Clean Up on Aisle 403(b)

August 7, 2012 ( - It is 2012, but some 403(b) plans are looking back to the past – 2009 to be exact.  Why?

2009 is now an open year for Internal Revenue Service (IRS) audits – and notably the first year the final 403(b) regulations became effective.  So, 403(b) plan sponsors who have been selected for audits are helping test the waters to determine both the success of the Service’s pre-2009 outreach efforts and the extent to which an employer may have encountered difficulties in implementing the 403(b) regulations.    

Even if your 403(b) plan is not under examination, this serves as a good reminder to review your plan so that you can identify and fix any outstanding issues now to help you sail through a potential audit in the future.  The following items are important to review periodically so that you can keep your plan in compliance with the final regulations.  

You Got a Plan for That?  

IRS guidance requires an employer (other than some church entities) to have had a written 403(b) plan in place by December 31, 2009 – regardless of whether the plan operated on a fiscal or calendar year.  For the most part, employers heeded this deadline and timely adopted their 403(b) plan documents.    

But this is only part of the requirement pertaining to running your 403(b) plan.  The IRS will also be looking to see that the terms of the plan match how the plan is in fact being operated.  For example, suppose the plan document states that all employees are eligible to make deferrals to the plan.  How would the IRS know if, in practice, part-time employees were either excluded from participating or not informed about the opportunity to make deferrals into the 403(b) plan?  An IRS auditor may seek validation from the employer’s human resources and payroll departments to determine any disconnects between the plan as written and the plan as operated.  Any disconnects could highlight defects either within the plan’s written document or in the day-to-day plan administration.    

The IRS anticipated that some 403(b) employers may need to clean up their plans.  As a result, the Service is expected to soon issue its updated Employee Plans Compliance Resolution System (EPCRS).  The new version of EPCRS will provide 403(b) plan sponsors options to correct their plan documents – for those documents that do not capture the IRS regulatory requirements — as well as to correct operational errors for plans that do not operationally follow the written terms of the plan.    

Confirm now that you are able to produce your 403(b) plan document and that the written plan is consistent with how the plan runs operationally so you are prepared if asked during an IRS audit.  

Sharing Is Caring  

The final 403(b) regulations also introduced the concept of “information sharing”.  This means that before processing a participant’s request for a loan, hardship, or distribution due to severance of employment, the plan sponsor and product providers must coordinate to confirm the participant has satisfied the conditions for a withdrawal.  The IRS was concerned that a participant might not appreciate the ramifications of the legal requirements – particularly when the primary goal is to gain access to his or her account.  The requirement to share information minimizes this concern by requiring the employer and investment providers to coordinate with each other before processing money out transactions.

According to the IRS, such coordination has reduced the number of errors for loans and hardships from 403(b) plans.  The IRS has also commented on the importance of the plan’s investment providers operating under the 403(b) regulatory requirements, rather than as a “fringe vendor.”  

Confirm now that your information sharing agreements are in place and you are able to document the coordination with your product providers.  An auditor will be expecting you to produce this during an audit.   

Names Can Hurt You  

“Rollover,” “transfer,” and “contract exchange” all suggest portability.  However, in the post-403(b) regulatory environment, each of these terms has a precise and distinct meaning.  For example, a contract exchange occurs when a participant moves amounts among different approved investment providers operating under an agreement to share information under the same 403(b) plan.  Since the amounts stay with in the same 403(b) plan, this is not considered a distribution.  As a result, the transaction is not subject to tax withholding or reflected on an IRS Form 1099-R.    

By contrast, a participant can move money out of the 403(b) plan in one of two ways – either via a rollover or a plan-to-plan transfer.  A rollover requires that the participant first be eligible for a distribution from the 403(b) plan, and – since this is a distribution – the rollover will be reported on an IRS Form 1099-R.  A plan-to-plan transfer does not require a distributable event.  This means that the characteristics of the former 403(b) plan (e.g., applicability of IRC withdrawal restrictions on amounts attributable to employee or employer contributions, spousal consent rules, etc.) are all still retained even when transferred to the new 403(b) plan.  Furthermore, rollovers have far more portability, since 403(b) plan assets can be rolled over to 401, 403(b), and governmental 457(b) plans that will accept rollovers and to traditional and Roth Individual Retirement Accounts and Annuities (IRAs).  However, a plan-to-plan transfer only permits movement among different 403(b) plans that will accept transfers.    

Ensure your written plan is operating under the correct terminology so that the plan appropriately complies with the IRS distribution rules pursuant to the 402(f) tax notice and withholding obligations.  

Double-checking now whether your 403(b) plan is in sync with daily operations can save you time and potentially IRS monetary sanctions if your 403(b) plan were to be audited in the future.  If you do find an error, do not wait – proactively correct it.  The IRS has indicated that for now, a 403(b) sponsor may rely in good faith on the existing 2008 version of EPCRS until the updated correction programs are released.  You can also expect to see shortly a 403(b) Fix-It Guide on the IRS website to help correct these errors.  The IRS understands that there may be spillage in the 403(b) aisle.  What the Service expects is that you put in your best efforts to clean it up.   


Linda Segal Blinn, J.D.*, is vice president of Technical Services for ING U.S. Retirement.  In this capacity, Blinn supervises the provision of legislative, regulatory, and compliance information to assist employers in operating their retirement plans.  A contributing author to several publications, Blinn also speaks frequently at industry associations meetings on retirement plan issues facing K-12 schools, higher educational institutions, and non-profit entities. 

This material was created to provide accurate information on the subjects covered.  It is not intended to provide specific legal, tax or other professional advice.  The services of an appropriate professional should be sought regarding your individual situation.  These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document.  The taxpayer should seek advice from an independent tax advisor.  

* Linda is not a practicing attorney.