403(b) plan mergers - distribution restrictions

[Guest Louise76]

An employer wants to merger two 403(b) plans - one provides for hardships and loans and the other does not. As I read the regulations, a plan merger would need to comply with the plan to plan transfer rules. Specifically, the requirement that the receiving plan must provide that to the extent any amount transferred is subject o any distribuiton restrictions under 1.403(b)-6, the receivng plan must impose restrictions on distributions... that are not less stringent than those imposed on the transferor plan."

I am thinking this means that the transferred amounts cannot be made available for loans and hardships. But couldn't the transferred plan be amended to provide for loans and hardships before the transfer? And then aren't we in the same place as with 401(k) plans where the IRS has esstentially said you can allow these types of options because it is treated like a plan amendment?

[TLGeer]

An employer wants to merger two 403(b) plans - one provides for hardships and loans and the other does not. As I read the regulations, a plan merger would need to comply with the plan to plan transfer rules. Specifically, the requirement that the receiving plan must provide that to the extent any amount transferred is subject o any distribuiton restrictions under 1.403(b)-6, the receiving plan must impose restrictions on distributions... that are not less stringent than those imposed on the transferor plan."

I am thinking this means that the transferred amounts cannot be made available for loans and hardships. But couldn't the transferred plan be amended to provide for loans and hardships before the transfer? And then aren't we in the same place as with 401(k) plans where the IRS has esstentially said you can allow these types of options because it is treated like a plan amendment?

You are correct as to hardship distributions. Loan provisions are generally not subject to this rule.

The plan-to-plan transfer rule as to distribution restrictions only appleas to restrictions under Regs. 1.403(b)-6. Regs. 1.403(b)-6(f) says:

"(f) Loans. The determination of whether the availability of a loan, the making of a loan, or a failure to repay a loan made from an issuer of a section 403(b) contract to a participant or beneficiary is treated as a distribution (directly or indirectly) for purposes of this section, and the determination of whether the availability of the loan, the making of the loan, or a failure to repay the loan is in any other respect a violation of the requirements of section 403(b) and §§1.403(b)-1 through 1.403(b)-5, this section and §§1.403(b)-7 through 1.403(b)-11 depends on the facts and circumstances. Among the facts and circumstances are whether the loan has a fixed repayment schedule and bears a reasonable rate of interest, and whether there are repayment safeguards to which a prudent lender would adhere. Thus, for example, a loan must bear a reasonable rate of interest in order to be treated as not being a distribution. However, a plan loan offset is a distribution for purposes of this section. See §1.72(p)-1, Q&A-13. See also §1.403(b)-7(d) relating to the application of section 72(p) with respect to the taxation of a loan made under a section 403(b) contract."

Regs. 1.403(b)-7(d) includes the following sentence:

"A deemed distribution is not an actual distribution for purposes of §1.403(b)-6, as provided at §1.72(p)-1, Q&A-12 and Q&A- 13."

Tom Geer

[Guest Louise76]

Thanks, Tom. I was concerned loans would be included b/c the regulations only generally refer to 1.403(b)-6 and then the first line of 1.403(b)-6(f) says "The determination of whether the availability of a loan, the making of a loan, or a failure to repay a loan made from an issuer of a section 403(b) contract to a participant or beneficiary is treated as a distribution (directly or indirectly) for purposes of this section"

But I can see what you are saying that you can read 1.403(b)-7(d) and the example language in 1.403(b)-6 to say that a a loan is not treated as a distribution ("Thus, for example, a loan must bear a reasonable rate of interest in order to be treated as not being a distribution.")

Putting that aside, what do you think about the employer's ability to amend the plan that will merge in to provide for hardships prior to the merger. If the employer has the ability to add hardships pre-merger, then isn't it really form over substance?

[TLGeer]

There are three kinds of restrictions involved here, and two levels of analysis.

First are restrictions required under 1.403(b)-6. These cannot be eliminated in any way and follow the money around the plan. So a transfer from a custodial account to an annuity does not permit the additional restrictions place on custodial accounts, regardless of how the transfer is implemented.

Second are additional restrictions contained solely in the plan document. These can be eliminated by amendments to the plan document. The regulations have no limitation on amendments, either general or specific to restrictions on distribution.

Third, and more difficult to deal with, are additional (i.e., not required by 1.403(b)-6) restrictions contained in the terms of the investment vehicle. The issuer can eliminate these to the same extent the employer can eliminate additional restrictions in the plan document, but that is unlikely. The employer, in connection with a plan merger, can allow contract exchanges to an alternate investment vehicle with fewer restrictions, but contract exchanges in the ordinary course of operations must carry these restriction forward. (contrast "distribution restrictions with respect to the participant that are not less stringent than those imposed on the contract being exchanged" in 1.403(b)-10(b)(2)© with "any distribution restrictions under §1.403(b)-6" in 1.403(b)-10(b)(3)(F).)

This last is a slightly aggressive reading. The drafters appear to have been thinking only of plan level-only issues in (3)(F) and only of investment vehicle-only levels in (2)© and appear not to have noticed the interstitial situation where investment vehicle-level restrictions are modified in connection with a merger. However, the language seems pretty clear. Note that I view the additional regulation of restrictions not required under 1.403(b)-6 as gratuitous.

An implication of the different treatment of contract exchanges within a single plan and those in connection with a merger is that it matters which plan, in form, survives. If all investment vehicle dogs with non-required restrictions are in Plan A, then make it merge into Plan B. Otherwise, assess, balance and apply judgment.

Tom Geer