403(b) and Loss of 501(c)(3) Status

[Guest PJW]

Could someone please tell me what happens to a 403(b) when the employer no longer qualifies as a 501©(3) org? Is there some sort of termination process? Is the loss of 501©(3) status a distributable event for the employees? Would a direct transfer to the employer's newly adopted 401(k) be permitted? Can the 403(b) accounts be maintained by the employees indefinitely? Any help would be appreciated. Thanks!

[mbozek]

Since a 403(b) annuity is not a qualified plan, there is no loss of tax deferred status for contributions and attributable earings for prior years when the employer met the requirements for c3 status. The only consequence is that contributions in a year the employer is not a C3 entity are subject to income and FICA taxation. See flush language at end of IRC 403(b) (1). For distribution purposes, the contributions made in a year that the employer is not a c3 entity will be treated as after tax contributions to be taxed under the annuity rules of IRC 72. Reg. 1.403©-1(a). There is no distributable event because of the loss of c3 status and since the employees own the annuities, the contracts can be maintained indefinitely.

[Guest jbroadbent]

Upon loss of 501©(3) status, the employer no longer qualifies to sponsor a 403(b) plan, so contributions under 403(b) must discontinue. Any funding after loss of c3 status must be viewed as an after-tax contribution. The employer may however choose to establish a 401(k) plan and allow current 403(b) assets to be rolled into the 401(k) plan. This would be the most worthwhile solution for employees, because without a provision in the 401(k) to allow it, employees must either discontinue contributions to their account (and wait out the penalty phase if it's an annuity) or begin making after-tax contributions to their account. The latter is not advisable because the participant will have a tough time at the conclusion determining pre and post-tax contributions and will most likely lose out in the calculation.

FYI: FICA is deducted from all 403(b) contributions, and is not a relevant factor in this discussion.

[mbozek]

What is the distribution event under IRC 403(b) that allows the 403(b) annuity accumulations to be rolled over to a 401(k) plan after the loss of c3 status?

[Guest jbroadbent]

Under legislation passed in the economic Growth and Tax Relief Reconciliation Act of 2001 there is increased portability for participants between plans. Beginning in 2002, amounts in section 403(b) arrangements can be rolled over to another 401(k) plan, a section 403(b) arrangement or an IRA. It is best to check each contract (or plan document if one is prepared) to see the extent allowed. All transfers must be made on a company-to-company basis to avoid penalties.

[Michael Devault]

EGTRRA does, indeed, permit distributions from 403(b) plans to be rolled into a 401(k), an IRA, etc. However, EGTRRA did not change section 403(b)(11), which requires that a specified event occur before distributions can be made.

Unless one of the qualifying events listed in 403(b)(11) takes place, the funds in the 403(b) account may not be distributed and rolled into another type of plan.

[Guest jbroadbent]

Check the front of IRS Publication 575 (Pension and Annuity Income) under Important Reminders>Rollovers to and from qualified retirement plans. It says "For rollover purposes, tax-sheltered annuity plans (403(b) plans) and eligible state or local government section 457 deferred compensation plans are qualified retirement plans. See Rollovers" (More info w/in)

Michael, you may be right:

I have asked around and am unable to determine whether or not a change in tax status is a qualifying event. This seems to be unique enough that it may require a Private Letter Ruling (PLR) from the IRS.

If it is determined that a change in tax status is not a qualifying event, then the money must remain in the accounts with no further contributions until there is one.

If it is determined that it is a qualifying event, then we have established the code that allows for rollover (EGTRRA & Pub 575).

I have not as yet searched for a previous Private Letter Ruling that pertains to this issue.