The IRS has issued proposed 403(b) regulations. The new regulations represent the first comprehensive guidance on 403(b) plans in 40 years. The new regulations incorporate the statutory changes from ERISA through EGTRRA and other IRS rulings issued since 1964. In addition, the regulations address other issues that have not been addressed by the IRS in any formal guidance. The new regulations are effective for taxable years beginning after December 31, 2005. The more significant issues addressed by the regulations are:

• Plan Document Requirement. The new regulations articulate, for the first time under the tax law, a written plan requirement. As with a qualified plan, the regulations require a 403(b) plan comply with the requirements in form and operation. The regulations specify that a plan should include all material provisions, including eligibility, benefits, limitations, contracts available under the plan and distributions. Previously, a 403(b) plan only needed to be in writing if it were subject to Title I of ERISA, and then, practitioners were not certain what language the document needed to contain. Unfortunately, the IRS acknowledges that the written plan requirement may subject “deferral only” 403(b) plans to Title I of ERISA.
• Exclusive Benefit Requirement. 403(b) custodial accounts (403(b)(7) plans) and retirement income accounts (church 403(b) plans) are subject to an exclusive benefit requirement.
• Life Insurance. After February 14, 2005, the IRS will not treat life insurance, endowment, accident and health, property, casualty or liability contracts issued as annuity contracts.
• Nondiscrimination and Coverage Requirements. The regulations eliminate the IRS Notice 89-23 safe harbors for complying with the nondiscrimination requirements. 403(b) plans now will need to comply with the same nondiscrimination and coverage requirements applicable to qualified plans.
• Elective Deferrals. The regulations provide guidance on elective deferrals that generally conforms 403(b) plans to the rules applicable to 401(k) plans: frequency of elections, negative elections, carryforward of elections, annual election opportunity, anti-conditioning, and correction of excess deferrals. The regulations also impose a timing requirement on the deposit of elective deferrals.
• Universal Availability Requirement. Although 403(b) plans cannot impose age and service conditions on elective deferrals, a 403(b) plan may exclude certain categories of employees. The regulations provide rules that permit geographically and functionally distinct units to apply this requirement separately.
• Catch-up Contributions. Certain 403(b) plans may be eligible for both the age-50 catch-up contribution and a special catch-up rule. The regulations apply an ordering rule to the two catch-up rules.
• Former-employee Contributions. An employer may make contributions to a former employee for 5 years following termination of employment. The regulations provide guidance on determining compensation and year of service for purposes of this provision.
• Distributions. 403(b) plan elective deferrals and 403(b)(7) employer contributions only may be distributed on certain events, including severance from employment. The severance from employment definition is similar to that of a 401(k) plan, but includes some exceptions to accommodate special situations in tax-exempt organizations. 403(b) plans also must comply with the direct rollover and required minimum distribution requirements.
• Loans. The regulations generally apply the same requirements applicable to qualified plans.
• Controlled Group Rules. The regulations include controlled group rules for tax-exempt organizations. Two or more organizations will form a controlled group (i.e., single employer) if 80% or more of the directors or trustees are the same, or 80% of the directors or trustees of one organization are controlled by another organization. The regulations also include a permissive aggregation rule. The controlled group rules do not apply to churches or governments. However, the final regulations may contain controlled group safe harbors for public schools.
• Plan Termination. The regulations, for the first time, address plan termination. A plan will be able to distribute its benefits as long as the employer does not make contributions to another 403(b) plan for a period of 12 months before and after the plan termination.
• Transfers and Exchanges. The regulations generally incorporate the rules articulated in Rev. Rul. 90-24.
• Consequences for Failing. Contributions that do not comply with the 403(b) requirements generally are taxable under Code §403(c) (annuities) or Code §§61, 83 and 402(b) (custodial accounts). However, the IRS provides a correction procedure for 403(b) plans under EPCRS.