Contract Requirements

March 13, 2024

4040 / When does an employee participating in a tax-sheltered annuity plan have an “effective opportunity” to make elective deferrals for purposes of the nondiscrimination requirements applicable to plans that offer salary reduction contributions?

<div class="Section1"> An employee is not treated as being permitted to have 403(b) elective deferrals contributed on the employee’s behalf unless the employee is provided an effective opportunity that satisfies the following requirements.<a href="#_ftn1" name="_ftnref1">1</a> Whether an employee has an effective opportunity is determined based on all relevant facts and circumstances, including (1) notice of the availability of the election, (2) the period of time during which an election may be made, and (3) any other conditions on elections. A 403(b) plan satisfies the effective opportunity requirement only if, at least once during each plan year, the plan provides an employee with an effective opportunity to make or change a cash or deferred election between cash or a contribution to the plan. Furthermore, an effective opportunity includes the right to have 403(b) elective deferrals made on his or her behalf up to the lesser of (1) the applicable limits for 403(b) elective deferrals, including any permissible catch-up elective deferrals under the age 50 catch-up, and the special 403(b) catch-up for certain organizations, or (2) the applicable limits under the contract with the largest limitation, and applies to part-time as well as full-time employees. An effective opportunity is not considered to exist if there are any other rights or benefits that are conditioned, directly or indirectly, on a participant making or failing to make a cash or deferred election with respect to a contribution to a 403(b) contract. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.403(b)-5(b)(2). </div>

March 13, 2024

4037 / What is the written plan requirement for 403(b) plans?

<div class="Section1"> Editor’s Note: Beginning January 1, 2023, Revenue Procedure 2022-40 allows plan sponsors to submit determination letter applications for individually designed 403(b) plans with respect to initial plan determination, plan terminations, and other issues that the IRS has yet to announce.  Plans sponsored by schools, churches and tax-exempt organizations will be permitted to apply in substantially the same way that is already available for individually designed qualified plans. <hr> Planning Point: Plans are not required to participate in the determination program. However, the program allows the plan to receive assurance from the IRS that the plan’s written form complies with the Internal Revenue Code. Applying also makes it easier for the plan to correct any errors under the EPCRS program. <hr> According to final regulations, a contract does not satisfy the requirements for exclusion from gross income ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4035">4035</a>) unless it is maintained pursuant to a plan. For this purpose, a plan is a written defined contribution plan that in both form and operation satisfies the requirements set forth in the regulations.<a href="#_ftn1" name="_ftnref1">1</a> Thus, a plan must contain all of the material terms and conditions for eligibility, benefits, applicable limitations, the contracts available under the plan, and the time and form under which benefit distributions would be made.<a href="#_ftn2" name="_ftnref2">2</a> A plan may contain optional features that are consistent with, but not required, under IRC Section 403(b), including features with respect to hardship withdrawal distributions, loans, plan-to-plan or annuity contract-to-annuity contract transfers, and acceptance of rollovers to the plan. If a plan contains any optional provisions, the optional provisions must meet, in both form and operation, the relevant requirements.<a href="#_ftn3" name="_ftnref3">3</a> A plan may allocate responsibility for performing administrative functions, including functions to comply with the requirements of Section 403(b) and other tax requirements. Any allocation must identify responsibility for compliance with the requirements of the IRC that apply on the basis of the aggregated contracts issued to a participant under a plan, including loans under IRC Section 72(p) and conditions for obtaining a hardship withdrawal. A plan is permitted to assign responsibilities to parties other than the eligible employer, but not to participants.<a href="#_ftn4" name="_ftnref4">4</a> The final regulations do not require that there be a single plan document.<a href="#_ftn5" name="_ftnref5">5</a> To satisfy the requirement that a plan include all material provisions, the regulations permit the plan to incorporate by reference other documents including the insurance policy or custodial account, which as a result then become part of the plan. Consequently, a plan may include a wide variety of documents, but it is important for the employer that adopts the plan to ensure that there is no conflict with other documents that are incorporated by reference.<a href="#_ftn6" name="_ftnref6">6</a> Notice 2009-3 provided relief from immediate compliance with the written plan requirement in calendar year 2009. Effective January 1, 2009, sponsors of 403(b) plans generally were required to maintain a written plan that satisfies, in both form and operation, the requirements of the final regulations. In response to numerous requests for deferral of the effective date, the IRS announced in Notice 2009-3 that it will not treat a 403(b) plan as failing to satisfy the requirements of IRC Section 403(b) and the final regulations during the 2009 calendar year, provided that, (1) on or before December 31, 2009, the sponsor of the plan had adopted a written 403(b) plan that was intended to satisfy the requirements of IRC Section 403(b), including the final regulations, effective as of January 1, 2009, (2) during 2009, the sponsor operated the plan in accordance with a reasonable interpretation of IRC Section 403(b), taking into account the final regulations, and (3) before the end of 2009, the sponsor made its best efforts to retroactively correct any operational failure during the 2009 calendar year to conform to the terms of the written 403(b) plan, with such corrections based on the general principles of correction set forth in the Employee Plans Compliance Resolution System “(EPCRS”).<a href="#_ftn7" name="_ftnref7">7</a> The IRS makes clear that the relief provided under Notice 2009-3 applies solely with respect to the 2009 calendar year and may not be relied on with respect to the operation of the plan or correction of operational defects in any prior or subsequent year.<a href="#_ftn8" name="_ftnref8">8</a> The IRS amended its EPCRS program to permit employers which have not timely adopted written plan documents under Notice 2009-3 to correct that error by submitting the document for approval of late adoption. This is done by filing under the Voluntary Compliance Program under the EPCRS, and paying a filing fee which specifically applies to nonadopters. Remedial Amendment Period The IRS has established an initial “Remedial Amendment Period” (“RAP”) for 403(b) plans related to changes imposed by the 2007 regulations.<a href="#_ftn9" name="_ftnref9">9</a> This remedial amendment period ran through March 31, 2020, under Revenue Procedure 2017-18. This deadline was delayed to June 30, 2020 in response to COVID-19. The first day of this RAP is January 1, 2010 (though plan sponsors were permitted to amend their plans retroactively to January 1, 2009), and the last day of the period is June 30, 2020. The IRS has now approved the first pre-approved 403(b) prototype plans submitted under Revenue Procedure 2013-22, as extended by Revenue Procedure 2014-28, under Revenue Procedure 2017-18. Any employer can also correct any plan document errors which occurred between January 1, 2009 and June 30, 2020 by adopting one of these IRS pre-approved plans by that date. Plan document errors made after the June 30, 2020 can be corrected in accordance with the EPCRS by making a filing under the Voluntary Compliance Program. Model Plan Language In 2007, the IRS issued Revenue Procedure 2007-71, which provides model plan language that may be used by public schools either to adopt a written plan to reflect the requirements of IRC Section 403(b) and Treasury regulations, or to amend a 403(b) plan to reflect the requirements of IRC Section 403(b) and Treasury regulations.<a href="#_ftn10" name="_ftnref10">10</a> The revenue procedure also provides rules for when plan amendments or a written plan are required to be adopted by public schools or other eligible employers to comply with final IRC Section 403(b) regulations. In addition, the revenue procedure addresses the use of the model plan language by employers that are not public schools. However, the model plan language is no longer effective after June 30, 2020, and any employer adopting such model plan must restate the plans to an IRS pre-approved document. 403(b) Prototype Plan Program The IRS has issued a pre-approved plan program for 403(b) plans similar to the current programs offered for IRC Section 401(a) tax-qualified plans under Revenue Procedure 2013-22. The IRS is only intending to issue determination letters to these pre-approved plans, and will not issue determination letters on individually designed 403(b) plans. The IRS program provides pre-approved documents for 403(b) retirement plans, which means that employers must restate their plans to reflect a new plan document by the end of a remedial amendment period (RAP) that ended June 30, 2020. Annuity contracts and custodial agreements must be updated, and the plan RMD requirements must be stated in the contracts themselves, rather than in the plan document. The employer must also complete an administrative appendix that will now be included with the IRS-approved plan documents.<a href="#_ftn11" name="_ftnref11">11</a> Interaction between Title I of ERISA and IRC Section 403(b) The Department of Labor is of the view that tax-exempt employers will be able to comply with the requirements in the new IRC Section 403(b) regulations and remain within the DOL’s safe harbor for TSA programs funded solely by salary deferrals. The DOL noted, however, that new IRC Section 403(b) regulations offer employers considerable flexibility in shaping the extent and nature of their involvement under a tax-sheltered annuity program. Thus, the question of whether any particular employer, in complying with the IRC Section 403(b) final regulations, has established a plan covered under Title I of ERISA must be analyzed on a case-by-case basis.<a href="#_ftn12" name="_ftnref12">12</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.403(b)-3(b)(3)(i). See Treas. Reg. §§ 1.403(b)-1 through 1.403(b)-11. <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.403(b)-3(b)(3)(i). See Treas. Reg. §§ 1.403(b)-1 through 1.403(b)-11. <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.403(b)-3(b)(3)(i). <a href="#_ftnref4" name="_ftn4">4</a>.  Preamble, TD 9340, 72 Fed. Reg. 41128, 41130 (7-26-2007). <a href="#_ftnref5" name="_ftn5">5</a>.  See Preamble, TD 9340, 72 Fed. Reg. 41128, 41130 (7-26-2007). See also Retirement Plan FAQs Regarding 403(b) Tax Sheltered Annuity Plans at https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-403b-tax-sheltered-annuity-plans. <a href="#_ftnref6" name="_ftn6">6</a>.  Preamble, TD 9340, 72 Fed. Reg. 41128, 41130 (July 26, 2007). <a href="#_ftnref7" name="_ftn7">7</a>.  Section 6 of Rev. Proc. 2008-50, 2008-35 IRB 464, as modified by Rev. Proc. 2013-12, 2013-1 CB 313, and superseded and supplemented by Rev. Proc. 2016-8, 2016-1 IRB 243 and Rev. Proc. 2019-5. <a href="#_ftnref8" name="_ftn8">8</a>.  Notice 2009-3, 2009-2 IRB 250. <a href="#_ftnref9" name="_ftn9">9</a>.  Rev. Proc. 2013-22, 2013-18 IRB 985. <a href="#_ftnref10" name="_ftn10">10</a>.  Rev. Proc. 2007-71, 2007-51 IRB 1184, as modified by Notice 2009-3, 2009-2 IRB 250. <a href="#_ftnref11" name="_ftn11">11</a>.  Rev. Proc. 2017-18, 2017-5 IRB 743. <a href="#_ftnref12" name="_ftn12">12</a>.  Department of Labor Field Assistance Bulletin No. 2007-02 (7-24-2007). </div></div>

March 13, 2024

4035 / What nine requirements must a tax sheltered annuity contract meet in order for contributions to be excluded from the employee’s gross income?

<div class="Section1"> Editor’s Note: The remedial amendment period (RAP) applicable to tax sheltered annuities (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4037">4037</a>) was extended through March 31, 2020 under Revenue Procedure 2017-18. Pursuant to this new plan, employers were required to restate their plans to reflect a new plan document by the end of the extended RAP. In response to COVID-19, the March 31 deadline was extended to June 30, 2020. Exclusion for Contributions to Purchase 403(b) Contracts Under final regulations ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4026">4026</a>), amounts contributed by an eligible employer for the purchase of an annuity contract for an employee are excluded from the gross income of the employee under IRC Section 403(b) only if each of the nine requirements below are satisfied.<a href="#_ftn1" name="_ftnref1">1</a> The final regulations require the 403(b) plan, in both form and operation, to satisfy the applicable requirements for exclusion.<a href="#_ftn2" name="_ftnref2">2</a> (1)  Purchase by Eligible Employer. A tax sheltered annuity contract must be purchased by an eligible employer ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4027">4027</a>).<a href="#_ftn3" name="_ftnref3">3</a> Final regulations provide that the annuity contract cannot be purchased under a qualified plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3832">3832</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3934">3934</a>), or an eligible governmental plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3600">3600</a>).<a href="#_ftn4" name="_ftnref4">4</a> Thus, an employer must agree to pay premiums. Although the employer must pay premiums, the premiums may be derived either directly from the employer as additional compensation to the employee or indirectly from the employee through a reduction in his or her salary. If premiums are to come from a reduction in the employee’s salary, the reduction must be made under a legally binding agreement between the employer and the employee, and the agreement must be irrevocable as to salary earned while the agreement is in effect. An employee is permitted to enter into multiple salary reduction agreements with the same employer during any one taxable year of the employer. For purposes of IRC Section 403(b), the frequency that an employee is permitted to enter into a salary reduction agreement, the salary to which such an agreement may apply, and the ability to revoke such an agreement generally is determined under IRC Section 401(k).<a href="#_ftn5" name="_ftnref5">5</a> All annuity contracts, including custodial accounts and retirement income accounts, purchased by an employer on behalf of an employee are treated as a single annuity contract for purposes of applying the requirements of IRC Section 403(b).<a href="#_ftn6" name="_ftnref6">6</a> Tax deferment will be achieved only for premium payments attributable to amounts earned by an employee after the agreement becomes effective; premium payments attributable to salary earned prior to the effective date, or after termination of the agreement, are includable in the employee’s gross income. For this purpose, salary is considered earned when the services for which it is compensation are performed, even though payment is deferred and subject to a risk of forfeiture.<a href="#_ftn7" name="_ftnref7">7</a> After-tax contributions can be made by payroll deduction to a 403(b) plan, but will not be excludable.<a href="#_ftn8" name="_ftnref8">8</a> The final regulations specify that contributions to a 403(b) plan must be transferred to the insurance company issuing the annuity contract or the entity holding assets of any custodial or retirement income account that is treated as an annuity contract within a period that is not longer than is reasonable for the proper administration of the plan. A plan may provide for elective deferrals for a participant under the plan to be transferred to the annuity contract within a specified period after the date the amounts would otherwise have been paid to the participant,<a href="#_ftn9" name="_ftnref9">9</a> although in no event may that ever be longer than as soon as reasonably possible. If a tax sheltered annuity plan is subject to Title I of ERISA, the Department of Labor requires that amounts an employee pays to the employer or has withheld from salary by the employer for contribution to a plan become plan assets as soon as these amounts reasonably can be segregated from the employer’s general assets, but in no event later than the 15th business day of the month following the month in which the contributions are received or withheld by the employer,<a href="#_ftn10" name="_ftnref10">10</a> though the DOL generally takes the position that the required period is a matter of a few days following the payroll date. A tax sheltered annuity plan also can qualify for the ERISA contribution safe harbor for small plans, which is generally a seven day period. (2)  Nonforfeitable Rights. An employee’s rights under a 403(b) contract must be nonforfeitable except for failure to pay future premiums.<a href="#_ftn11" name="_ftnref11">11</a> According to final regulations, an employee’s rights under a contract are not nonforfeitable unless the participant for whom the contract is purchased has at all times a fully vested and nonforfeitable right to all benefits provided under the contract.<a href="#_ftn12" name="_ftnref12">12</a> The effect of this requirement is that salary reduction contributions to a tax sheltered annuity must be immediately vested. Actual employer contributions can be subjected to delayed vesting by treating such nonvested contributions as being subject to 403(c) instead of 403(b). Tax sheltered annuity plans are not subject to the vesting rules under Section 411, but may be subject to ERISA’s vesting rules. PPA 2006 extended to employer nonelective contributions the faster vesting requirements that had applied to employer matching contributions since 2002. The vesting requirements are satisfied under either a three year cliff vesting schedule that reaches 100 percent after three years of service or a graduated vesting schedule, i.e., 20 percent after two years of service, 40 percent after three years, 60 percent after four years, 80 percent after five years, and 100 percent after six years. This change effectively makes all employer contributions in defined contribution plans subject to the faster vesting requirements.<a href="#_ftn13" name="_ftnref13">13</a> There are vesting rules applicable to employer contributions in plan years beginning after December 31, 2001 ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3863">3863</a>). With exceptions for governmental and certain church plans, tax sheltered annuity plans with actual employer contributions generally are subject to ERISA and must comply with ERISA’s minimum vesting schedules if they delay vesting. (3)  Participation and Coverage. Except for contracts purchased under plans by certain churches or certain governmental plans, tax sheltered annuity contracts generally must be provided under a plan that meets minimum participation, coverage and nondiscrimination requirements if employer contributions are made to those contracts ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4032">4032</a>).<a href="#_ftn14" name="_ftnref14">14</a> (4)  Limits on Elective Deferrals. Under final regulations, a contract must satisfy IRC Section 401(a)(30), relating to limits on elective deferrals. A contract does not satisfy this limit unless the contract requires all elective deferrals for an employee not to exceed the limits of IRC Section 402(g)(1), which include (1) elective deferrals for the employee under the contract, and (2) any other elective deferrals under the plan under which the contract is purchased and under all other plans, contracts, or arrangements of the employer.<a href="#_ftn15" name="_ftnref15">15</a> (5)  Nontransferable. A contract must be expressly nontransferable.<a href="#_ftn16" name="_ftnref16">16</a> An agreement between employer and employee that the employee will not transfer the contract is not sufficient.<a href="#_ftn17" name="_ftnref17">17</a> For this purpose, an employer is considered to have purchased a new contract when it pays the first premium on a previously issued contract.<a href="#_ftn18" name="_ftnref18">18</a> Although the contract must be nontransferable, the employee can surrender the contract to the insurer, borrow against the loan value, transfer assets to another 403(b) annuity contract or custodial account ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4051">4051</a>) and exercise all other ownership rights. Tax results of a policy loan are discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4057">4057</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4067">4067</a>. (6)  Minimum Required Distributions. Tax sheltered annuity contracts and custodial accounts must provide that distributions of at least a minimum amount must be made.<a href="#_ftn19" name="_ftnref19">19</a> These requirements were previously permitted to be incorporated in a plan by reference ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4069">4069</a>), but now must be stated in the annuity contracts themselves.<a href="#_ftn20" name="_ftnref20">20</a> (7)  Direct Rollover Option. A plan generally must provide that if a distributee of any eligible rollover distribution ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4001">4001</a>) elects to have the distribution paid directly to a traditional IRA, another tax sheltered annuity (if applicable), or an eligible retirement plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3994">3994</a>) and specifies the plan to which the distribution is to be paid, then the distribution will be paid to that plan in a direct rollover ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3995">3995</a>).<a href="#_ftn21" name="_ftnref21">21</a> Before PPA 2006, amounts held in an annuity contract or account described in IRC Section 403(b) could not be converted directly to a Roth IRA.<a href="#_ftn22" name="_ftnref22">22</a> Effective for distributions beginning after December 31, 2007, distributions from a 403(b) plan may be rolled over directly into a Roth IRA, subject to the rules that apply to rollovers from a traditional IRA into a Roth IRA. This eliminates the necessity for a conduit traditional IRA.<a href="#_ftn23" name="_ftnref23">23</a> The payor of a 403(b) annuity contract or custodial account must withhold 20 percent from any eligible rollover distribution that the distributee does not elect to have paid in a direct rollover ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3998">3998</a>).<a href="#_ftn24" name="_ftnref24">24</a> A safe harbor explanation that a payor may give to recipients of eligible rollover distributions from tax sheltered annuities is provided in Notice 2002-3.<a href="#_ftn25" name="_ftnref25">25</a> (8)  Limitation on Incidental Benefits. The contract must satisfy the incidental benefit requirements of IRC Section 401(a) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3824">3824</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4028">4028</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4055">4055</a>, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4076">4076</a>).<a href="#_ftn26" name="_ftnref26">26</a> (9)  Maximum Annual Additions. The annual additions to the contract must not exceed the applicable limitations of IRC Section 415(c), treating contributions and other additions as annual additions ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4037">4037</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4040">4040</a>).<a href="#_ftn27" name="_ftnref27">27</a> Plan in Form and Operation According to final regulations, a contract does not satisfy the requirements for exclusion from gross income unless it is maintained pursuant to a plan. For this purpose, a plan is a written defined contribution plan that, in both form and operation, satisfies the requirements set forth in IRC Section 403(b) and Treasury regulations.<a href="#_ftn28" name="_ftnref28">28</a> Thus, a plan must contain all of the material terms and conditions for eligibility, benefits, applicable limitations, the contracts available under the plan, and the time and form under which benefit distributions would be made ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4031">4031</a>).<a href="#_ftn29" name="_ftnref29">29</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.403(b)-3(a). <a href="#_ftnref2" name="_ftn2">2</a>.  Preamble, TD 9340, 72 Fed. Reg. 41128, 41129 (7-26-2007). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 403(b)(1). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.403(b)-3(a)(1). <a href="#_ftnref5" name="_ftn5">5</a>.  SBJPA ’96, § 1450(a). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 403(b)(5); Treas. Reg. § 1.403(b)-3(b)(1). <a href="#_ftnref7" name="_ftn7">7</a>.  GCM 39659 (9-8-87). <a href="#_ftnref8" name="_ftn8">8</a>.  Bollotin v. U.S., 76-2 USTC ¶ 9604 (S.D. N.Y. 1976), aff’d, 77-1 USTC ¶ 9,450 (2d Cir. 1977). <a href="#_ftnref9" name="_ftn9">9</a>.  Treas. Reg. § 1.403(b)-8(b). <a href="#_ftnref10" name="_ftn10">10</a>.  Labor Reg. § 2510.3-102. <a href="#_ftnref11" name="_ftn11">11</a>.  IRC § 403(b)(1)(C). <a href="#_ftnref12" name="_ftn12">12</a>.  Treas. Reg. § 1.403(b)-3(a)(2). <a href="#_ftnref13" name="_ftn13">13</a>.  IRC § 411(a)(11). <a href="#_ftnref14" name="_ftn14">14</a>.  IRC § 403(b)(1)(D); Treas. Reg. § 1.403(b)-3(a)(3). <a href="#_ftnref15" name="_ftn15">15</a>.  Treas. Reg. § 1.403(b)-3(a)(4). <a href="#_ftnref16" name="_ftn16">16</a>.  Treas. Reg. § 1.403(b)-3(a)(5). <a href="#_ftnref17" name="_ftn17">17</a>.  Rev. Rul. 74-458, 1974-2 CB 138. <a href="#_ftnref18" name="_ftn18">18</a>.  Rev. Rul. 68-33, 1968-1 CB 175. <a href="#_ftnref19" name="_ftn19">19</a>.  IRC § 403(b)(10); Treas. Reg. § 1.403(b)-3(a)(6). <a href="#_ftnref20" name="_ftn20">20</a>.  TAMRA ’88, § 1101A(a)(3), Rev. Proc. 2017-18, 2017-5 IRB 743. <a href="#_ftnref21" name="_ftn21">21</a>.  IRC §§ 403(b)(10), 401(a)(31); Treas. Reg. § 1.403(b)-3(a)(7). <a href="#_ftnref22" name="_ftn22">22</a>.  Treas. Reg. § 1.408A-4, A-5. <a href="#_ftnref23" name="_ftn23">23</a>.  IRC § 408A(e). <a href="#_ftnref24" name="_ftn24">24</a>.  IRC § 3405(c). <a href="#_ftnref25" name="_ftn25">25</a>.  Notice 2002-3, 2002-2 IRB 289, as updated by Notice 2009-68, 2008-2 CB 423. <a href="#_ftnref26" name="_ftn26">26</a>.  Treas. Reg. § 1.403(b)-3(a)(8). <a href="#_ftnref27" name="_ftn27">27</a>.  Treas. Reg. § 1.403(b)-3(a)(9). <a href="#_ftnref28" name="_ftn28">28</a>.  Treas. Reg. § 1.403(b)-3(b)(3)(i). See Treas. Reg. §§ 1.403(b)-1 through 1.403(b)-11. See also Preamble, TD 9340, 72 Fed. 41128, 41130 (July 26, 2007). <a href="#_ftnref29" name="_ftn29">29</a>.  Treas. Reg. § 1.403(b)-3(b)(3)(i). See Treas. Reg. §§ 1.403(b)-1 through 1.403(b)-11. </div></div>

March 13, 2024

4039 / What nondiscrimination requirements apply to tax sheltered annuity plans offering salary reduction contributions?

<div class="Section1"> Tax sheltered annuity plans offering salary reduction contributions generally are subject to a single nondiscrimination rule (the “universal availability” rule) with respect to salary reduction contributions. The requirement does not apply to contracts purchased by certain churches or church-controlled<a href="#_ftn1" name="_ftnref1">1</a> organizations.<a href="#_ftn2" name="_ftnref2">2</a> If any employee may elect to have the employer make contributions to a TSA under a salary reduction agreement, then all employees of the organization other than certain excludable employees generally must be allowed to elect to have the employer make contributions of more than $200 annually pursuant to a salary reduction agreement.<a href="#_ftn3" name="_ftnref3">3</a> Furthermore, the employee’s right to make elective deferrals also includes the right to designate 403(b) elective deferrals as Roth contributions, if Roth contributions are otherwise permitted under the plan.<a href="#_ftn4" name="_ftnref4">4</a> The final 403(b) regulations clarify that an employee is not treated as being permitted to have 403(b) elective deferrals unless the employee is provided with an effective opportunity that satisfies certain requirements (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4040">4040</a>). The general thrust of this rule is to require that all employees be eligible to make salary reduction contributions if the opportunity to make salary reduction contributions is offered to any employee, as a way to prevent discrimination in favor of the highly compensated employees. The employer may, however, require a minimum annual salary reduction contribution of more than $200, and may exclude from participation in a salary reduction agreement any employee who is not willing to reduce salary by more than $200 per year.<a href="#_ftn5" name="_ftnref5">5</a> The rule probably also prohibits employer efforts to cap an employee’s annual salary reduction contributions at $200 or less. In addition, the nondiscrimination rule applicable to salary reduction contributions allows an employer to exclude certain other employees, including those who are participants in an IRC Section 457(b) deferred compensation plan of a governmental employer, a qualified cash or deferred IRC Section 401(k) arrangement of the employer, or another tax sheltered annuity.<a href="#_ftn6" name="_ftnref6">6</a> Certain ministers<a href="#_ftn7" name="_ftnref7">7</a> may be excluded as well.<a href="#_ftn8" name="_ftnref8">8</a> A contribution is considered not made pursuant to a salary reduction agreement if under the agreement it is made pursuant to a one time irrevocable election by the employee at the time of initial eligibility to participate.<a href="#_ftn9" name="_ftnref9">9</a> The legislative history provides that if an employee has a one-time election to participate in a program that requires an employee contribution, the contribution will not be considered an elective deferral to the extent that the employee is not permitted subsequently to modify the election in any manner.<a href="#_ftn10" name="_ftnref10">10</a> An employer that historically has treated one or more of its various geographically distinct units as separate for employee benefit purposes may treat each unit as a separate organization so long as the unit is operated independently on a day-to-day basis. Units located within the same Standard Metropolitan Statistical Area generally are not geographically distinct.<a href="#_ftn11" name="_ftnref11">11</a> A plan will not be treated as violating the requirements under IRC Section 403(b)(12) merely on account of the making of, or the right to make, catch-up contributions ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3761">3761</a>) by participants age 50 or over under the provisions of IRC Section 414(v), so long as a universal availability requirement is met.<a href="#_ftn12" name="_ftnref12">12</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.403(b)-5(b)(2). <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.403(b)-5(d). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC §§ 403(b)(1)(D), 403(b)(12)(A)(ii), 403(b)(12)(B). See also Treas. Reg. § 1.403(b)-5(b)(1). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.403(b)-5(b)(1). <a href="#_ftnref5" name="_ftn5">5</a>.  See, e.g., H.R. Rep. No. 99-426 (Tax Reform Act of 1986), at 715, reprinted in 1986-3 CB (vol. 2), at 715; H.R. Conf. Rep. No. 99-841 (TRA ’86), at II-420, reprinted in 1986-3 CB (vol.4), at 420. See also Treas. Reg. § 1.403(b)-5(b)(3)(i). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 403(b)(12)(A); Treas. Reg. § 1.403(b)-5(b)(4)(ii). <a href="#_ftnref7" name="_ftn7">7</a>.  Described in IRC § 414(e)(5)(C). <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 403(b)(12)(A). <a href="#_ftnref9" name="_ftn9">9</a>.  IRC § 403(b)(12)(A). <a href="#_ftnref10" name="_ftn10">10</a>.  H.R. Conf. Rep. No. 99-841 (TRA ’86), at II-420, reprinted in 1986-3 CB (vol. 4), at 420; General Explanation of TRA ’86, p. 680. <a href="#_ftnref11" name="_ftn11">11</a>.  Treas. Reg. § 1.403(b)-5(b)(3)(ii). <a href="#_ftnref12" name="_ftn12">12</a>.  IRC § 414(v)(3)(B). </div></div>

March 13, 2024

4041 / What nondiscrimination requirements apply to a tax sheltered annuity plan that provides for contributions other than by salary reduction?

<div class="Section1"> According to the final regulations, under IRC Section 403(b)(12)(A)(i), employer contributions and employee after-tax contributions must satisfy all of the following nondiscrimination requirements in the same manner as a qualified plan under IRC Section 401(a): (1)  Section 401(a)(4), relating to nondiscrimination in contributions and benefits, taking Section 401(a)(5) into account (2)  Section 401(a)(17), limiting the amount of compensation that can be taken into account (3)  Section 401(m), relating to matching and after-tax employee contributions (4)  Section 410(b), relating to minimum coverage<a href="#_ftn1" name="_ftnref1">1</a> Section 401(a)(26), although listed in IRC Section 403(b)(12)(A)(i), no longer applies to defined contribution plans. The final regulations do not adopt the good faith reasonableness standard of Notice 89-23 for purposes of satisfying the nondiscrimination requirements of IRC Section 403(b)(12)(A)(i).<a href="#_ftn2" name="_ftnref2">2</a> The Notice 89-23 standard continues to apply to state and local public schools and certain church entities for determining whether the controlled group rules apply.<a href="#_ftn3" name="_ftnref3">3</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3842">3842</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3867">3867</a> for the actual requirements of IRC Section 401(a)(4), IRC Section 401(a)(5), IRC Section 401(a)(17), IRC Section 401(m), and IRC Section 410(b). Governmental plans. A governmental plan is one established by the United States government, the government of any state or political subdivision, or any agency or instrumentality of any of them.<a href="#_ftn4" name="_ftnref4">4</a> The minimum participation and coverage and nondiscrimination requirements described in IRC Section 403(b)(12)(A)(i), other than IRC Section 401(a)(17), do not apply to state and local governmental plans. In particular, the requirements of IRC Sections 401(a)(4), 401(a)(5), 401(m), and 410(b) do not apply to such plans.<a href="#_ftn5" name="_ftnref5">5</a> Sponsors of governmental 403(b) plans must comply with regulations under IRC Section 401(a)(17).<a href="#_ftn6" name="_ftnref6">6</a> 501(c)(3) tax-exempt organizations. Regulations under IRC Sections 401(a)(4), 401(a)(5), and 410(b) generally are effective for plans maintained by tax-exempt organizations. Tax-exempt sponsors of 403(b) plans must comply with regulations under Section 401(a)(17). All employees of a group of employers that are members of a controlled group of corporations or all employees of trades or businesses that are under common control will be treated as employed by a single employer for purposes of the minimum participation, coverage, and nondiscrimination rules ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8964">8964</a>).<a href="#_ftn7" name="_ftnref7">7</a> Under the final regulations, common control exists between an exempt organization and another organization if at least 80 percent of the directors or trustees of one organization either are representatives of, or are directly or indirectly controlled by, the other organization. A trustee or director is treated as a representative of another exempt organization if he or she also is a trustee, director, agent, or employee of the other exempt organization. A trustee or director is controlled by another organization if the other organization has the general power to remove the trustee or director and designate a new trustee or director. Whether a person has the power to remove or designate a trustee or director is based on facts and circumstances.<a href="#_ftn8" name="_ftnref8">8</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.403(b)-5(a). <a href="#_ftnref2" name="_ftn2">2</a>.  Preamble, T.D. 9340, 72 Fed. Reg. 41128, 41134 (7-26-2007). <a href="#_ftnref3" name="_ftn3">3</a>.  Preamble, T.D. 9340, 72 Fed. Reg. 41128, 41134 (7-26-2007). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 414(d). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 403(b)(12)(C). <a href="#_ftnref6" name="_ftn6">6</a>.  Treas. Reg. § 1.401(a)(17)-1(d)(4)(i). <a href="#_ftnref7" name="_ftn7">7</a>.  IRC §§ 403(b)(12)(A)(i), 414(b), 414(c). <a href="#_ftnref8" name="_ftn8">8</a>.  Treas. Reg. § 1.414(c)-5; T.D. 9340, 72 Fed. Reg. 41128, 41158 (7-26-2007). </div></div>

March 13, 2024

4038 / What nondiscrimination requirements must a tax sheltered annuity meet?

<div class="Section1"> The SECURE Act 2.0 created new rules so that long-term, part-time employees will be permitted to participate in 403(b) plans.  Starting in 2025, the rules governing long-term part-time participation apply both to defined contribution plans and ERISA-governed 403(b) plans. Prior to 1989, there was no requirement that all employees, or that all of any class of employees, be made eligible for participation in an employer’s tax sheltered annuity plan. In years beginning after 1988, except for contracts purchased by certain churches or church-controlled organizations, tax sheltered annuities must be provided under a plan that meets certain nondiscrimination requirements.<a href="#_ftn1" name="_ftnref1">1</a> Notice 89-23 provided that a tax sheltered annuity plan would be deemed to be in compliance with these nondiscrimination requirements if the employer operated the plan in accordance with a reasonable, good faith interpretation of the requirements.<a href="#_ftn2" name="_ftnref2">2</a> Notice 89-23 provided guidance for complying with the nondiscrimination rules. Also, transitional safe harbors were generally available for tax sheltered annuities to meet most of these requirements. The final 403(b) regulations do not include the Notice 89-23 good faith reasonable standard, however.<a href="#_ftn3" name="_ftnref3">3</a> The final regulations provide that an annuity contract does not satisfy the nondiscrimination requirements unless the contributions are made pursuant to a plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4035">4035</a>), and the terms of the plan satisfy the nondiscrimination rules.<a href="#_ftn4" name="_ftnref4">4</a> In General Various employees, including students employed by a school in which they are enrolled and regularly attending classes and employees who normally work fewer than 20 hours per week, generally may be excluded.<a href="#_ftn5" name="_ftnref5">5</a> If any students or part-time employees are excluded, all must be.<a href="#_ftn6" name="_ftnref6">6</a> An employee normally works fewer than 20 hours per week if (1) for the twelve month period beginning on the date the employee’s employment commenced, the employer reasonably expects the employee to work fewer than 1,000 hours of service as defined in IRC Section 410(a)(3)(C) in that period, and (2) for each plan year ending after the close of the twelve month period beginning on the date the employee’s employment commenced or, if the plan so provides, each subsequent twelve month period, the employee worked fewer than 1,000 hours of service in the preceding twelve month period.<a href="#_ftn7" name="_ftnref7">7</a> In the case of plans subject to ERISA, if an employer requires a minimum age or a minimum number of years of service, the employer may not require that the employee complete a period of service extending beyond the date the employee becomes 21 or, if later, completes one year of service. If an employee is given a non-forfeitable right to 100 percent of his or her accrued benefits as normally would be the case with a tax sheltered annuity, the waiting period may be as much as two years instead of one. In the case of employees of an educational institution, the age may be 26 instead of 21 if after one year of service the employee is 100 percent vested and the employee’s rights are non-forfeitable.<a href="#_ftn8" name="_ftnref8">8</a> Under the SECURE Act 2.0, nonunion employees who perform at least 500 hours of service for at least two consecutive 12-month periods (and are at least 21 years old) must be allowed to participate in ERISA-governed 403(b) plans. These long-term, part-time employees may be excluded from coverage and nondiscrimination testing requirements.  Periods before January 1, 2023 are not taken into account in calculating the two consecutive 12-month period requirement. Title I of ERISA, regarding reporting, disclosure, participation, and vesting, does not apply to governmental and church plans.<a href="#_ftn9" name="_ftnref9">9</a> ERISA also generally does not apply to tax sheltered annuities of other employers unless the plan is established or maintained by the employer.<a href="#_ftn10" name="_ftnref10">10</a> A salary reduction plan generally will not be considered “established or maintained” by an employer if, among other things, employee participation is voluntary, employer involvement is limited to such things as requesting and providing information and collecting and remitting premiums, and the employer permits employees at least a reasonable choice among products and annuity contractors; an employer need not seek out products and contractors.<a href="#_ftn11" name="_ftnref11">11</a> An employer was found to exceed the limited involvement permitted under the regulation where the employer evaluated circumstances and exercised its judgment in determining eligibility for in-service withdrawals on account of disability or financial hardship.<a href="#_ftn12" name="_ftnref12">12</a> <hr> Planning Point: Since the issuance of the 2007 regulations, the DOL has issued extensive guidance on the circumstances when an employer may be considered establishing and maintaining a plan.<a href="#_ftn13" name="_ftnref13">13</a> <hr> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC §§ 403(b)(1)(D), 403(b)(12). <a href="#_ftnref2" name="_ftn2">2</a>.  Notice 89-23, 1989-1 CB 654, as modified by Notice 90-73, 1990-2 CB 353, Notice 92-36, 1992-2 CB 364 and Notice 96-64, 1996-2 CB 229; see also Ann. 95-48, 1995-23 IRB 13. <a href="#_ftnref3" name="_ftn3">3</a>.  Preamble, 72 Fed. Reg. 41128, 41134 (July 27, 2007). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. §§ 1.403(b)-5(c), 1.403(b)-5. <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 403(b)(12)(A). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 403(b)(12)(A). <a href="#_ftnref7" name="_ftn7">7</a>.  Treas. Reg. § 1.403(b)-5(b)(4)(iii)(B). <a href="#_ftnref8" name="_ftn8">8</a>.  ERISA § 202. <a href="#_ftnref9" name="_ftn9">9</a>.  ERISA § 4(b). <a href="#_ftnref10" name="_ftn10">10</a>.  ERISA § 3(2). <a href="#_ftnref11" name="_ftn11">11</a>.  Labor Reg. § 2510.3-2(f). <a href="#_ftnref12" name="_ftn12">12</a>.  DOL Adv. Op. 94-30A. <a href="#_ftnref13" name="_ftn13">13</a>.  DOL Adv. Op. 2012-02A; Field Assistance Bulletins 2010-01 2009-02 and 2007-02. </div></div>

March 13, 2024

4036 / What prohibited distribution requirements apply to tax-sheltered annuity plans?

<div class="Section1"> A custodial account invested in mutual funds must provide that amounts will not be made available before the employee dies, attains age 59½, has a severance from employment, becomes disabled within the meaning of IRC Section 72(m)(7), encounters financial hardship or except as may be otherwise provided by regulations, with respect to amounts invested in a lifetime income investment (i) on or after the date that is 90 days prior to the date that such lifetime income investment may no longer be held as an investment option under the contract, and (ii) in the form of a qualified distribution (as defined in section 401(a)(38)(B)(i)) or a qualified plan distribution annuity contract (as defined in section 401(a)(38)(B)(iv)).<a href="#_ftn1" name="_ftnref1">1</a> Hardship withdrawals may be made only on account of an immediate and heavy financial need ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3798">3798</a>). In years beginning after December 31, 1988, financial hardship distributions may be made only from assets held as of the close of the last year beginning before 1989 and from amounts contributed thereafter under a salary reduction agreement, not including earnings on these amounts. An annuity contract must provide that distributions attributable to salary reduction contributions, including the earnings on them, may be made only after the employee attains age 59½, has severance from employment, dies, becomes disabled, or in the case of hardship, except that the earnings on salary reduction contributions may not be distributed for financial hardship, or, for tax years beginning after 2020, with respect to amounts invested in a lifetime income investment (i) on or after the date that is 90 days prior to the date that such lifetime income investment may no longer be held as an investment option under the contract, and (ii) in the form of a qualified distribution or a qualified plan distribution annuity contract.<a href="#_ftn2" name="_ftnref2">2</a> These restrictions apply for years beginning after 1988, but only with respect to distributions attributable to assets other than assets held as of the close of the last year beginning before 1989.<a href="#_ftn3" name="_ftnref3">3</a> Assets held prior to that date are not subject to these restrictions. <hr> Planning Point: The Bipartisan Budget Act of 2018 removed the restriction on distributing earnings as hardship distributions beginning in 2019 (although the changes remain optional for plan sponsors) for qualified plans. Despite this, it remained unclear whether the new rules will apply to 403(b) plans because of the way the statute itself is drafted. The Section 403(b) regulations (as well as Section 403(b) itself) clearly prohibit the distribution of earnings as hardship distributions.<a href="#_ftn4" name="_ftnref4">4</a> Late in 2022, Congress passed the “SECURE Act 2.0,” which clarified that the newly expanded rules do apply equally to 403(b) plans. 403(b) plans may thus allow distributions of qualified non-elective contributions, including earnings, qualified matching contributions, including earnings and earnings on elective deferrals. Participants will no longer be required to take all available plan loans before they are able to take a hardship distribution under the new rules.  The expanded hardship distribution rules will only apply if the plan itself decides to amend the terms of the plan document. The new rules are effective for plan years beginning after December 31, 2023. <hr> Timely distributions of excess elective deferrals ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4047">4047</a>) and excess aggregate contributions ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4038">4038</a>) may be made without regard to the above restrictions,<a href="#_ftn5" name="_ftnref5">5</a> as they are amounts not attributable to salary reductions that are held in an annuity contract. For the restrictions affecting retirement income accounts, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4052">4052</a>. Amounts borrowed from a tax sheltered annuity and treated as a deemed distribution under IRC Section 72(p) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4063">4063</a>) are not treated as actual distributions for purposes of these distribution restrictions and will not violate these restrictions.<a href="#_ftn6" name="_ftnref6">6</a> If a participant’s accrued benefit is reduced or offset to repay a loan, an actual distribution occurs for purposes of these distribution restrictions.<a href="#_ftn7" name="_ftnref7">7</a> Accordingly, a plan may be prohibited from making such an offset to enforce its security interest in a participant’s account balance attributable to salary reduction contributions until a date on which a distribution is permitted under IRC Section 403(b)(11).<a href="#_ftn8" name="_ftnref8">8</a> Similarly, it would seem that servicing a plan loan with tax sheltered annuity funds before a distribution is permitted would constitute a prohibited distribution. Even though a distribution may be permitted under these rules for hardship or after severance from employment, it may nonetheless be subject to a 10 percent tax in addition to income tax as a premature distribution ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4074">4074</a>). These rules also apply to custodial accounts. A distribution to a former spouse pursuant to a qualified domestic relations order (“QDRO”) will be permitted under certain circumstances ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3915">3915</a>) even though the distribution otherwise might be prohibited under the prohibited distribution rules.<a href="#_ftn9" name="_ftnref9">9</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 403(b)(7)(A)(ii). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 403(b)(11); Treas. Reg. § 1.403(b)-6(d)(1)(ii). <a href="#_ftnref3" name="_ftn3">3</a>.  TAMRA ’88, § 1011A(c)(11). See also Let. Rul. 9442030. <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.403(b)-6(d)(2). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC §§ 402(g)(2), 401(m)(6). <a href="#_ftnref6" name="_ftn6">6</a>.  Treas. Reg. § 1.72(p)-1, A-12. <a href="#_ftnref7" name="_ftn7">7</a>.  Treas. Reg. § 1.403(b)-6(g). <a href="#_ftnref8" name="_ftn8">8</a>.  Treas. Reg. § 1.72(p)-1, A-13(b). <a href="#_ftnref9" name="_ftn9">9</a>.  IRC § 414(p)(10); Treas. Reg. § 1.403(b)-10(c). </div></div>