SunGard Relius

Prior to the issuance of the new final 403(b) regulations, Code §403(b) did not provide for plan termination as a distributable event. An employer which wanted to terminate its 403(b) plan could not distribute a participant’s account balance until the participant incurred a distributable event. For plans subject to ERISA, it forced the employer to continue complying with the reporting and disclosure requirements until all participants incurred a distributable event (e.g., termination of employment). One of the more positive aspects of the new 403(b) regulations was the inclusion of a provision which treats plan termination as a distributable event. The following questions and answers address several of the more important issues regarding 403(b) plan termination.

Q: May an employer sponsoring a 403(b) plan freeze (i.e., cease future contributions) the plan?

A: Yes. An employer may amend the plan to eliminate future contributions for existing participants. Since the frozen plan would continue to be subject to the written plan requirement, the employer would need to update the plan for any required changes. Furthermore, if the plan were subject to Title I of ERISA, the plan would need to continue to comply with the reporting (e.g., 5500) and disclosure requirements (e.g., summary plan description).

Q: May an employer sponsoring a 403(b) plan terminate the plan?

A: Yes. For taxable years commencing after December 31, 2008, the plan would need to contain provisions permitting termination in order for the employer to effect a plan termination.

Q: Is plan termination a distributable event?

A: Yes. A plan termination is a distributable event for 403(b) plans. Generally, a plan termination distribution would qualify as an eligible rollover distribution and the participant could roll over the distribution to an eligible retirement plan (e.g., IRA). However, there are limitations as described below.

Q: May a 403(b) plan sponsor treat plan termination as a distributable event before the effective date of the final regulations (January 1, 2009)?

A: Yes. However, if a plan sponsor wants to distribute pursuant to plan termination before January 1, 2009 (and after July 26, 2007), all contracts (and custodial accounts) must be in operational compliance with all of the new regulatory requirements other than the written plan requirement. However, an insurance company may object to making an annuity contract distribution on plan termination because the contract does not provide for the distribution, regardless of the fact that the regulations permit the distribution.

Q: In order for an employer to terminate a 403(b) plan, what steps do the regulations require the employer to complete?

A: The steps are:

1. The plan must contain plan termination provisions (after 2008).
2. The employer (including related employers) cannot make contributions to any other 403(b) plan for the period beginning on the date of plan termination and ending 12 months after distribution of all assets from the terminated plan. However, if, for the period 12 months before plan termination and ending 12 months after distribution of all plan assets from the terminated plan, fewer than 2% of the employees who were eligible under the terminated plan were eligible under an alternative 403(b) plan, the employer may disregard the alternative plan.
3. The employer may not treat contributions which were not vested (considered as part of a 403(c) contract) at plan termination as contributions to a 403(b) plan. The employer may choose to vest the contributions prior to termination.
4. The plan must distribute all accumulated benefits under the plan to all participants and beneficiaries as soon as administratively practicable after plan termination. Apparently, the plan must provide all appropriate documentation in connection with the distribution, including a 402(f) notice .

Regarding requirement 2, note that a 401(k) plan is not an alternative 403(b) plan. This means an employer can terminate a 403(b) plan, establish a 401(k) plan, and allow participants to roll balances into the 401(k) plan. Notice that a rollover (following a distributable event) is the only way to move money between a qualified plan and a 403(b) plan; the employer cannot simply transfer the funds or otherwise merge the plans.

The employer should note that ERISA and state law may impose other requirements, such as: (1) filing a final Form 5500, and (2) adopting some form of a corporate resolution.

Q: Do the regulations provide any alternative methods to comply with the distribution requirement?

A: Yes. The regulations will treat a plan’s distribution of a fully paid individual insurance annuity contract (or custodial account) as a distribution. This will facilitate plan termination in 403(b) plans where the plan maintains individual contracts and may lack sufficient legal control over the contracts to effect a distribution. In such a case, the employer might notify the participant and the vendor that it is terminating the 403(b) plan and that as of a certain date the plan will treat the individual contract as “distributed.” It appears that the plan or the vendor should report the distribution on a Form 1099-R since the regulations treat the delivery of the contract as a distribution. Under current instructions, the value of a distributed annuity contract shows on line 8 of the 1099-R and is not included in lines 1 or 2a. Note: One issue the IRS fails to resolve in the regulations is whether a distributed individual contract can continue to exist after the employer has terminated the 403(b) plan. A careful and conservative reading of the regulations would suggest that after December 31, 2008, a contract cannot exist without the written 403(b) plan unless the contract is grandfathered under Rev. Proc. 2007-71. Therefore, a plan distributing an individual contract should inform the participant to roll over the contract within 60 days to avoid tax consequences. The annuity vendor may be willing to convert the contract to an Individual Retirement Annuity.

403(b) Plan Specialty Workshop. During July, SunGard will present a comprehensive one-day workshop on 403(b) plan requirements in six cities. In particular, the program will focus on transfers, exchanges, plan terminations and the written plan requirement. The course includes case studies illustrating the new rules and attendees will receive an outline updated for the regulations. For more information and to register, visit our Web site.

403(b) Prototype Plan. SunGard has created a 403(b) prototype document to assist employers in complying with the new written plan requirement. The document includes a basic plan document and two alternative adoption agreements: deferral only and employer contributions and deferrals. Visit our Web site for additional information on this product.