The main provisions regarding the written 403(b) plan and 403(b) contracts as outlined by the Groom Law Group include:
Written Plan Requirement
Historically, a few 403(b) requirements have been required by statute to be in the underlying 403(b) contract (a term which in this context includes custodial account agreements and church retirement income accounts), and ERISA has always imposed a written plan document requirement on 403(b) plans subject to that law. However, the final regulations impose, for the first time, a requirement under the Code that there be a written plan containing all material terms and conditions for eligibility, benefits, limitations, the contracts available under the plan, and the time and form of distribution. In addition, any optional provisions (such as for loans and hardship distributions) must be set forth in the plan.
Significantly, the final regulations do not require a single plan document – the “plan” may incorporate by reference other documents, including separate contracts and related documents supplied by the annuity providers and account trustees or custodians. For example, a “wrap document” – similar to the concept used in many ERISA-covered welfare plans – could supplement an annuity contract that contained certain terms. However, the onus is on the employer to ensure that there are no gaps and that conflicts among documents are addressed. This will be challenging in cases where there are numerous investment providers.
IRS intends to help address the potential costs associated with satisfying the written plan requirement for many employers that do not already have a written plan. In this regard, the IRS in November published additional guidance for model plan provisions that may be used by employers to ease the administrative burdens of satisfying the written plan requirement (See IRS Offers Model 403(b) Plan Language for Public Schools). The final rules also provide that a plan may allocate administrative responsibilities to the employer or another person – but not participants – to ease administrative burdens. Those persons responsible for compliance with the applicable Code requirements should be identified in the relevant documents.
In conjunction with the final regulations, the Department of Labor (DoL) issued a Field Assistance Bulletin No. 2007-02 (FAB) to provide additional guidance on the extent to which compliance with the final regulations would cause employers to exceed the limitations on “employer involvement” permitted under the DoL’s longstanding safe harbor for tax-sheltered annuity programs. DoL Reg. Â§ 2510.3-2(f). In general, the DoL believes that complying with the final 403(b) regulations does not per se convert a salary-reduction-only plan relying on the safe harbor into a plan subject to ERISA – that analysis continues to be done on a case-by-case basis. As discussed further below in our review of the FAB, this new written plan requirement may cause non-ERISA 403(b) plan sponsors relying on that regulatory exemption to look at it more closely to determine whether their plans have been or will continue to be exempt from ERISA.
What Must be in a 403(b) Contract
The regulations indicate that certain 403(b) provisions must be in the contract, including:
- nonforfeitability (which the final rules define by reference to the regulations under section 411 vesting rules for qualified plans, though, during the initial period the contract is unvested, the contract must at all times satisfy the 403(b) requirements),
- nontransferability (sec. 401(g)),
- limit on elective deferrals (the final regulations require a section 403(b) contract to include this limit (sec. 402(g)),
- minimum required distribution rules (including the incidental death benefit rule) (sec. 401(a)(9)),
- direct rollover rules (sec. 401(a)(31)), and
- limitation on incidental benefits (sec. 401(a)).
It is unclear whether the plan document could include one or more of those rules instead, especially in the case of a “wrap document.”
What Must be in the Plan
The final regulations require that certain other 403(b) provisions be in the plan document, including:
- identifying the contracts and accounts available under the plan,
- coverage and contribution provisions,
- section 415 limits on annual additions,
- optional provisions (such as loans, hardships and transfers), andprovisions coordinating and allocating compliance responsibilities.
Annuity Contracts Treated as Single Contract
As under current law, all annuity contracts purchased for an individual are treated as a single contract, but contributions in excess of the 415 limits are treated as made to a separate, non-403(b) contract so long as they are separately accounted for. If not, the entire contract (i.e., all contracts) fails to meet 403(b).
Effect of Failures
In general, an entire 403(b) plan may be disqualified if it fails to meet the plan document, eligible employer, or nondiscrimination requirements. In this regard, the final regulations clarify certain operational failures, such as the failure to operate the plan in accordance with its coverage provisions, that will cause all contracts issued under the plan to fail to be 403(b) contracts.
However, most operational failures, e.g., contribution limits, distributions, etc., generally will not adversely affect the contracts issued to other employees that qualify in form and operation with 403(b) where the failure affects a particular employee. The IRS' EPCRS Program (Rev. Proc. 2006-27) already reflects these general principles.
Exclusive Benefit Requirement
The Code does not refer to an exclusive benefit requirement for 403(b) plans. Nevertheless, the final regulations add an exclusive benefit requirement for all assets held in 403(b) custodial accounts, as well as retirement income accounts maintained by a church-related organization, whether covered by ERISA or not. The final regulations do not appear to impose the exclusive benefit rule on annuity contracts (although ERISA programs are subject to the same requirement under section 403(c)(1)).
Incidental Benefits Restricted
The final regulations take a very restrictive approach on the provision of any benefits other than retirement benefits under 403(b) programs. In particular, the final rules prohibit the use of term and permanent life insurance and endowment contracts to fund 403(b) programs, even if the premiums are limited under the longstanding 25%/50% incidental tests - subject to a grandfather rule for contracts issued before September 24, 2007. This reflects a strict interpretation of what funding vehicles or investments Code section 403(b) permits.
The final rules do not allow (subject to the same grandfather rule) the provision of health or accident insurance benefits - a practice that was much less frequently used, but nevertheless permitted in the past.
Death benefits that are part of an annuity contract issued by an insurance company are permitted, assuming the death benefits do not cause the contract to fail to satisfy any requirement applicable to 403(b) plans, and that the incidental death benefit rules are satisfied.
Waiver of premium provisions that continue contributions during long-term disability under an annuity contract are permitted if they satisfy (together with any death benefits) the incidental test.
Defined Benefit 403(b) Plans Not Permitted
The final regulations provide that a section 403(b) plan must be maintained pursuant to a "written defined contribution plan." An exception exists for TEFRA church defined benefit plans in existence on September 3, 1982.