IRS Moves On 403(b) Plans Concern AALU And ACLI
An effort by the Internal Revenue Service to consolidate and clarify the rules governing 403(b) annuities and accounts has drawn concern from the life industry that the changes could create burdens for employers and therefore reduce the availability of such plans.
At an IRS hearing on the proposed regulations, representatives of the life industry listed several areas of concern, including proposed changes dealing with the use of insurance contracts for funding “incidental death benefits” under section 403(b) plans.
Retirement plans governed by section 403(b) of the Internal Revenue Code are similar to the better known 401(k) plans but are designed for employees of nonprofit institutions such as charities, churches or public schools and universities. Regulations for the plans have been issued in the past through Revenue Rulings and private letter rulings, and the IRS said in its introduction to the proposed regulations that they were being offered as a means to bring the rules governing 403(b) plans more in line with those governing 401(k)s.
The proposed rules have raised some concerns for the industry, however, most notably in the use of life insurance in 403(b) plans. Life insurance contracts historically have been used to fund incidental death benefits for 403(b) plans, and while the proposed regulations would not prohibit continuing this practice, they do bar life policies from being used as annuities for 403(b) purposes.
In a letter to the IRS prior to the hearing, Lawrence Raymond, secretary of the Association for Advanced Life Underwriting, told the IRS the proposed rules have created “significant confusion about the extent to which separate life insurance contracts [as defined under Code section 7702] can be used to provide incidental death benefits.” At the hearing, he reiterated that the proposed regulations should not overwhelm the fact that incidental death benefits are and should be allowed in 403(b) arrangements just as they have been historically allowed in qualified plans. Although he acknowledged it was likely unintentional, Raymond said the proposed regulations would at best create confusion and at worst impose a barrier to implementation of incidental death benefits.
The possibility of the rules, even unintentionally, barring incidental death benefits in 403(b) plans also drew concern from the American Council of Life Insurers.
“Not only would this proposal reverse long-standing industry practice and participant expectations, it would strip away the opportunity to obtain through their employment the valuable protections life insurance contracts offer individuals and that they may not otherwise receive as an employee benefit,” said Sanford Koeppel, vice president of legislative and regulatory affairs for Prudentials retirement business, who testified on behalf of the ACLI. “We fail to see the rationale in denying these participants benefits that have traditionally been available in section 403(b) plans and that will continue to be available in other retirement plans.”
The ACLI also asked the IRS to ensure, in crafting the final version of the proposed rule, that complying with them would not trigger coverage under the Employee Retirement Income Security Act. Again, the issue was one of clarity, as Koeppel said the ACLI didnt believe complying with provisions of the proposed regulations would trigger ERISA coverage but that the regulations themselves “have not made that explicit.”
Should that uncertainty continue, he said, the entities offering 403(b) plans might stop doing so for fear of ERISAs administrative burdens.
“In a voluntary system where very small nonprofit entities, churches and school districts have implemented these arrangements as a convenience to their employees and do not have the resources to deal with the complex array of requirements, fiduciary duties and potential liability that comes with ERISA coverage, many plan sponsors will be compelled to terminate their plans, and others will be deterred from offering new ones,” he said.
Additionally, the AALUs Raymond told the IRS the proposed rules could seriously restrict the transfer of funds from one plan to another, and thereby significantly restrict the investment alternatives available to plan participants. In crafting a final version of the proposed regulation, he said, the IRS should leave the prior rules governing transfers in place or incorporate the Revenue Ruling that established them into the final regulation.
The timing of the regulations, which the ACLIs Koeppel noted would be implemented by 2006, was also seen as a potential problem. The ACLI “believes that the government cannot reasonably expect 403(b) annuity issuers and sponsors to expend the significant amounts of money and resources required to comply with final regulations by the proposed effective date of Jan. 1, 2006,” he said. “The insufficient time to comply that has been proposed is further exacerbated by the inability to rely on the proposed regulations in the interim.”
Instead, Koeppel argued that the rule should have varying effective dates. For those plans filed with a state insurance regulator within six months of the final regulations effective date, the rules could be applied retroactively, he said, “as long as the plans involved were in reasonable good faith compliance with the final regulations in the interim.”
For government plans not funded with annuity contracts, Koeppel suggested a transition period similar to the one that currently exists in the proposed regulations for church and collectively bargained plans, with an effective date for all other plans no sooner than the second Jan. 1 after regulations are finalized.
“This would allow at least one full year to implement all necessary changes,” he said, adding that the effective date should also be delayed until a ruling on the ERISA issues is handed down by the Department of Labor.
Reproduced from National Underwriter Edition, February 18, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.