Proposed Section 403(b)
Revenue Service has proposed the "first comprehensive guidance on
section 403(b) arrangements in over 40 years" in regulations that
were proposed on November 16, 2004.
effective date of the proposed regulations, which cannot be relied
upon until they are issued in final form, has been postponed until
taxable years beginning after December 31, 2006 (union plans and
church plans may have different effective dates).
regulations generally impose requirements that will make
employer-sponsored Section 403(b) plans more like qualified
retirement plans. The
specific requirements include:
Employer-sponsored Section 403(b) plans have to be
maintained pursuant to a written defined contribution plan document.
The plan document must contain all material terms, including
eligibility, benefits, benefit limits, contracts available under the
plan and the time and form of benefit distributions.
The plan may contain permitted optional provisions dealing
with hardship distributions, plan loans, plan-to-plan transfers and
acceptance of rollovers.
Participant notice requirements will be imposed in
order to implement the required "universal availability" of any
salary reduction contributions provided by the plan.
Participants must be given an "effective opportunity" to
make or change such contributions by providing notice of the right
to do so as well as the specific election mechanics.
The following categories of excludable employees
listed in IRS Notice 89-23 will no longer be subject to exclusion
from a Section 403(b) plan:
employees who make a one-time election to waive 403(b)
participation in order to participate in a governmental plan;
employees covered by a collective bargaining
visiting professors (currently limited to exclusion
for a one-year period under certain conditions); and
employees affiliated with a religious order who have
taken a vow of poverty.
403(b) plans can continue to exclude employees eligible to make
elective deferrals under a Section 401(k) maintained by the
employer, non-resident aliens, students performing services and
employees who normally work fewer than 20 hours per week (see item 4
Section 403(b) plans have always been permitted to
exclude employees who normally work fewer than 20 hours per week.
The proposed regulations permit this exclusion of part-time
employees, but also provide that an employee will be considered to
work fewer than 20 hours per week only
the employer reasonably expects the employee to
complete fewer than 1,000 hours of service during the first 12
months of employment; and
for each plan year ending thereafter, the employee
completed fewer than 1,000 hours of service in the preceding 12
There are currently no restrictions on when a
participant may take a distribution of non-elective employer
contributions plus earnings from a 403(b) annuity contract.
The proposed regulations would permit such distributions only
upon termination of employment or another sanctioned trigger event
(a fixed number of years, upon attainment of a stated age or upon
the occurrence of a disability).
Qualified plan antidiscrimination tests of Code
Sections 401(a)(4) and 410(b) are to be applied to employer 403(b)
plan contributions in lieu of the good faith standard of IRS Notice
89-23, which is targeted for revocation.
Also, the annual limit on annual compensation that may be
taken into account pursuant to Code Section 401(a)(17), which is
$220,000 for 2006, will apply to Section 403(b) plans under the
Participant hardship distributions will be permitted
in accordance with the Section 401(k) rules on hardship
Elective deferral contributions to a Section 403(b)
plan, just like 401(k) contributions, must be transferred by the
employer to the plan within 15 business days following the month in
which such deferrals are deducted from the participantís pay.
Life insurance policies (except for grandfathered
policies) may not be used to fund a Section 403(b) plan.
Section 403(b) plans can be terminated by an
employer-sponsor with plan assets distributed to participants with
full rollover options even if participants have not separated from
service or otherwise incurred a sanctioned trigger event referred to
in item 5 above.
In-service plan-to-plan 403(b) asset transfers by
participants will be limited, as in qualified retirement plans, to
transfers to a receiving plan in which the employee is a
contract exchanges among annuity contract providers must occur
within the same 403(b) plan and the exchanged assets must not be
diminished in the transaction.
The annuity transfer rights provided by Rev. Rul. 90-24 will
be restricted accordingly.
As we have already discussed in some detail,
tax-exempt employers will be aggregated based on an 80 percent
director control test to determine the identity of all entities to
be treated as a single employer for Section 403(b) purposes.
The above rules,
subject to modification by the anticipated final regulations, will
require a conforming amendment of existing plan documents.
The optional plan features identified in item 1 above may
warrant consideration by employers.
Any additional monitoring of antidiscrimination compliance
(item 6 above) should be arranged with the relevant service
provider. There also
may be a need to modify the language of existing contracts with
service providers to specify new duties and responsibilities in
light of the above regulations.
In addition to
the above, tax-exempt employers should consider the "Roth
403(b)" option. This
option would allow participants to make elective Section 403(b)
contributions that would not currently be excluded from income for
tax purposes but would be distributable free of income tax after age
59Ĺ, if certain conditions are met.
Unlike a Roth IRA, there is no income restriction on those
eligible to make Roth 403(b) contributions.
Consequently, this option would permit highly compensated
employees to make such contributions for the first time.
The new Roth 403(b) rules are currently effective and can be
implemented at any time.
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