Contract Requirements

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>