Final 403(b) Regulations

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Final 403(b) Regulations

• Focus on Impact for K-12
• Public Schools

Presented by Dar Hansen, CFP, EA WEA Trust
Member Benefits
2
Overview of presentation

• Provide summary of relevant features of final
  403(b) regulations
• Discuss impact on public education employers and
  employees
• Planning strategies and action steps

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A little background

• In November 2004, the IRS issued proposed 403(b)
  regulations
• Hinted at shift away from payroll accommodation
  programs
• Focus on employer as sponsor of retirement plan
  (many new responsibilities for employers)
• IRS received many comments from the public

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Final regulations issued

• On July 23, 2007
• Published on July 26, 2007
• General effective date for most provisions is
  January 1, 2009
• Different effective dates for specific provisions
  (more specifics later)

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Overall impressions

• Committed to treating 403(b) programs as employer
  plans
• IRS referred to a change in culture, recognizing
  the 403(b) as an employer plan
• As often as possible, implemented rules to make
  403(b) plans as similar as possible to other
  elective deferral plans
• Incorporated many 401(k) requirements and
  interpretations into regulations

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Biggest changes under the regs

• Written plan documentation requirement
• Restrictions on employee changes in investments
• Changes were based on the products used to fund
  the 403(b) accounts
• Based on Rev. Rul. 90-24 which established
  criteria for transferring 403(b) accounts
• Employers and product providers will have
  different relationships
• Clarifications on certain issues will require
  changes
• Consequences of defects or errors

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Changes for employers

• More contact with product providers to coordinate
  responsibilities
• Plan maintenance
• Annual notice requirements
• Communicating the plan to employees
• Evaluating product provider performance under the
  plan
• Determine partner relationships for compliance
  purposes

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Now, about the regulations

• General effective date for most provisions is tax
  year beginning after December 31, 2008
• Delayed effective date
• For 403(b) plans maintained pursuant to a
  collective bargaining agreement in place on July
  26, 2007, effective date is earlier of
• expiration of contract, or
• July 26, 2010.

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Different effective dates

• 90-24 transfers permitted under current rules
  until September 24, 2007
• Significant changes thereafter
• Will cover on later slides
• Prohibition on life insurance contracts in 403(b)
  plans effective for contracts issued after
  September 24, 2007
• Restrictions on in-service withdrawals of
  employer contributions to annuity contracts not
  effective for any contract entered into prior to
  January 1, 2009

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New plan requirements

• The 403(b) plan must satisfy a list of specific
  qualifications
• Requirements for written plan documentation
• Separate requirements for underlying custodial
  accounts and annuity contracts
• Operational requirements (new)
• Failure of any of these elements causes the
  employee to lose the exclusion from income
  otherwise provided under 403(b)

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What happens if there is a defect under the plan?

• General Rule
• No exclusion from income
• How much is lost depends on type of error
• Entire plan (all accounts under the plan) is
  disqualified if the employer
• Fails to maintain the written plan document, or
• Fails to satisfy the universal availability
  requirements, or
• If the problem is not an operational problem.
• An operational problem occurs if the plan does
  not follow the terms of the plan document
• Employees contracts fail individually due to
  operational errors

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What happens for operational errors?

• Employees contracts fail individually due to
  operational errors
• An operational failure by one product provider
  can affect ALL contracts held for that employee
  under the plan
• Regs state that all contracts held by a
  participant under the plan are considered one
  account contract
• Exception to this aggregation rule
• Where contract requirements for unvested amounts
  and excess 415(c) contributions (over the 45,000
  limit in 2007) are not satisfied

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An overview of the plan document requirements

• Two requirements
• Written plan documentation required which
  includes all material terms and conditions for
• Eligibility
• Applicable limitations (contributions)
• Benefits
• Distributions
• Contracts available under the plan
• The plan must adhere to the 403(b) requirements
  in both form and operation

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Plan documents may

• Allocate administrative duties to responsible
  parties
• BUT, no provision for shifting liabilities
• Still need a hold harmless agreement that
  protects the school district
• Use multiple documents, but regs recommend a
  single document for multiple vendor plans
• Incorporate by reference the underlying contracts
  and custodial accounts
• Must include procedure for resolving conflicting
  provisions

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Plan documents may

• Include optional features, such as
• Employer contributions
• Roth contributions
• Hardship withdrawals
• Loans
• In-service withdrawals
• Acceptance of rollovers
• Exchanges to 403(b) products approved within the
  plan
• Plan to plan transfers (in or out)

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Plan documents may

• Exclude features to limit, simplify compliance or
  reduce liabilities, such as
• Prohibiting loans
• Prohibiting financial hardships
• Excluding 15-years-of-service catch-up limit
• Allowing every employee to participate in the
  plan
• Restricting the number of product providers and
  require providers to take on certain
  administrative responsibilities

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Where to get a plan document?

• IRS will release model language that school
  districts can use to create a plan document that
  meets the regulations requirements (if used and
  followed, will comply)
• Vendors will offer their documents
• Third party administrators (TPAs) will offer
  their documents
• Issue Following the terms of the document
• The employer must read it to identify the terms
  and responsibilities

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Key concepts to understand

• Terms of plan document must be followed
• Operational error consequence (just the affected
  participant)
• Employers, employees, and vendors must know terms
  of the plan document
• Employers will have to choose strategy to satisfy
  administrative requirements
• Self administration
• Work with vendors directly
• Work with TPA

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How will this requirement affect 403(b) plans of
K-12 employers?

• Puts focus clearly on the employer
• Employer will be responsible for document
• Including maintenance and updates
• Selecting document provider consideration
• Amend or change plan document at any time and as
  often as desired
• IRS has hinted that there may be problems with
  eliminating certain rights, benefits, and
  features retroactively

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Vendor related issues with document requirements

• Issues to consider relating to product providers
• Will they be able to follow the terms of each
  employers plan?
• Can products be timely amended and reregistered
  to satisfy requirements?
• Customer service and administrative support must
  shift to plan level
• Vendors will have to
• Take responsibility for optional features such as
  monitoring distributions and loans, or
• Be able to work with TPAs.

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Next big issue

• The regulations impose severe restrictions on
  employees rights to change investment products
  during employment
• Transfers and exchanges
• Rollover rights NOT affected
• Include transition period for changes
• First transition period ended September 24, 2007
• Immediate need to consider options quickly to
  communicate changes to employees

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Transfers and exchanges

• Lesson on new terminology after 9/24/2007
• Transfer is moving a 403(b) account under one
  employers plan into investment products
  permitted under another employers 403(b) plan
  (generally requires a severance from service with
  one employer)
• Exchange is change of investment products among
  investment options under the current employers
  403(b) plan
• Rollover is removal of account from employers
  403(b) plan into any other eligible retirement
  plan (only available after the employee
  experiences a distributable event such as
  severance from service or age 59½.)

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Transfers completed by September 24, 2007

• Transfers under Rev. Rul. 90-24 were permitted
  until September 24, 2007
• Prior rules applied for 60 day period from
  publication date
• Employers were generally not involved in these
  transactions
• Regs state that Rev. Rul. 90-24 will be repealed
  by future guidance

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Transfers and exchanges between 9/25/2007 and
1/1/2009

• Permitted only if employer and vendor receiving
  the proceeds from another vendor enter into an
  information sharing agreement (or, if electing
  to comply early, a hold harmless/service provider
  agreement) and
• The written plan document must ratify the
  exchanges that occurred during the interim and
  permit exchanges and/or transfers
• Both actions must be completed by
  January 1, 2009

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If the plan permits exchanges

• Employers plan document would have to permit
  exchanges
• Three requirements to qualify as a tax free
  exchange
• The value of the accumulated benefit is not less
  after the transfer
• Normal contract charges are permitted.
• Special transfer fees are not.
• The receiving contract has distribution
  restrictions at least as restrictive as the
  sending contract (same as old rules)
• Employer and receiving vendor have an information
  sharing agreement for compliance purposes

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After December 31, 2008

• No transfers or exchanges unless permitted by the
  plan document
• Exchanges restricted to only those products
  authorized in employers plan document
• No exchanges/transfers outside of authorized
  products during employment
• Plan could authorize different vendors for
  exchanges than for payroll access
• After employment, employees could transfer to
  another employers 403(b) plan if both plans
  permit

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Informal clarification

• According to Bob Architect (IRS spokesperson)
• After 9/24/2007 and before 1/1/2009 (or
  compliance date)
• Employees can make 90-24 transfers so long as the
  plan, as adopted by January 1, 2009,
  retroactively permits the exchange by allowing it
  in the plan document and executing an information
  sharing agreement with the recipient product
  provider
• Risk of compliance lies with the employee for
  interim transfers
• They have to be confident that their employer
  will permit exchanges and will enter into an
  agreement with that vendor.
• After compliance or 12/31/2008, only new rules
  apply

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Implications?

• Severely restricts employee investment changes
  after September 24, 2007
• Employee would have to acknowledge risk that
  employer may not approve exchange later, or
• Employer would have to permit exchange by
  entering into an agreement with the recipient
  before the exchange
• Absolutely unclear what happens to 403(b)
  accounts that are not named under an employers
  plan on January 1, 2009

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Other changes under the regulations

• Catch-up contribution ordering ratified
• Anything over annual deferral limit
• First, looked at as part of 15-years-of-service
  catch-up if employee is eligible.
• Then, age 50 catch-up considered.
• Investment restrictions on 403(b)s
• Limited to annuity contracts and 403(b)(7)
  custodial accounts (no stocks, bonds, CDs,
  T-Bills, etc.)
• Life insurance contracts issued after
  September 24, 2007, are NOT permitted

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Other changes under the regulations
Post-employment employer contributions

• Employer contributions for former employees
  permitted for up to five years after year of
  severance from service
• No post-employment employer contributions after
  the month of retirees death (monthly
  compensation to be determined based on 1/12 of
  annualized compensation)
• IRS auditors are looking to see if there is
  constructive receipt (Is it really treated as an
  employee option rather than an employer
  contribution?)

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Impact

• Post-employment contribution agreements need to
  be reviewed prior to 1/1/2009
• Determine if contracts require payments after
  death
• To 403(b) account, or
• To beneficiary.
• If contract language requires post mortem
  payments, amendments will be required prior to
  applicable effective dates

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Post-employment salary reduction contributions

• Regulations permit employees to make elective
  deferrals from amounts received after severance
  from service, so long as
• Proceeds are received by the later of the end of
  the year, or
• 2½ months following severance date, and
• Payments are for amounts employees would have
  received if they had not severed service
• Accumulated leave payments okay
• Retirement incentives or severance benefits may
  not be used for deferrals unless received as part
  of final paycheck

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Universal availability

• For salary reduction contributions, if employer
  offers plan to any employees, then all employees
  must be allowed to participate. Certain
  exceptions apply
• Students
• 20 hours per week
• Regs clarify universal availability requirements.
  20-hour-per-week exclusion based on actual hours
  worked
• If reasonable expectation that employee will not
  work 1,000 hours in year of hire, can exclude
  during 1st year.
• Thereafter, have to look back to count hours to
  determine if employee actually worked at least
  1,000 hours.
• Effectively requires schools to count actual
  hours of service for all employees if they want
  to exclude employees with fewer than 20 hours per
  week

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Universal availability

• Requires meaningful written notice to employees
  of eligibility to participate at least annually
• Electronic may be okay
• Posting in faculty lounge is not
• Employees must have reasonable opportunity to
  make deferral elections at least once per year
• Violations of universal availability requirements
  result in plan failure

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Financial hardships

• Clear authority to rely on 401(k) regulations for
  guidance on financial hardships
• Vendors are required to notify employer of
  withdrawal because
• Salary reduction contributions must be stopped
  for six months
• To ALL vendors, and
• All plans (such as 403(b) and 457(b)).

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Issues related to the plan termination option

• To allow distributions, contracts and custodial
  accounts would have to be amended
• Consideration will have to be given to who
  controls the assets of terminated plans
• Regs permit fully paid up contracts to be treated
  as distributed
• No relief for custodial accounts
• How can school districts distribute ALL plan
  assets as is required?
• Must employees consent to distributions?
• What about outstanding loans and the 10 early
  distribution penalty if there is a cash
  distribution?

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Other requirements

• Elective deferral contributions be remitted to
  the insurance company or custodian as soon as
  administratively possible
• Suggests standard of no later than 15 business
  days in the month following reduction of salary
• May require changes to employers procedures
• Issue to address with TPA or common remitter
• Consider electronic remitting

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What the regulations do not do

• Do not impose a fiduciary duty on employers
• IRS does not have authority to do so
• Public schools are exempt from ERISA, so ERISA
  duties do not apply
• However, every state has established certain
  standards for appropriate behavior between
  employers and employees and when handling assets
  on behalf of another
• May be potential litigation (just have to wait
  and see)

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What to do now

• Take time to make good decisions
• Schools will have to decide how to address new
  responsibilities
• Ignore the changes and continue as before?
• Do it yourself?
• Partner with product providers? (coupled with
  service contracts)
• Use a third party administrator as manager
• Level of service is important
• Strings?
• Costs

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More to do

• Review current 403(b) program
• Vendors
• Terms of plan (eligibility and exclusions)
• Procedures
• Plan communications (notice to employees)
• Enrollment procedures
• Payroll issues

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How will your new plan compare to your current
plan?

• Everything you do in the interim period should
  focus on reaching goals in a consistent manner by
  12/31/2008
• Plan design and documentation
• Vendor selection
• Compliance/administrative support
• Employee communication

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Questions?
Contact your retirement plan consultant WEA Trust
Member Benefits 1-800-279-4030