Employer Termination of ERISA 403(b) Plan

[Lori Foresz]

Not for profit has an ERISA 403(b) plan and they want to terminate and start a 401(k) in order to have more alternatives regarding investment types (i.e. stocks, bonds, etc.)

I know that there is an issue regarding whether an employer can really terminate a 403(b) plan or if it has to continue forever until the last participant terminates or the ER goes under.

I am reading the 403(b) prototype, and it expressively gives the ER the right to terminate the plan, however, Morgan Stanley is saying no.

Has anyone ever terminated an ERISA 403(b) Plan? Is this possible. The client has been asked to get legal opinion (and we will suggest this) but I just wanted to get some thoughts so I wouldn't be sending them on a wild goose chase.

Any help is greatly appreciated!!!

[E as in ERISA]

If my recollection is correct, the reason that you can't "terminate" a 403(b) is that you can only make distributions at 59-1/2, severance, death or disability. So even if you said you were terminating, you couldn't distribute the money out unless all employees meet one of those.

Does the employer have any involvement other than withholding the deferrals and sending them on? Does it make contributions, limit investment options?

The employer can try and eliminate its involvement. It can open up investment options so that employees can transfer them wherever they want. It can stop making any employer contributions into the arrangement.

I think that there are links on here -- if you look for discussions about how you can attempt to make it into a non-ERISA plan....

[rcline46]

Would be interesting to see the document language permitting termination of the plan. Do not know how you can have a 'prototype' 403(b) since a 403(b) is not a qualified plan and therefore would not have had the IRS review a mass submitter document.

Maybe you are not looking at the correct document, and just maybe you don't have a 403(b) plan.

[mbozek]

An employer can certainly terminate a 403(b) plan but the only consequence is that no further contributions will be made to the plan since the employees own their accounts/annuity contracts. If the plan is subject to ERISA a final 5500 must be filed.

Is the client aware of the additional costs of maintaining a 401k plan such as ADP testing, qualification requirements, full 5500 reporting, auditors requirements, etc that do not apply to 403b plans. Also in a 403b plan all HCE are eligible to contribute 13k because there is no adp test.

[Lori Foresz]

Thanks. I see the problem and wish the IRS would allow elective transfers between 403(b)s and 401(k)s upon plan termination so that employees don't have to have two accounts under two separate plans.

The employer makes contributions to the plan, so I believe it is considered an ERISA plan and limited reporting has been done.

I too thought there was no such thing as a prototype 403(b), but this document clearly says "403(b) prototype" and is a Merrill Lynch doc. Perhaps it is not a true "prototype" (with IRS approval) just a boiler plate document to faciliate adoption.

It is a small plan, so no audit issues and there are no HCES, so no ADP testing issues. The employees just want more investment flexibility besides mutual funds and we can't think of any way to do this without starting up a 401(k) plan. There are only six employees and all have balances in the 403(b) plan. No terms have bals. Unfortunately, it looks like they will have to start up a new plan but leave the 403(b) balances as invested. Rats! Thanks for the input everyone!

[Lori Friedman]

Can a 403(b) plan terminate? The simple answer is "yes, but..."

Plan termination isn't a distributable event for a 403(b) plan. A decision to terminate the plan can't, by itself, allow distributions to participants who are subject to withdrawal restrictions (age, haven't separated from service, etc.) Very often, a terminated 403(b) plan will hang around for years and years, even though it doesn't receive any additional contributions, until all of the covered employees have moved on to new jobs.

It's unfortunate that this organization wishes to replace its 403(b) arrangement with a 401(k) plan. When I list the advantages of 501©(3) designation, the unique ability to offer 403(b) coverage is right near the top of the list. There's a wide, diverse selection of mutual fund investments available to 403(b) participants. Maybe the organization's problem isn't its choice of plan, but its choice of investment provider? Unfortunately, there are countless people out there trying to sell 401(k) plans, but just about nobody promoting 403(b) arrangements.

[AndyH]

mbozek, you aren't stating that the employer can officially vote to terminate an ERISA 403(b) and simply file a final 5500, in effect washing it's hands of it even though all assets have not been distributed, are you? Or are you?

[mbozek]

There are no assets to distribute in a 403(b) plan because there is no trust, only annuity contracts in which the participants have an ownership interest.

[AndyH]

I find a Yes answer hard to accept. Just wish away any employer responsibility in an ERISA 403(b) with a termination resolution? I want your answer to be right.

Does anybody out there also take that position?

Separate but unrelated, does the employee still have "ownership" in an ERISA 403(b) invested in custodial mutual funds where some participants are not necessarily vested?

[joel]

Yes, I agree...there are no plan assets to distribute because there were never any plan assets in the first place.

[Lori Friedman]

Although it's true that a 403(b) plan doesn't hold assets in a Sec. 401(a) trust, it's an oversimplification to say that a 403(b) plan has no assets.

The answer to Igolden's question depends on whether a 403(b) plan is an ERISA or a non-ERISA arrangement.

A non-ERISA plan consists solely of salary reduction agreements and the annuity contracts and/or custodial accounts into which contributions are made. Plan termination is usually as simple as stopping additional salary reductions, with employees keeping their annuity contracts and custodial accounts.

When a 403(b) plan is subject to ERISA, however, plan termination is more difficult. 403(b) plans don't have plan termination as a distributable event. If a 403(b) plan is replaced with another type of plan, the 403(b) assets can't be transferred to the new plan. The transfers occur on a participant-by-participant basis, as each individual has a distributable event such as separation from service, death, or disability.

[mbozek]

A 403(b) plan does not report assets on the 5500. 403(b) assets can be transferred to a qualified plan or IRA upon termination of employment or upon 59 1/2 in both ERISA and non ERISA plans or to another 403(b) contract at any time under Rev rul 90-24.

[AndyH]

Well, there is no disagreement about that, and I thank you for the comments. I have a client with such an arrangement that is represented by ERISA counsel so I am asking the client to solicit the opinion of their Counsel and see if they agree that a vote to terminate can end the employer's responsibilities and 5500 filings.

[Lori Friedman]

You might find it helpful to take a closer look at Rev. Rul. 90-24, which addresses the nonrecognition treatment of a 403(b) exchange.

The ruling holds that a contract-to-contract transfer isn't an actual distribution or a taxable event. An employee may wish to make an in-service change of 403(b) vehicles, for investment or other reasons. This can be accomplished by having the insurance carrier or custodian transfer all or part of the employee's interest to a different funding arrangement, if the carrier or custodian is willing to do so. The IRS stated in Rev. Rul. 90-24 that it would recognize such a transfer as nontaxable if the transferee arrangement continues to apply the same withdrawal restrictions that applied before the transfer.

Rev. Rul. 90-24 concerns transfers among and within 403(b) plans, not plan terminations or transfers to qualified plans.

After 12/31/01, amounts can be rolled over from a 403(b) plan to a qualified plan. A rollover from a 403(b) plan, however, isn't permitted until a distributable event occurs. Unlike a qualified plan, plan termination isn't a distributable event for a 403(b). See PLR 200317022 -- An employer's request to transfer plan assets en masse from a terminated 403(b) plan to a 401(k) plan was denied.

[AndyH]

Lori, I'm not sure what your point is.

[Lori Friedman]

Andy, I was just expanding on mbozek's helpful comment, from above. I simply enjoy this stuff, which explains why I'm mired in Sec. 403(b) on the gorgeous, sunny afternoon before the Labor Day weekend and not getting a start on the holiday. Cheers!