(b)lines Series: 403(b) Final Regulations - Transfers and Exchanges

March 4, 2008 ((b)lines) - The new 403(b) regulations concerning plan transfers and contract exchanges both expand permissible transactions for participants and place controls on conditions of the transactions to ensure compliance with limitations and distribution restrictions. Participants are no longer on their own to decide if they can make a transfer or exchange. These provisions of the new regulations were generally effective September 24, 2007.

The main provisions regarding transfers and exchanges outlined by the Groom Law Group include:

Tax-Free Transfers and Exchanges

The final regulations provide for three specific kinds of non-taxable exchanges or transfers of amounts in section 403(b) contracts, which are not subject to the distribution restrictions:

• change of investments within the same plan (contract exchange),
• plan-to-plan transfer with another employer plan receiving the exchange, or
• transfer to purchase permissive service credit (or repayment to a governmental DB plan).  

Contract Exchanges

As under the proposed regulations, contract exchanges under the same plan may be made if conditions similar to the conditions for transfers are met. The Preamble of the regulations explains that this is intended for mere change of investment within the same plan.   However, the final regulations expand the requirements to allow exchanges to contracts otherwise not allowed as plan investments if the transferee contract includes distribution restrictions that are no less stringent than those imposed on the contract being exchanged and the employer enters into an agreement with the issuer of the other contract to provide information in the future to comply with the Code, including information regarding employment status, severance from employment, hardship withdrawal, and deemed distribution of a loan. It remains to be seen whether such information sharing agreements will be commonly entered into given the additional administrative complications they introduce.

Plan-to-Plan Transfers

The final regulations permit transfers between 403(b) contracts between separate plans, provided that both plans permit it, and generally reflect the requirements of Revenue Ruling 90-24 that the benefit not be reduced and the transferee contract impose restrictions on distributions no less stringent than those imposed on the transferor.  

If a transfer does not constitute a complete transfer of the participant or beneficiary's interest in the 403(b) plan, the transfer must be treated as involving a pro-rata portion of the participant's or beneficiary's after-tax contributions, if any.

Under prior guidance transfers by employees and beneficiaries may only be made to 403(b) contracts of the individual's employer. The final regulations expand this provision to include a former employer - that is, if the participant (or decedent, in the case of a beneficiary transfer) is an employee or former employee of the employer for the receiving plan.

Permissible Service Credit Transfers

The final regulations track the proposed rules and include only a "barebones" statement of the EGTRRA rule that permits 403(b) plan transfers to purchase permissive service credit under a governmental defined benefit plan (or to repay a prior cashout under such a plan).   The preamble confirms that such a transfer will not violate the general in-service distribution prohibition for elective deferrals and earnings.