The main provisions regarding distributions outlined by the Groom Law Group include:
Qualified Profit-Sharing Plan Distribution Restrictions Imposed
Under current rules, elective deferrals to 403(b) annuity contracts – and all contributions, elective and non-elective, to 403(b)(7) custodial accounts – are generally subject to distribution restrictions prior to age 59Â½, death, disability, financial hardship or severance from employment (subject to a grandfather rule for the December 31, 1988 account balance). However, non-elective employer contributions to 403(b) annuity contracts have not been subject to statutory restrictions on distributions.
The final regulations impose the qualified profit-sharing plan distribution rules (contained in various longstanding regulations and rulings under section 401(a)) on 403(b) plans). This generally means that the plan must provide a predetermined formula for distributing the funds in the plan after a fixed number of years (generally at least two), the attainment of a stated age (e.g., 59Â½) , or after the occurrence of an event (such as a layoff, illness, disability, retirement, death or severance from employment). The restriction does not apply to insurance contracts issued before January 1, 2009, and a plan amendment adopted before January 1, 2009, to comply with these rules will not violate ERISA’s anti-cutback rules.
The final regulations clarify that, as under profit-sharing plans, these restrictions do not apply to after-tax employee contributions (and earnings thereon), which can be distributed at any time.
Severance from Employment
The final regulations generally follow the 401(k) rules for determining whether there is severance from employment that permits distributions (or cuts off the ability to make elective deferrals). However, for purposes of distributions from a 403(b) plan, they provide that a severance occurs when an employee ceases to be employed by an eligible employer that maintains the 403(b) plan. Thus, for example, an employee transferring from a tax-exempt parent to a for-profit subsidiary, an employee of a public school transferring to another agency of the State, or a minister employed by a non-501(c)(3) organization entity ceasing to perform services as a minister but continuing to be employed by the same entity, will all be considered to have severed employment. Conversely, the final regulations provide that a severance from employment is not triggered when an employee transfers from one 501(c)(3) entity to another that is treated as the same employer, or from one public school to another public school of the same state employer.
401(a)(9) Grandfather For Pre-’87 Monies
As under prior guidance, pre-’87 monies may be grandfathered from the statutory minimum distribution rules, but only if the amount is accounted for separately. The final regulations also indicate that the pre-’87 account balance will cease to be treated as such if it is distributed and rolled over to another 403(b) contract, but will be preserved if it is directly transferred to another 403(b) contract and accounted for separately. There is no mention of an age 75 beginning date for the pre-’87 portion, but this may continue to be permitted under interpretations of the regulatory “incidental death benefit” requirement.
The final regulations preserve the current rule that the required minimum distribution rules must be separately determined for each separate contract, but that distributions required under one 403(b) contract can be satisfied by a distribution from another 403(b) contract (similar to the rules for IRAs).
Plan Termination Permissible
The final regulations provide for the first time that 403(b) plans can be terminated, and that benefits can be distributed upon plan termination. However, this does not apply if another entity in the same controlled group makes contributions to another 403(b) plan under which 2% or more of the employees in the terminated 403(b) plan participate within 12 months before and after the date of plan termination. This "successor plan" concept is adopted from the 401(k) rules, but does not prohibit the maintenance or establishment of a 401(k) plan. To be considered terminated, all accumulated benefits must be distributed as soon as administratively practicable; for example, this can be satisfied by delivery to participants and beneficiaries of fully paid individual annuity contracts. The final regulations also add the requirement of immediate 100% vesting of participant accounts as of the date of plan termination
Taxpayers can rely on this provision starting July 26, 2007, if all of the contracts issued under the plan at that time satisfy all of the applicable requirements of the final regulations other than the written plan requirement. Thus, there is an opportunity to terminate 403(b) plans before the general effective date of the final regulations, if certain steps are taken. Some organizations may use this as an opportunity to substitute 401(k) plans for their 403(b) plans, though 401(k) plans having to comply with nondiscrimination testing requirements continues to be a large impediment to such change.
Employer Ceasing to be an Eligible Employer
The final regulations provide that if an employer ceases to be eligible to maintain a 403(b) contract, the plan can either be frozen (no further contributions made, but no immediate distributions) or terminated.
-David Levine, David Powell, Groom Law Group, Chartered
This feature is to provide general information only , does not constitute legal advice as part of an attorney-client relationship, and cannot be used or substituted for legal or tax advice.