On February 22, 2011, the IRS issued Revenue Ruling 2011-7, which clarifies the procedure that the sponsor of a Code Section 403(b) plan must follow to terminate the 403(b) plan in accordance with the final regulations that apply to those plans.
The final Section 403(b) regulations, released in July 2007, required 403(b) contracts to have a written plan document and permitted plans to include provisions providing for plan termination and distribution of accumulated benefits. While the regulations included some guidance concerning how termination could be accomplished, practitioners and sponsors have raised many questions on points that the regulations failed to address. Therefore, the IRS released this latest Revenue Ruling to clarify the termination requirements.
One difference between 403(b) plans and other types of qualified defined contribution plans is that many 403(b) plans include investments in individual insurance annuities and other individual contracts to which the sponsor is not a party. Rev. Rul. 2011-7 takes this distinction into account by applying the 403(b) plan termination steps to four types of 403(b) plans.
Types of 403(b) Plans
The four types of 403(b) plans are based on the manner in which their assets are invested:
- Fully paid individual annuity contracts issued by an insurer,
- A group annuity contract covering multiple participants, each of whom receives an individual certificate,
- Mutual funds in custodian contracts, and
- A money purchase pension plan that distributes benefits in the form of individual annuities purchased from insurers.
Termination procedure
The proper termination steps include the following:
- The sponsor must sign a binding resolution to cease future purchases of annuity contracts and to terminate the 403(b) plan.
- All benefits under the terminating 403(b) plan must be fully vested and nonforfeitable on termination.
- All accumulated benefits under the 403(b) plan must be distributed as soon as administratively practicable after the plan terminates. The delivery of fully paid individual insurance annuity contracts is treated as a distribution. The mere provision for, and making of, benefit distributions to participants or beneficiaries on plan termination do not cause a contract to cease to be a 403(b) contract.
- The delivery of fully paid individual insurance annuity contracts is treated as a distribution.
- The mere provision for, and making of, benefit distributions to participants or beneficiaries on plan termination do not cause a contract to cease to be a 403(b) contract.
Comment: “As soon as administratively practicable” generally means within 12 months following termination.
- Participants and beneficiaries must be notified of such plan termination.
- Participants and beneficiaries must be notified of their rollover rights in accordance with Code Section 402(f).
- The 403(b) plan cannot make any contributions to any other 403(b) plan (determined on a controlled group basis pursuant to Code Section 414) during the period beginning on the date of plan termination and ending 12 months after distribution of all assets from the terminated plan. There is an exception to this requirement: Contributions to another 403(b) plan will be disregarded if, at all times during the period beginning 12 months before the termination and ending 12 months after distribution of all assets from the terminated plan, fewer than 2% of the employees who were eligible under the terminating 403(b) plan as of the date of plan termination are eligible under the other 403(b) plan.
- There is an exception to this requirement: Contributions to another 403(b) plan will be disregarded if, at all times during the period beginning 12 months before the termination and ending 12 months after distribution of all assets from the terminated plan, fewer than 2% of the employees who were eligible under the terminating 403(b) plan as of the date of plan termination are eligible under the other 403(b) plan.
Tax Consequences of Distributions on 403(b) Plan Termination
In addition to the procedures for terminating a 403(b) plan, Rev. Rul. 2011-7 also explains the tax consequences of certain distributions which may occur on a 403(b) plan termination.
- Participants and beneficiaries in plans meeting the termination requirements will not be taxed on distributions made in the form of an individual annuity contract or an individual certificate evidencing fully paid benefits under a group annuity contract until amounts are actually paid out of the contract, so long as the contract maintains its status as a 403(b) contract.
- Any other distributions as part of a plan termination are included in gross income, except to the extent the amount is rolled over to an IRA or other eligible retirement plan by a direct rollover or transfer made within 60 days of distribution.
While the Revenue Ruling could have been clearer, it appears that a contract will maintain its status as a 403(b) contract if it adheres to the requirements of Section 403(b) as in effect at the time of the delivery of the contract. In other words, it appears that there is no need to update the provisions of the contract following its distribution to reflect future changes in the law and regulations.
Comment: While this is helpful for employers, it is likely to create administrative complexity for vendors.
This legal update was included in the Profit Sharing/401k Council of America Executive Report on March 17, 2011.