4060 / May an employee transfer funds from a 403(b) account to purchase past service credit?

Yes.

Plan participants may exclude from income amounts directly transferred from an IRC Section 403(b) tax sheltered annuity to a governmental defined benefit plan that are used to purchase permissive service credit. Likewise, a participant may use directly transferred amounts to repay contributions or earnings that previously were refunded because of a forfeiture of service credit under either the transferee plan or an IRC Section 403(b) tax sheltered annuity maintained by a governmental employer in the same state.¹

PPA 2006 modifies the definition of permissive service credit. Under the new definition, “permissive service credit” means service credit that relates to benefits to which a participant is not otherwise entitled under a governmental plan, rather than service credit that a participant has not received under a plan.

Credit qualifies as permissive service credit if it is purchased to provide an increased benefit for a period of service already credited under the plan (e.g., if a lower level of benefit is converted to a higher benefit level otherwise offered under the same plan) as long as it relates to benefits to which the participant is not otherwise entitled.

PPA 2006 also allows participants to purchase credit for periods regardless of whether service is subject to the limits on nonqualified service. Under the provision, service as an employee of an educational organization providing elementary or secondary education can be determined under the law of the jurisdiction in which the service was performed. Thus, for example, permissive service credit can be granted for time spent teaching outside of the U.S. without being considered nonqualified service credit.²

The limits regarding nonqualified service are not applicable in determining whether a plan to plan transfer from a Section 403(b) annuity to a governmental defined benefit plan is for the purchase of permissive service credit. Thus, the failure of the transferee plan to satisfy the limits does not cause the transferred amounts to be included in the participant’s income. The transferee plan must satisfy the limits in providing permissive service credit as a result of
the transfer.

Plan-to-plan transfers under IRC Section 403(b)(13) may be made regardless of whether a transfer is made between plans maintained by the same employer. The provision also provides that amounts transferred from a Section 403(b) annuity to a governmental defined benefit plan to purchase permissive service credit are subject to distribution rules applicable under the IRC to the defined benefit plan.³