Terminating a 403b plan

[Santo Gold]

I was asked about a real small 403b plan (less than 10 people) and apparantly the non-profit wants to now do away with the plan. Are 403b plans terminated in the same manner as a 401k/DC plan? Is an amendment needed to terminate? Any sort of distribution forms used? Can/should terminations be filed with the IRS?

Thanks

[Nassau]

The following are action items for terminating a 403(b) plan

A. 403(b) plans are generally set up under either a group format (i.e., group annuity contract) or individual account format (i.e., individual annuity contract). For 403(b) plans which utilize a group format approach and the plan sponsor is certain where all 403(b) plan assets are being held, termination of the plan is relatively straightforward and would consist of the following steps:

· Adopt a resolution terminating the plan.

· Amend the plan to eliminate future contributions, permit plan termination, and distribution of assets upon plan termination.

· If terminating prior to 1/1/2009, the plan must satisfy all requirements of the final 403(b) regulations.

· Provide notice to all interested parties in the plan, informing them of the plan termination (i.e., date of termination, time and form of distribution payments).

· Fully vest participants in their account balance upon plan termination (i.e., attributable to employer contributions, employee contributions are always 100% vested).

· Unallocated assets remaining in the forfeiture account must be allocated to all remaining participants and must be allocated in a non discriminatory manner (e.g.; pro-rata).

Ø If the plan provides that forfeitures will be used to reduce future employer contributions, it first must be amended to provide for reallocation of forfeitures.

· Upon plan termination, the mode of distribution must be by lump sum or annuity purchase.

Ø Note, generally a terminating 403(b) plan is permitted to distribute accumulated benefits to plan participants as long as the employer (including any entities in the employer’s controlled group) does not make contributions to another 403(b) contract beginning on the date of plan termination and ending 12 months after distribution of all plan assets.

· File a final form 5500. Note: 403(b) plans will be required to file a more comprehensive 5500 for plan years beginning in 2009.

B. Actions necessary to terminate a 403(b) plan that has utilized an individual account approach or where the plan sponsor is uncertain where all plan assets are being held (e.g., due to prior 90-24 transfers), are not so clear. There is no explicit guidance on how a plan sponsor may make distribution of plan assets from accounts over which it has no control or knowledge. In some instances there may be specific contract terms prohibiting the employer to take unilateral action such as terminating the plan and forcing distributions. Consideration is particularly relevant for salary reduction only plans and school districts. In these cases sponsors should engage legal counsel for direction.

[J Simmons]

I was asked about a real small 403b plan (less than 10 people) and apparantly the non-profit wants to now do away with the plan. Are 403b plans terminated in the same manner as a 401k/DC plan?

Similar, but not necessarily the same. The regulatory provision that for the first time specifies that termination can be a distribution triggering event for 403b plans is set forth in Treas Reg § 1.403(b)-10(a). Since those regs do not take effect until 1/1/2009, some opine that termination before then cannot be a distribution triggering event for those EEs under age 59 1/2 and yet employed by the employer.

For 403b plan termination to be a distribution trigger for any one of your less than 10 people, all the 403b plan assets must be distributed wthin a reasonable period of time after the termination of the plan. Bob Architect of the IRS has indicated a year is probably the outside limit for this. The problem is that unless the 403b plan is funded only with a group 403b annuity contract, the employer is not a part to the individual 403b contracts funding that plan. You'd need all the vendors and employees to consent in writing that they will distribute upon instruction from the employer that it has terminated the 403b plan, or else you could have some improper rollovers to IRAs or other employer plans by reason of the attempted termination.

Due to possible surrender charges, transfer fees, back-end loads, etc., some of the employees may not be willing to so agree. In that case, you might want to simply document and freeze the plan with the documents specifying no new loans, propose info sharing agreements with each of the vendors, and answer requests from the vendors when and as they come about the employment status of individual contract holders, date/year of birth verification, and other loans from other 403b contracts or qualified plans of the employer. Such greatly minimizes the regulatory burden on the employer, and continue the 403b plan as frozen (updating the docs as may be needed) until all contract-holding employees have either reached age 59 1/2 or terminated employment. Then termination is not needed as a distribution triggering event, so then a termination can be attempted.

Is an amendment needed to terminate?

Generally speaking, yes, but I think the plan document would need to be examined first--if there is one now. If not, the cautious thing to do would be to adopt a plan document that comports with the new regs, theres a non-ERISA plan document model attached to Rev Proc 2007-71. That plan document ought to specify that the right to amend and terminate is reserved by the employer.

Any sort of distribution forms used?

402f notices and rollover option are required before there can be a distribution. The employer ought to make sure to take that step if the vendor(s) will not.

Can/should terminations be filed with the IRS?

Not at this time.

[Santo Gold]

But does the company have to meet a certain criteria in order to even be able to terminate a 403(b)? I heard something about there having to be less than 2% of active employees eligible to participate before a termination can occur. Is this or something similar to this, correct?

Thanks

[J Simmons]

I think the 2% is a 401k notion related to termination, not a 403b one.

The criteria is that the employer must be able to cause all of the plan assets (what 403b contracts/accounts have to be included as plan assets is not clear under the regs or guidance) to be distributed within a reasonable period of time, which Bob Architect suggests is one year (as with 401a QRPs). If the employer cannot, then the benefits of any active employee under age 59 1/2 that were rolled out of the context of a 403b product (thinking the 403b plan was terminated) did not have an "access event" (Architect's terminology) and the rollover contribution to IRA (or other plan) is improper.

[Guest Sieve]

John --

The -10(a)(1) reg does contain a 2% rule relating to the ability to again start a new 403(b) plan after termination of an earlier 403(b) plan. It's basically the same as the 401(k) rule which limits the ability of a plan termination to be considered a distributable event if another dc plan starts within 12 months.

I also thought I saw in the preambles or the regs that a plan termiantion can occur even before the effective date of the regs, but I can't find that now. Or am I just dreaming (or smoking something illegal)?

[Everett Moreland]

I also thought I saw in the preambles or the regs that a plan termination can occur even before the effective date of the regs, but I can't find that now. Or am I just dreaming (or smoking something illegal)?

72 Federal Register 41128, 41139 (July 26, 2007):

"For periods following July 26, 2007 and before the applicable date, taxpayers can rely on these regulations, except that (1) such reliance must be on a consistent and reasonable basis and (2) the special rule at § 1.403(b)–10(a) of these regulations permitting accumulated benefits to be distributed on plan termination can be relied upon only if all of the contracts issued under the plan at that time satisfy all of the applicable requirements of these regulations (other than the requirement at § 1.403(b)–3(b)(3)(i) of these regulations that there be a written plan)."

[Guest Sieve]

Thanks for that, Everett!

[J Simmons]

72 Federal Register 41128, 41139 (July 26, 2007):

"For periods following July 26, 2007 and before the applicable date, taxpayers can rely on these regulations, except that (1) such reliance must be on a consistent and reasonable basis and (2) the special rule at § 1.403(b)–10(a) of these regulations permitting accumulated benefits to be distributed on plan termination can be relied upon only if all of the contracts issued under the plan at that time satisfy all of the applicable requirements of these regulations (other than the requirement at § 1.403(b)–3(b)(3)(i) of these regulations that there be a written plan)."

(Emphasis added.)

Has anybody attempted this non-document-all-contracts-compliant approach to termination other than perhaps where a single group contract is the only funding vehicle for 403b contributions to date? What actions could the employer take to change the 403b contracts to which it is not a party to remove any non-compliant terms? Could the employer do anything to bring into compliance 403b contracts of an employee if the employer learned that an employee has ever had outstanding loans from different vendors that in the aggregate (403b5) exceeding the 72p limits? Is there a correction the employer can take if the universal availability rule has not been followed, so that the employer can then take this termination approach? How would the employer be certain that a participating employee's deferrals for a year did not exceed what was allowed to the 403b contract (rendering that contract not compliant) as he or she may have made deferrals to another employer's 403b or 401k plans for that same year?

Seems that it would involve more time and less certainty of compliance than the employer (a) adopting a 403b plan document with a reserved rights to the employer to terminate, and unlike the model language attached to Rev Proc 2007-71, to instruct payout, (b) giving out the 'reasonable, good-faith' invitations to all post-2004 vendors asking them to subordinate the 403b contracts to such 403b plan document, and © on January 1, 2009 terminating the 403b plan and instructing payout of all the 403b contracts that the vendors agreed were so included. That's assuming that you're comfortable with the notion that the other 403b contracts, those that the vendor refused such invitation, are not 'included' in the 403b plan's assets.

[Guest Sieve]

John --

The quoted preamble language indicates that distributions resulting from plan termination cannot occur unless all requirements are met at the time of the distribution. So, why couldn't you terminate the plan prior to 1/1/2009 but simply limit distributions as a result of the termination until 2009?

Would you then still have to institute a written document? I thought not.

[J Simmons]

The preamble says "For periods following July 26, 2007 and before the applicable date [January 1, 2009], taxpayers can rely on these regulations, except that... (2) the special rule at § 1.403(b)–10(a) of these regulations permitting accumulated benefits to be distributed on plan termination can be relied upon only if only if all of the contracts issued under the plan at that time satisfy all of the applicable requirements of these regulations (other than the requirement ... that there be a written plan)." (Emphasis added.)

I read that to be that a distribution may be made 7/26/07-12/31/08 without a plan document if the plan is terminated. I don't read that preamble language to grant that leeway if the distribution (incident to termination) is not made before 1/1/09.

Are you trying the non-document-all-contracts-compliant approach to termination on any 403b programs you may be advising?

[Guest Sieve]

Actually, John, I'm having providers tell me that they can distribute as a result of a 403(b) plan "termination" without the requirement of a plan document and an ISA. I am hearing it so often that I'm starting to believe it and wonder if they might not somehow be right.

When I suggest providing (or amending) a document as of 1/1/09 which simultaneously terminates the plan, I'm hearing "not necessary, because you are stopping contributions to the plan and we can then make distributions based on the plan termination without the document".

Do they have their heads screwed on wrong, or is mine?

[J Simmons]

My concern lies primarily in the employer being able to accomplish the distribution of all the individual 403b contracts that are part of the undocumented plan within a reasonable time of terminating (i.e., a year), and secondarily whether that payout must be before 1/1/09 to be done without a plan document.

If not all assets are distributed within a year, then there is no -10(a) termination. Bob Architect has been repeating that warning at seminars since last January (and I most recently heard Bob say that as part of the NTSAA's Webinar of October 24). Many of the individual 403b contracts between employees and vendors do not defer to the employer if it instructs to payout. If you have some under age 59 1/2, active employees that attempted a rollover to an IRA or other plan as part of a plan termination distribution, it's a bad rollover as the employee did not have an 'access event' permitting distribution. Consequently, I would not try a termination under the current -10(a) if individual 403b contracts are involved unless I first had all the employees and all the vendors signed off that they would do the payout within a year if the employer terminates.

Of course, without defining what 403b contracts must be considered as plan assets, -10(a) requires that all of plan assets be timely distributed incident to the termination in order for termination to be an 'access event' for those under 59 1/2 and yet employed by the employer. I would at least want to go through the employer invitation step (reasonable, good-faith effort to include and maintain under the employer's 403b plan document, Rev Proc 2007-71) and be refused or ignored by a vendor before I took the position that the 403b contracts issued by the vendor were not part of my plan's assets. Without that step, what 403b contracts would have to be paid out within one year in order to termination to be an access event permitting payout and rollover for those under 59 1/2 and yet employed by the employer? I don't know. Which 403b contracts are included in a plan is cited as the first of six vague areas in the October 22, 2008 letter initiated by the Groom Law Firm and Conner & Winters (and signed by about 30 others, including American Benefits Council, MetLife, The Principal, Great-West, and SPARK Institute) to Thomas W Reeder, IRS Office of Benefits Tax Counsel, asking for a postponement of the 1/1/2009 effective date of the new regs.

The Preamble approach further complicates the attempt to do a non-document termination by requiring that each of the 403b contracts satisfy "all of the applicable requirements of these regulations" other than the plan document requirement. At least if you have a plan document designed to meet the regs and provide in it that the plan provisions override any conflicting or inconsistent provisions in the 403b contracts maintained pursuant to the plan document, then any 403b contract as to which the invitation is accepted and is then subordinated to the plan document (by signature of the vendor and/or the employee) is brought into compliance with the new regs. Many of the individual 403b contracts floating around out there predate the new regs being proposed in 2004, and each would have to be carefully scrutinized and compared to the 2007 final regs' requirements before you could know that the 403b contract meets all the applicable requirements of the regs.

Sounds like a mighty tall order to me. At that, I'd yet read the Preamble to require the payout to occur before 1/1/09.

I'm recommending to employers that do not want to continue operating a 403b plan that they adopt a plan document, freeze the plan, and keep the documents updated until some future guidance gives more certainty about the ability and practicality of terminating.

By the way, the IRS has a free phone conference featuring Bob Architect on the 403b regs, set for Thursday, December 4, 2008, at 2:00 PM EST.

Conference Name: 967425/ EP CE&O Area Analyst

Access Code: 195499

Toll-Free Phone: 1-866-216-6835

Toll Phone: 1-913-227-1220

[Guest Sieve]

I had been convinced of the need to establish a document and then freeze/terminate the Plan simultaneously with adoption. The worst that happens if you terminate a plan with a document and everything is not distributed within a year is to have an ongoing plan (for which you already have a document). I'm pretty conservative about these matters, and this is a conservative approach. Thanks for again reminding me of the need for documents.

You're more in tune to this than I am. In your view, is there any realistic chance of a postponement of the effective date of the regs?

[J Simmons]

While there are many ERs that yet do not have documents in place, it has been about a year now since the model 403b plan language attached to Rev Proc 2007-71 was published and many ERs have adopted plan documents.

We're only 39 days out, and it has now been 31 days since the letter was sent to Reeder and 25 since ASBO (Association of School Board Officials) made a similar request to the IRS.

On November 13, Architect said the request for postponement was then under 'high level review' at the IRS.

Nevertheless, I think the prospects of a delay are actually getting dimmer each day. I hope to be pleasantly surprised, but would appreciate even more answers to questions about which 403b contracts are "plan assets" after the section 8.01 invitation has been made by an employer and either accepted or rejected/ignored by each vendor and if an employer's asking as part of that invitation that the vendor subordinate the 403b contracts to a 403b plan that gives the employer the unilateral power to instruct payout belies the invitation being a reasonable, good-faith effort to include those 403b contracts in the employer's 403b plan. That would open a practical path towards plan termination.

[Guest Gregor]

· Unallocated assets remaining in the forfeiture account must be allocated to all remaining participants and must be allocated in a non discriminatory manner (e.g.; pro-rata).

Does anyone have a citation for this point?

Thanks.