Final 403(b) Regulations

Focus on Impact for K-12Public Schools

Presented byDar Hansen, CFP®, EA

WEA Trust Member Benefits

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

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)

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

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

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

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.

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

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)

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

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

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

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)

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

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

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

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

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.

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

Transfers and exchanges

•Lesson on new terminology after 9/24/2007– Transfer is moving a 403(b) account under one

employer’s plan into investment products permitted under another employer’s 403(b) plan (generally requires a severance from service with one employer)

– Exchange is change of investment products among investment options under the current employer’s 403(b) plan

– Rollover is removal of account from employer’s 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.)

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

If the plan permits exchanges…

•Employer’s 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

After December 31, 2008…

•No transfers or exchanges unless permitted by the plan document

•Exchanges restricted to only those products authorized in employer’s 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 employer’s 403(b) plan if both plans permit

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

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 employer’s plan on January 1, 2009

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 retiree’s 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?)

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

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

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

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

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)).

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 employer’s procedures– Issue to address with TPA or common remitter– Consider electronic remitting

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)

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

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

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

Questions?

Contact your retirement plan consultant

WEA Trust Member Benefits

1-800-279-4030