Participants enrolled in 403(b) plans can expect big changes next year, many of them for the better. That’s because on January 1, 2009 new rules governing 501(c)(3) or tax-exempt organizations take effect. The revisions, issued by the IRS in July of 2007, represent the first comprehensive overhaul of the 403(b) regulations since 1964.
David Pratt a professor of law at Albany Law School in Albany, N.Y. and a counsel to Reish, Luftman, Reicher & Cohen, P.C., of Los Angeles, Calif., discussed the 403(b) changes during a March 12 webcast hosted by the Society of Financial Service Professionals, Newtown Square, Pa. For the advisors engaged in employee benefits planning, he said, the new rules’ most dramatic impact is to more closely align 403(b) plans with their counterpart at for-profit companies, 401(k) plans, in part by increasing choices and resources available to employers and plan participants.
“If you know 401(k) plans, then you can adapt to the 403(b) universe fairly easily,” says Pratt. “There are, however, subtle but important differences between the two plan types.”
For employers, he added, the biggest changes will be a rise in administration costs, increased responsibility for insuring regulatory compliance and, not least, the need to draft a plan document containing the terms and conditions for eligibility, limitations and benefits under the plan. The modifications will most significantly impact non-profits–charities, churches and public educational institutions among them–that until now haven’t had to meet ERISA compliance standards that govern 401(k) plans.
But with the added burdens come enhanced control. Employers, Pratt noted, can now transfer 403(b) plan assets from one vendor to another without the employee’s consent and terminate a 403(b) arrangement. Plan vendors previously questioned this authority, holding that because employees owned their accounts, the primary relationship between vendor and employee had to continue.
The new regs, said Pratt, contain more restrictive investment options than are available under 401(k) plans. The choices permitted include annuities, mutual funds and–for churches only–retirement income accounts. The plans now also allow Roth IRA contributions.
Perhaps most attractive for boomer plan participants, said Pratt, are special catch-up provisions allowed under rule 402(g)(7), which are separate from the IRC 414(v) catch-up provisions that apply to qualified plans generally. The rule allows for up to $15,000 in catch-up contributions, but to qualify employees must have accrued at least 15 years of service. The catch-up contributions are also limited to certain 403(b)-eligible employers, such as health and welfare agencies and educational institutions. Pratt observed also that plan participants are additionally subject to a controversial “ordering rule.”
“If an employee is both over age 50, and thus eligible for the both the regular 414(v) and 403(b) catch-up contributions, then the regs require that employers subject any catch-up contributions first to the special [402(g)(7)] rule,” said Pratt. “And because of the $15,000 lifetime maximum that applies under the rule, the risk is that the catch-up contributions will be used up fairly quickly.”
Another advantage for plan participants, said Pratt, is the opportunity to continue to receive employer-paid contributions for up to 5 years following termination of service, so long as they continue to receive compensation during that period. The employer contributions must cease, however, if the employees dies during the 5 years.
Additionally, employers are allowed to treat as deferred compensation payments made to employees within 2 1/2 months following termination of employment. The deferred comp might include, for example, accrued vacation pay. Pratt emphasized, however, that all elective deferrals must satisfy a new “universal availability” test, mandating that plan contributions meet the same non-discrimination rules as apply to all qualified plans.
Thus, employers who allow employees to defer compensation must, with few exceptions, offer the opportunity to all employees. The deferral option must also be extended at the start of an individual’s employment (as opposed, as is often the case with qualified plans, following the completion of a year of service).
“Ideally, employers should determine whether new hires wish to contribute to a 403(b) plan at the orientation session,” said Pratt. “If they choose not to contribute, then it’s important to have documentation to that effect, as the IRS is policing [the universal availability provision] quite aggressively. Employers who don’t have documentary evidence could have difficulties if they’re audited.”
In addition to the special catch-up and post-employment compensation provisions, the 403(b) regs are different from those governing 401(k)s in their treatment of non-compliance. Excess annual contributions to a participant’s account, said Pratt, do not disqualify the 403(b) plan in total.
If, for example, annual contributions to a plan total $50,000, exceeding the per annum cap limit, the excess would simply be taxed and maintained under a separate account. Pratt noted, however, that the rules do not make clear when a separate account has to be set up.
He added that 403(b) distribution rules have been liberalized and made consistent with those governing 401(k) plans. Thus plan distributions can be made following termination of employment, after the employee has reached age 59 1/2 or in cases involving financial hardship.