Article: New Regulations Affect 403(b) Plan Sponsors

December 2008

New Regulations Affect 403(b) Plan Sponsors

Form 5500 filing requirement and other regulatory changes add to the administrative workload

As most not-for-profit managers are aware, a 403(b) tax-sheltered annuity is a retirement plan offered by schools, hospitals, churches, charities and certain other tax-exempt organizations. It is the counterpart of the 401(k) plan that is popular in the for-profit sector.

Historically, a 403(b) has been relatively easy to administer, but recent regulatory changes have added significantly to the administrative workload associated with those plans.

Form 5500 requirement. Until recently, 403(b) plans were exempt from the ERISA-imposed annual Form 5500 reporting, disclosure and audit requirements. However, in November 2007 the Department of Labor eliminated that exemption.

The removal of this exemption subjects ERISA-covered 403(b) plans to the same Form 5500 reporting and audit requirements as 401(k) plans, effective with their 2009 Form 5500 filings. Generally, 403(b) plans sponsored by charities are subject to ERISA, whereas 403(b) plans sponsored by religious organizations and governments are not.

“Large” ERISA-covered 403(b) plans (generally plans with 100 or more participants) will be required to file audited financial statements beginning with their 2009 Form 5500 filing. “Small” 403(b) plans (generally fewer than 100 participants) may be eligible to use a new Short Form 5500 and, thus, may be eligible to use abbreviated reporting forms without audited financial statements. The U.S. Department of Labor estimates that approximately 7,000 large 403(b) plans will be subject to the new audit requirements and another 9,000 small plans may be eligible to use the abbreviated reporting forms.

New regulations, model plan language. On July 23, 2007, the IRS issued the first comprehensive regulations for 403(b) plans in 43 years (published in the July 26, 2007, Federal Register). In summary, the new regulations:

impose due diligence and compliance criteria;
require 403(b) programs to be maintained per a written defined contribution plan that satisfies 403(b) in both form and operation and contains all of the terms and conditions for eligibility, limitations and benefits under the plan;
provide stricter transfer rules; and
establish a bright-line universal availability test.

With some exceptions, the general effective date is for taxable years beginning after December 31, 2008.

Also, the IRS’s Revenue Procedure 2007-71 provides model plan language that may be used by public schools to either adopt a written 403(b) plan or to amend their 403(b) plan to reflect the requirements of the Internal Revenue Code and final 403(b) regulations.

Background

Generally, 403(b) annuities are funded by elective deferrals made under salary-reduction agreements and may include non-elective employer contributions. Participants may include employees of public school systems, colleges or universities, 501(c)(3) tax-exempt organizations, cooperative hospital service organizations, churches, and public school systems organized by Indian tribal governments.
How 403(b) plans work. A 403(b) plan is very similar to a 401(k) in that it allows employees to defer some of their salary to make contributions to the plan. Contributions can be made by (a) elective deferrals under a salary reduction agreement; (b) non-elective contributions, including employer matching or discretionary contributions; (c) employee after-tax contributions; or (d) any combination of the above.

Contributions and investment earnings in a 403(b) are tax-deferred until withdrawn (assumed to be after retirement), at which time they are taxed as ordinary income. A 403(b) plan can also accept designated Roth IRA contributions, subject to certain requirements.

Employee elective deferrals are subject to limitations and are immediately 100% vested. As with 401(k) plans, special 403(b) catch-up contributions are permitted if (a) the participant has reached age 50 by the end of the year, and (b) the maximum elective deferrals that can be made to the 403(b) account have been made for the plan year.

Employer contributions may be made, with vesting over a specified time period in accordance with plan terms. Withdrawals are permitted after a distributable event occurs (e.g., retirement, death, disability, severance from employment), and rollovers or transfers are permitted to an eligible retirement plan.

Plan investments. 403(b) plans comprise individual investment accounts, which can be any of the following types:

fixed and variable annuity contracts with insurance companies [403(b)(1) annuities],
a custodial account made up of mutual funds [403(b)(7) accounts], or
a retirement income account set up for church employees [403(b)(9) accounts].

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.