403(b) Outlook: Withdrawal Restrictions/Employer Contributions
December 05, 2008
What is the new rule? For 403(b)(1) annuity contracts issued on or after Jan., 1, 2009, benefits attributable to employer contributions can only be distributed after severance from employment, disability or occurrence of a stated event such as attainment of a specific age or after a fixed number of years (at least two). (Treasury Regulation Section 1.403(b)-6(b))
Background: Under the Internal Revenue Code, all amounts in a 403(b)(7) custodial account under a 403(b) plan (including both employer contributions and employee elective deferrals) cannot be paid to a participant until the participant has a "triggering event," such as disability, severance from employment or attaining age 59 ½. These statutory withdrawal restrictions also apply to salary reduction contributions to a 403(b)(1) annuity, but not to employer contributions to a 403(b)(1) annuity. There is also an exception for elective deferral contributions to a 403(b)(1) annuity made before Jan. 1,1989. This grandfather rule for 403(b)(1) elective deferrals does not apply to elective deferrals contributed to a 403(b)(7) mutual fund. The final 403(b) regulations retain the rule that exempts these pre-1989 elective deferral accumulations from the withdrawal restrictions, provided they are accounted for separately. They also clarify that after-tax employee contributions are not subject to withdrawal restrictions.
TIAA-CREF will be providing specimen 403(b) plan documents that reflect this new rule.
What has changed? The final regulations impose withdrawal restrictions on employer contributions to a 403(b)(1) annuity IF the contract is issued on or after Jan. 1, 2009. Employer contributions made to a 403(b)(1) annuity contract issued before Jan. 1, 2009 are not subject to this new rule. Although the Internal Revenue Code and the final regulations do not impose any withdrawal restriction on employer contributions made to these contracts, a plan could always impose more stringent withdrawal restrictions. And to the extent employer contributions to a 403(b)(7) mutual fund are transferred to a 403(b)(1) annuity, the more stringent withdrawal restrictions must be imposed on the accumulation even if it is transferred to an annuity contract issued before Jan. 1, 2009.
Effective date: The withdrawal restrictions on employer contributions apply only to contracts issued on or after Jan. 1, 2009. This new rule will not apply to contributions in contracts issued before Jan. 1, 2009, if the contract receives contributions after that date.
What happens if you fail to comply? If your plan currently permits unrestricted in-service distributions (either lump sum or annuity) of employer contributions to a 403(b)(1) annuity contract, you will need to amend your plan to reflect the new withdrawal restrictions for annuity contracts issued after 2008. The final regulations also provide that a 403(b) plan can be amended before Jan. 1, 2009, to comply with the new withdrawal restrictions without violating the ERISA anti-cutback rules. If you do not comply with this requirement, it will be considered a contract failure. As a result, any contract issued after 2008 (and all other contracts issued to the employee) could lose their tax-deferred status and would, therefore, need to be included in the employee’s gross income.
Read more about withdrawal restrictions.
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