on the December 31, 1986, account balance prior to age 75, the payer not only must track the pre-1987 account balance, but must also provide for tracking any distributions that are above the required minimum distribution for the year.  Distributions that are greater than the required minimum distribution reduce the pre-87 account balance.  Also, the payer must provide the participant with this information if requested by the participant.

In addition to the above rules, certain amounts are subject to the incidental benefit rule (the pre-1987 account balance, and annuity contracts).  However, if the distribution satisfies the §401(a)(9) rules, it is deemed to satisfy the incidental benefit rules.

If a participant has multiple §403(b) accounts, the aggregation rule applicable to IRAs applies to the participant’s §403(b) accounts.  However, distributions from IRAs cannot be used to satisfy RMDs from IRAs and distributions from §403(b) accounts cannot be used to satisfy RMDs from IRAs.  Also, the aggregation rule does not apply to a §403(b) annuity contract that has been annuitized.

Although full compliance with the final §403(b) regulations is not required until January 1, 2009 (other that the restriction on certain transfers after September 24, 2007), it is important for employers that maintain §403(b) plans to begin taking certain steps now, in order to assure that its §403(b) plan will continue to receive tax-favored status on behalf of the participants and beneficiaries. PenServ has advised our clients to consider several facts:

• IRS is working on several issues, including plan document requirement.  While Revenue Procedure 2007-71 was issued comments were accepted through March 31 and therefore, no action needs to be taken at this time.  There is adequate time to implement a plan document prior to the current required compliance date.  At this time, there is no IRS approved document unless it is the Model Document.  That document is only valid if it is adopted in it’s entirety with no modifications.  As soon as the document

• issue is resolved, PenServ will advise clients and update employers on the proper procedures to be followed.

• Employers should review its current §403(b) program and determine what plan features or provisions to include in the written plan document  

• A Compliance Model should be developed that determines which of the various requirements will be managed with in-house staff, through the approved vendors, or by use of an independent TPA.

• Current investment providers should be identified to determine the specific “approved” investment providers that will ultimately be specified in the written plan.

• In selecting the approved investment providers, consideration should be given concerning the employer’s fiduciary duties involved in determining such investment providers, including any state law requirements such as satisfying requests for proposal requirements (RFPs).

• Data should be gathered concerning current and former employees who have a 403(b) account with respect to that employer so that the employer can identify the “accumulated benefit” no later than the effective date of the regulations.  

• Employees should be notified concerning the restrictions and new requirements regarding exchanges and plan-to-plan transfers.

• If the employer decides to use a TPA for some or all compliance requirements, the employer should inquire whether the TPA is an independent firm or is affiliated with a specific funding vehicle.  

• Once these critical decisions are made, the employer should develop an implementation schedule that permits adequate time to ensure all aspects of compliance is complete and tested prior to the January 1, 2009 implementation date.

Compliance for non-ERISA plans is a new concept for public educational institutions.  Under the new regulations, however, the employer will be responsible for a number of plan activities including but not limited to:

• Annual Notification of Eligibility under Universal Availability Rule

• Ensuring the plan distributes excess deferrals on a timely basis

• Apply catch-up deferrals according to regulations

• Applying earnings to excess deferrals

• Ensuring hardship distributions are administered accurately

• Ensuring participant loans are administered accurately

• Determine if investments are allocated to the correct sources

• Ensure investment providers comply with plan provisions

• Ensure the plan document is maintained

• Monitor distributable events available under the plan

• Maintain records required to provide reports in the case of an IRS audit.

The employer or the TPA employed by the employer should maintain records adequate to demonstrate that the plan has maintained compliance with the new regulations. Records that demonstrate that all employees have been advised of their eligibility under the plan.

• Demonstrate that all deferrals comply with the limits and ordering of contributions to the plan.

• Track application of elective deferrals to investment providers.

• Demonstrate that distribution provisions of the plan have been followed

• Demonstrate that hardship and loan rules have been followed.

• Maintain plan document, plan policies and procedures compliant with IRS regulations

Overview

The Universal Availability rule applies to the elective deferral portion of the plan.  Except for Church plans, the rule applies to all other 403(b) programs. 

The Non-Discrimination Rule

The Universal Availability rule requires an employer to offer an “effective opportunity” to eligible employees to make elective deferrals of more than $200 and such election must be “made available” to all eligible employees at least annually.  An effective opportunity does not exist if there are any other rights or benefits that are conditioned on a participant making or failing to make a deferral election.

The following employees may be excluded from the Universal Availability rule:

1. Employees participating in a §457(b), §401(k) or another §403(b) plan of the employer.

2. Nonresident aliens with no U.S. income

3. Certain students (generally those students on work study programs).

This exclusion is subject to the age and service requirements under §410(b) (referring to the age 21 and 1-Year Service exclusion), including separate testing for employees that do not meet the minimum age and service requirements.

4. Employees who normally work less that 20 hours per week.

An employee works less than 20 hours per week if and only if:

1. For the 12-month period beginning on the date of hire, the employer reasonably expects the employee to work less than 1,000 hours during the ensuing 12 months; and
2. For each plan year thereafter (or anniversary dates measured from the employee’s date of hire), the employee worked less than 1,000 hours in the preceding 12-month period.

Exclusions No Longer Permitted

Notice 89-23 included transitional rules for additional exclusions that the final §403(b) regulations did not adopt.  Effective January 1, 2009, these exclusions will no longer be available unless a special grandfathering effective date applies.  These additional excluded employees under Notice 89-23 were:

1. Employees making a one-time election to participate in a governmental plan (described in §414(d) of the Code) instead of a §403(b) plan.
2. Collectively bargained employees
3. Visiting professors for up to one year
4. Employees who have taken a vow of poverty

The Universal Availability Rule and the compensation limit under §401 (a)(17) ($230,000 for 2008) apply to State and Local Governments.

Prior to 1974, the only type of §403(b) investment was an annuity.  Such annuities must be non-transferable, may be fixed or variable and need not specify TSA on the agreement.  Effective January 1, 1974, Congress expanded the investment options to include stock in a regulated investment company.  Under these arrangements, a “bank” custodian is required, and the investment is made in regulated investment company stock (mutual funds).

A Retirement Income Church Account (RCIA) is a defined contribution plan and may be established and maintained by a church or a convention or association of churches.  One primary difference between the RCIA and other 403(b) plans is that there is not necessarily a Custodian nor is the account necessarily maintained by an insurance company. 

There are several exceptions for Retirement Income Church Accounts:

• RICAs may only be adopted by a church or church-related association;

• Generally, non-discrimination requirements applicable to other §403(b) do not apply to RICAs; and

• Special exclusion allowance rules apply to RICAs in addition to the normal rules.

It is essential for employers to understand the regulations and their responsibility under these new rules.  There are various types of vendors in the marketplace that may be able to monitor and provide required services and many that are monitoring plan activities after the transactions occur. 

The various activities include:

• Common Remitter.  A common remitter is a firm or entity that captures data from the employer’s payroll and distributes the funds to investment providers selected by the participant.  

• Recordkeeper.  The recordkeeper maintains the details of the plans investments and may track contributions and earnings on the account.  The recordkeeper generally issues checks and payments based on instructions from the Administrator.

• Third Party Administrator.  This group provides compliance services, collects data from the investment providers and tracks contributions, loans, hardship payments and plan distributions from the plan,   The TPA generally maintains the records required for the employer in the case of an IRS audit.

Once the employer has selected the plan’s providers, a Compliance Model should be developed to determine if the in-house procedures will meet the requirements of IRS in the case of an audit.  The surviving investment providers should be identified and source information for each participant should be determined.  If a provider is unable to provide accurate data, the funds must be allocated to a restricted source.  Employees should be notified if any accounts are subject to restrictions under the plan or if a vendor being used is no longer approved by the Plan. Once the plan’s new policies and procedures are developed and implemented a review of the procedures should be conducted to ensure all regulations are covered prior to the January 1, 2009 deadline.

Overview

The following final IRS Audit Guidelines were issued by IRS in May, 1999 and therefore, do not reflect changes to the §403(b) Code and Regulations.  We anticipate these guidelines will be updated during 2009, prior to the 2010 audits.  Since many of the rules did not change, certain items in the audit guidelines will remain part of the current requirements.  For example, a review of the contribution limits were required prior to the new regulations and were part of the guidelines established in 1999.