403(b) Outlook: Plan Terminations

June 19, 2008

403b Outlook Archive 403(b) Outlook Archive

What is the rule? Under the final 403(b) regulations, employers can terminate a 403(b) plan provided the accumulated benefits under the plan are distributed to participants. Distributing the annuity contract or the certificate to the participant is enough to satisfy this requirement; participants do not actually have to receive a distribution from the contract. The regulations further require that the employer not make contributions to another 403(b) plan for at least 12 months after the plan is terminated. Employers can, however, establish a 401(k) plan immediately. The final regulations also provide that plan termination is considered a triggering event and participants will be entitled to receive a distribution from the annuity contracts to the extent permitted under the terms of the contract. In addition, a participant may roll over an eligible distribution to another plan that accepts it or to an IRA. (Treasury Regulation Section 1.403(b)-10(a))

A note about frozen plans: According to the final regulations, an employer can elect to eliminate future plan contributions ("freeze" the plan) instead of terminating it. If they elect to freeze the plan, employers will need to maintain the plan, keeping it in compliance with current law and regulations on an ongoing basis.

What has changed? Prior to the final 403(b) regulations, there was no statutory authority for plan terminations. Plan termination was not included in the list of 403(b) plan triggering events under the Internal Revenue Code . The final regulations have added plan terminations as a triggering event to the list. As a result, if a 403(b) plan is terminated, participants will be entitled to receive a distribution from their 403(b) annuity contracts to the extent permitted by the terms of the contracts.

Effective date: Jan. 1, 2009

What happens if you fail to comply? If another 403(b) plan is established within 12 months of the plan termination, the termination will not be valid and any distribution could violate the early withdrawal restrictions. This is a contract failure which could result in the loss of tax deferral for all contracts purchased for the individual under the terminated plan.

Next week’s issue: Vesting Requirements

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