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Merging a 401k plan into a 403b plan


cpc0506

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Hello.

A new client has come to us. The client has a 401k plan and a 403b plan. The 401k plan was established in 1999 and was funded until the employer got its

501 © (3) designation at which point it established a 403b plan and just stopped contributions to the 401k plan. The cleint is telling us that the 401k plan is 'frozen'. I have not heard this term used for a 401k plan.

The client told us that they wanted to terminate the 401k plan. My question is: can we not just merge the 401k plan into the 403b plan? What issues would arise? I would suggest that merging the plans will eliminate the need to restate the 401k plan for PPA.

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No can do, although now "kissing cousins" 403b and 401k are still fundamentally different and cannot be "merged".

You can certainly terminate the 401k and let each participant individually elect to rollover to the 403b but my personal opinion is that you're going in the wrong direction (don't get me started on why 401k is better thanan ERISA 403b).

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About not merging plans across different tax-Code sections, see IRS Letter Ruling 2003-17-022.

Leaving aside (or integrating) questions about which plan ought to be the survivor,

consider whether it's feasible to amend the to-be-terminated plan to provide that the only form of distribution is a single-sum payment, and that for a distributee who does not properly instruct his or her preference between money and a direct rollover, the default is a direct rollover to the survivor plan.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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Do the funds have to be rolled over to the 403b plan? Or can the employee take a distribution from the terminated 401(k) plan?

What if it was the other way around? Say the client decided to terminate the 403b plan and keep the 401k plan, can the employee take a distribution from the 403b plan or would it have to be transferred to the 401k?

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A 403(b) is not an "alternative defined contribution plan" that would prevent the 401(k) plan termination from being a distributable event, so the employees could take a distribution from the terminated 401(k) plan.

1.401(k)-1(d)(4)Rules applicable to distributions upon plan termination

(i)No alternative defined contribution plan.—

A distribution may not be made under paragraph (d)(1)(iii) of this section if the employer establishes or maintains an alternative defined contribution plan. For purposes of the preceding sentence, the definition of the term "employer" contained in §1.401(k)-6 is applied as of the date of plan termination, and a plan is an alternative defined contribution plan only if it is a defined contribution plan that exists at any time during the period beginning on the date of plan termination and ending 12 months after distribution of all assets from the terminated plan. However, if at all times during the 24-month period beginning 12 months before the date of plan termination, fewer than 2% of the employees who were eligible under the defined contribution plan that includes the cash or deferred arrangement as of the date of plan termination are eligible under the other defined contribution plan, the other plan is not an alternative defined contribution plan. In addition, a defined contribution plan is not treated as an alternative defined contribution plan if it is an employee stock ownership plan as defined in section 4975(e)(7) or 409(a), a simplified employee pension as defined in section 408(k), a SIMPLE IRA plan as defined in section 408(p), a plan or contract that satisfies the requirements of section 403(b), or a plan that is described in section 457(b) or (f).

If the 403(b) is the one terminated, the distribution rule is in 1.403(b)-10(a). In theory, a 403(b) can be terminated and the employees paid out. However, in practice it may not always work out that way depending on the language in the individual contracts. If you search the 403(b) section here, you should find some discussions about it.

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Despite the IRS use of the term "transfer" with respect to direct rollovers, direct rollovers are still rollovers and they are under the control of the participant. A rollover is what a participant does (or directs a plan to do) with an eligible rollover distribution. If there is no distribution, there is no rollover. Disposition of a distribution is entirely within the control of a participant. Whether or not the participant is eligible for a distribution or will get a mandatory distribution is subject to plan terms. Whether or not a distribution is an eligible rollover distribution (not whether or not it will be rolled over) is a matter of plan terms. For example, required distributions are not rollable. A plan would not comply with an instruction to directly roll over an amount that is a required distribution.

Your questions should start with, "Is a participant eligible for distribution (e.g. because of plan termmination)?" Then, "Is the distribution an eligible rollover distribution?"

Transfers are another matter and are easily confused with direct rollovers. Since you are already overloaded to confusion, you need not bother with learning about transfers for your mission. Transfers are not permitted between 401(k) and 403(b) plans.

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Client is intent on terminating the 401(k) plan and keeping the 403b plan. So, if I have read everything correctly, we have a distributive event for the 401(k) plan and the employees take either take their money or roll the funds to the 403b plan (which does allow for rollover contributions from qualified plans).

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