David Powell, Groom Law Group, answers:
Prior rules for terminating 401(a) plans have long required distribution of all assets as well as imposed certain requirements for considering an annuity to be distributed, such as on termination of a defined benefit plan. There was little guidance on terminating 403(b) plans prior to the final IRS regulations, however. When those regulations were issued, those essentially indicated that the distribution of an annuity contract will be considered a distribution from a 403(b) plan for IRS purposes. But neither the regulation nor the more recent 403(b) termination guidance in Revenue Ruling 2011-7 clearly indicates that a distributed contract includes an annuity that was already in the participant’s hand (for example a typical individual annuity or certificate in a group contract).
Further, in its guidance the IRS did not opt to treat custodial accounts as annuity contracts, so those, apparently, must be distributed in cash. In other words, cash will have to be distributed from the 403(b)(7) custodial accounts, though it can be rolled into IRA or into another plan in which a participant is participating that will accept it if it otherwise satisfies the rules for an eligible rollover distribution.
And then another troublesome question is whether the IRS position is also the U.S. Department of Labor’s view. For Employee Retirement Income Security Act (ERISA) plans, the DoL has long had a concern as to when an annuity contract may be considered distributed and ceases to be a plan asset (sometimes known as a “fully allocated annuity”), because as long as it is a plan asset, it is subject to the protections of ERISA. Although the DoL may have had an opportunity to review the IRS’ termination guidance before it was issued, it is still not clear that the DoL considers annuity contracts distributed as described in the IRS termination guidance to be distributed for ERISA purposes. Consequently, while the DoL has not indicated that sponsors cannot terminate 403(b) plans, it also hasn’t said that a termination for IRS purposes will be sufficient for DoL purposes. And if not terminated for ERISA purposes, for example, the 403(b) plan sponsor will continue to have duties with respect to the plan, such as filing 5500s. Of course, if a plan is not subject to ERISA, only the IRS view matters.
Ultimately, the only thing we know will satisfy both agencies that a 403(b) plan is fully terminated is if every penny that was in the plan is distributed to participants in cash. And as a final point, sponsors need to read and understand annuity and custodial account contracts. Those may not allow the employer to cause a distribution to participants unilaterally upon plan termination, though we may see that provision more often in the future.
For more information about the IRS guidance, see What the IRS Guidance on Plan Terminations Means.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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