403(b) Outlook: Operational Compliance

November 26, 2008

403b Outlook Archive 403(b) Outlook Archive

What is the rule? Under the final 403(b) regulations, all 403(b) plans must be administered according to the terms of a written plan. In addition, the final regulations provide that plan terms will control if there is an inconsistency between the terms of the written plan and the provisions of the annuity contracts or custodial agreements that fund the plan. (Treasury Regulation Section 1.403(b)-3(b)(3))

Important: In the case of an annuity contract, the relationship between plan participants and the issuer of the annuity contract is generally governed by the terms of the annuity contract or certificate. The issuer is legally bound by the terms of the annuity contract, notwithstanding a potential conflict between the plan and contract. As a result, plan sponsors must ensure that there is no conflict between the terms of the written plan and the terms of the 403(b) contracts used as funding vehicles. If there are inconsistencies, the annuity contract could be disqualified. TIAA will be providing specimen 403(b) plan documents designed to meet the new requirements that will be aligned with TIAA-CREF annuities.

What has changed? All 403(b) plans, including governmental plans and non-ERISA salary reduction plans must be in writing. Institutions will be responsible for ensuring that their written plans are in compliance in both form and operation which means the plans must be operated in accordance with the terms of the written documents. You will need to review the terms of the annuity contracts and custodial agreements used to fund your plan and draft your written plan to ensure that it does not conflict with the terms of these contracts and agreements.

In addition to the written plan requirement, the final regulations require that plan sponsors and vendors share information on such issues as loans, hardship distributions and termination of employment. The regulations provide that the written plan should coordinate the various responsibilities of the plan sponsor and the annuity contract/ mutual fund vendors under the plan. In addition, the regulations provided that you cannot delegate administrative responsibilities to employees, for determining appropriate loan amounts, hardship withdrawals and verification of employment. You will need to establish compliance procedures with your vendors to ensure that you are operating your plan in accordance with the requirements of the IRC and the final regulations.

Effective date is Jan. 1, 2009.

What happens if you fail to comply? If you fail to operate the plan according to the written plan document, all contracts for all participants in the plan could lose their tax-deferred status and would, therefore, need to be included in the employee’s gross income.

Read more about information sharing agreements.

Next week’s issue: Form 5500 Audit Requirements

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