This is the third post in our 403(b) Crunch Time Series, the purpose of which is to help 403(b) plans get ready for the January 1, 2009 compliance deadline for the new Internal Revenue Service regulations. I’ve been joined by Bob Toth as a guest blogger. Bob, a Partner in the Baker & Daniels law firm, has over 25 years experience advising 403(b) plans and service providers.
On Friday, I discussed Complying With The 403(b) Contribution Limit. Now it’s Bob’s turn, and here’s his post on Trouble Terminating Tax Deferred Annuity Plans.
Okay, okay, so I thought I would lighten the load some by trying a bit of alliteration with the "traditional" term for 403(b) contracts: the Tax Deferred Annuity (the "TDA"). Whether or not the alliteration works is one thing, but its pretty clear that many terminations may not work well.
The new regulations are causing advisors and employers alike to take pause and to assess whether or not its worthwhile to continue with their current 403(b) arrangements. Many are seriously considering terminating the 403(b) plan and replacing them (where possible) with a 401(k) plan.
Pretty straightforward, you would think, eh? After all, the regs allow for the termination of 403(b) plans, terminations which then become distributable events. The whole deal seems simple enough. The problem, however (as always seems to be the case with 403(b) plans), is in the details.
The rules require that all of the assets of the plan be distributed upon termination in order for the termination to be effective. IRS spokesmen have said that this distribution must occur within a 12 month period following the action terminating the plan. To facilitate this, the regs actually recognize that a terminating distribution can be in the form of a fully paid annuity contract. Sounds simple enough? Just terminate the plan, notify the insurance carrier to either distribute a fully paid annuity contract or to take the employer’s name off of its files, and life is good.
Well , the IRS has complicated matters by taking the position that custodial accounts-in spite of statutory language apparently to the contrary- will not be honored as annuity contracts for termination distribution purposes.
Making matters even worse, Bob Architect, the IRS’ Senior Tax Law Specialist and the resident expert on 403(b) plans, has recently stated that even a conversion of group annuity contracts to individual contracts may not even be recognized upon termination as being valid. As Bob Stevenson, a Partner in the Stevenson Keppleman Associates ERISA law firm in Ann Arbor, MI said in a letter to his clients, "it may be that Mr. Architect spoke out of confusion."
All of this confusion has a real, practical effect: If a 403(b) plan has custodial accounts (or the type of annuity contracts to which Mr. Architect refers) within them, and the employer has no right to distribute the assets upon termination, AND some employees refuse to take a distribution of the cash from the contract, then the plan has never been terminated.
If the plan has not been terminated, then there has been no distributable event. If there has been no distributable event, any rollover to an IRA or another plan for those who HAVE taken a distribution will fail. Those attempted rollovers will become taxable because no distributable event has occurred. This sounds pretty draconian, but this is what happens.
So step carefully if you are attempting to terminate a 403(b) plan and distribute the assets. Check with the vendors to see if their contracts allow terminating distribution, and how it will be done. Without that kind of groundwork, you could be making a very expensive mistake for plan participants.
Thanks, Bob. Look for #4 in our 403(b) Crunch Time Series on Wednesday when I’ll be talking about The Change in 403(b) Universal Availability.