4057 / May an employee exchange his or her tax sheltered annuity contract for another contract within the same plan?

Under the final 403(b) regulations, a non-taxable exchange or transfer is permitted for a 403(b) contract if it:

(1)  is a mere change of investment within the same plan, that is, a contract exchange;

(2)  constitutes a plan-to-plan transfer, so that there is another employer plan receiving the exchange (see Q 4058); or

(3)  it is a transfer to purchase permissive service credit ( Q 4060).¹

Contract Exchanges within the Same Plan

Under prior law, Revenue Ruling 90-24 provided that a direct transfer between issuers of an amount representing all or part of an individual’s interest in an IRC Section 403(b) annuity or custodial account was not a distribution subject to tax or to the premature distribution penalty provided that, after the transfer, the funds transferred continued to be subject to distribution requirements at least as strict as those applicable to them before the transfer.² The final 403(b) regulations revoked Revenue Ruling 90-24 and any exchanges now are allowed under rules that generally are similar to those applicable to qualified plans.³

The final regulations provide that a 403(b) contract of a participant or beneficiary may be exchanged for another 403(b) contract of that participant or beneficiary under the same 403(b) plan if each of the following conditions is satisfied:

(1)  the plan under which the contract is issued provides for the exchange;

(2)  the participant or beneficiary has an accumulated benefit immediately after the exchange that is at least equal to the accumulated benefit before the exchange, taking into account the accumulated benefit under both 403(b) contracts immediately before the exchange; and

(3)  the new contract is subject to distribution restrictions with respect to the participant that are no less stringent than those imposed on the contract being exchanged and the employer enters into an information sharing agreement with the issuer of the new contract.⁴

Under the information sharing agreement, the employer and the issuer agree that from time to time in the future they will provide each other with the following information:

(1)  information about the participant’s employment;

(2)  information that takes into account other 403(b) contracts or qualified employer plans, such as whether a severance from employment has occurred for purposes of the distribution restrictions and whether the hardship withdrawal rules are satisfied; and

(3)  information necessary for the resulting contract to satisfy other tax requirements, such as whether a plan loan satisfies the conditions so that the loan is not a deemed distribution under IRC Section 72(p)(1).⁵

The rule for contracts received in an exchange does not apply to a contract received in an exchange that occurred on or before September 24, 2007, if the exchange (including the contract received in the exchange) satisfied the rules applicable at the time of the
exchange.⁶