Moreover, the importance of this topic has grown for the broad spectrum of employers eligible to sponsor 403(b) plans, in light of those very same regulations.
Prior to the final regulations, plan termination was not a critical issue for many public employer plans. Without the requirement of a written plan, and with distribution restrictions almost universally imposed by the investment product(s) selected by the plan sponsor, in many cases a public sector plan sponsor might simply cease contributions and lift any plan restrictions in excess of those required under the Code.
Investment providers would be responsible for administering the withdrawal restrictions, the loan limitations, and the minimum distribution rules (for individuals age 70 ½ or older), as they were for many such plans. Of course, under the final regulations, that employer would remain responsible at least for properly allocating those responsibilities to the investment providers.
By contrast, many plans of private tax-exempt employers are subject to Title I of ERISA, and, as such, have been subject to a written plan requirement since their inception, along with requirements for filing annual returns (Form 5500), distributing summary plan descriptions, and generally following applicable ERISA requirements. For those plans, the concept of plan termination takes on increasing significance: once a plan is properly terminated, the plan sponsor can file the final Form 5500.
The question has been what constitutes distribution of the assets, for purposes of qualifying as a termination. Also, if the Section 403(b) plan did not waive otherwise applicable withdrawal restrictions in the event of plan termination, could the assets be considered distributed for purposes of ERISA but not for purposes of the Code? A number of employers and their counsel wrestled with that question, and made their individual decisions.
The final 403(b) regulations answered a part of the question, providing that required withdrawal restrictions could be bypassed in the event of plan termination. However, to qualify, certain requirements must be satisfied, including:
- All assets must be distributed to the individual participant from the plan, either in cash or in the form of an annuity contract. (For purposes of IRS rules, a certificate under a group annuity contract is considered an annuity contract.)
- No contribution may be made by the plan sponsor to any 403(b) plan for one year following the 403(b) plan termination. Employers maintaining more than one 403(b) plan and proposing to terminate only one of them would be required to suspend contributions to any remaining 403(b) plan for a year following the final termination distribution, with certain very limited exceptions.
For a number of 403(b) plans, termination may not be a readily available option.
- A public school that did not maintain a written plan prior to the final regulations may not have retained authority to require a cash distribution from all of the annuity contracts and custodial accounts maintained under the plan, and the addition of a written plan may not by itself be able to confer that authority on the employer. An in-kind distribution of the annuity contract that otherwise satisfies the requirements of the regulations generally can avoid this standoff; however, a similar option is not available for custodial accounts.
- A college or university (or any other qualifying 403(b) plan sponsor) with multiple 403(b) plans cannot terminate one plan unless it is prepared to cease contributions to the other 403(b) plan(s) that it maintains.
- A private tax-exempt employer may have an issue similar to the public school example if it has maintained a voluntary non-ERISA 403(b) plan. A critical requirement for such a plan is that the employer could not have had the authority to exercise contractual or account rights (such as imposing distribution elections), regardless of whether those rights were actually exercised. Contractually, a decision that those rights now exist might necessarily mean that they always did, potentially striking a blow to the employer's prior view of its limited plan involvement.
- A private tax-exempt employer may have another issue, depending upon the position taken by the Department of Labor regarding which contracts and accounts are included in the plan. For example, the IRS allows a plan to exclude contracts and accounts with providers that were deselected prior to 2005. If the Department of Labor instead required the plan to include all contracts and accounts with positive cash value which have not otherwise been distributed out of the plan, then the employer may need to take into account a larger number of contracts and accounts in determining whether termination distributions can be accomplished.
An employer that decides to cease all contributions to a 403(b) plan, but finds itself either unable or unwilling to take all of the steps to terminate that plan, still has the ability to freeze the plan. A frozen plan, however, will still require a written plan as well as ongoing compliance with the requirements of the final 403(b) regulations.
- Richard Turner serves as Vice President and Deputy General Counsel for VALIC. Turner has worked extensively with retirement plans and products for 25 years and is a frequent speaker on the topic. He is also a contributing author of the "403(b) Answer Book."