On July 26, 2007 the IRS published the final regulations for 403(b) plans in the Federal Register, including specific guidance on Roth 403(b) plans. Although the general effective date for the regulations is January 1, 2009, several key provisions have transitional effective dates based upon a date 60 days from the publication date.

This article provides a brief summary of the final regulations based on information currently available.

Provisions Applicable to General 403(b) Marketplace

1. The general effective date of the final regulations is January 1, 2009, However, 403(b) programs that are maintained pursuant to a collective bargaining agreement ratified and in effect on July 26, 2007 must comply with the final regulations by the earlier of July 26, 2010 or the expiration date of the bargaining agreement (without extensions). If the authority to amend a church plan is held by a church convention, the effective date of these regulations is the first plan year following December 31, 2009. There are transitional deadlines for certain other provisions such as Rev. Rul. 90-24 transfers, life insurance in 403(b) contracts and exclusions from participation under IRS Notice 89-23. In some instances those deadlines are sooner than the January 1, 2009 deadline.
2. All 403(b) programs must be maintained pursuant to written plan documentation. The regulations suggest that employers that have multiple 403(b) investment products utilize a single plan document under which the vendors’ contracts would be incorporated and coordinated. The plan document would have to address any conflicting provisions between underlying annuity contracts and custodial accounts. The regulations also indicate that the IRS will issue model plan language for public school employers, prior to the effective date, which will satisfy this requirement.
3. The 403(b) plan must comply in both "form and operation" to the plan document and regulations. That means the regulations will not be satisfied by simply adopting a plan document. The employer, the vendors providing investment products under the plan and any third parties involved in the administrative or compliance functions of the plan must adhere to the terms of the plan as written. Failing to comply with the terms of the plan will disqualify the entire plan. See item 14 below.
4. Under the written plan, administration and compliance responsibilities may be allocated between the employer and/or third parties, such as the product providers and third party administrators, but may not be assigned to employees. Any allocation must bear a relationship to the responsibility. For example, only the employer can satisfy the universal availability requirement (see item 9 below) and only the vendor knows the employee’s account balance.
5. Transfers (movement of investments from a 403(b) plan sponsored by one employer to a 403(b) plan sponsored by another employer) and exchanges (movement from one investment provider to another investment provider) will be permitted, but with limitations. Transfers and exchanges are not required, but the plan document may allow them. After January 1, 2009, plans may permit exchanges from one investment product to another so long as the investment company receiving the transferred amount establishes a relationship with the employer (or its representative) to exchange information necessary for compliance. The current ruling that allows employees to transfer without employer involvement will be repealed 60 days after July 26, 2007. It is unclear what the governing rules for exchanges and transfers are between September 24, 2007 and December 31, 2008. It is also unclear how these new rules will apply to existing 403(b) contracts.
6. Transfers and exchanges for former employees would be permitted, provided that such individual already has established a 403(b) account into which funds may be moved. The proposed regulations had restricted transfers and exchanges to active employees only. 403(b) accounts may not be established under an employer’s plan if the individual no longer has an employment relationship with the employer.
7. Post employment contributions may not be made for a former employee after the month in which the former employee dies. For this purpose, the former employee’s considered compensation is determined to be 1/12 of the employee’s compensation over his final year of service. No contributions may be made after the month in which occurs the employee’s date of death.
8. Additional restrictions were imposed on withdrawals from employer contributions to annuity contracts. Under the regulations, access to employer contributions held in annuity contracts would be restricted to disability, severance from service, or a stated age. Thus, the rules governing withdrawals from employee contributions and employer contributions are more similar.
9. The universal availability requirement in the proposed regulations was included in the final regulations. Thus, all employees must be eligible to participate in the 403(b) plan unless they are eligible to participate in another salary reduction program (like a 457(b) plan or a 401(k) plan), are unwilling to contribute at least $200 per year to the 403(b) plan, or normally work fewer than 20 hours per week for the employer. To test the 20/week standard, the regulations permit employers to use a 1,000 hour per work year standard. However, once that employee completes 1,000 hours of service, he or she must be eligible in all future years. Employers may not exclude groups of employees by classifications, such as substitute teachers, bus drivers, summer help or similar groups of employees. Nor may participation in the 403(b) plan be conditioned upon any other event, such as being "benefit eligible" or refraining from health insurance.
10. Employees must receive "meaningful" notice of their right to participate in the 403(b) plan and such notice must be provided at least annually. Similarly, they must be given the right to enroll, change their investment instructions (for new contributions) and stop making contributions at least annually. These are minimum requirements and employers may certainly permit more frequent changes.
11. Life insurance is not permitted as part of a 403(b) program unless issued before September 24, 2007.
12. The final regulations emphasize the rule that treats all 403(b) contracts issued for a participant as a single contract. Thus, if an individual directs his 403(b) contributions to be invested into two different 403(b) accounts with two different vendors, that individual is treated as having just one contract for compliance purposes. That means if an error occurs in one contract, it will affect all contracts held for that individual.
13. The definition of "health and welfare service agency" (for purposes of the 15 years of service "catch up" limitation) has been expanded to include adoption agencies and agencies that provide services to the disabled, those with substance abuse problems, or deliver home health services.
14. The final regulations clarify the consequences of failing to meet the new requirements, as follows:
1. All contracts (and accounts) under the employer’s 403(b) plan are disqualified if:
1. the employer is not eligible to offer a 403(b) program,
2. the employer fails to maintain a written plan,
3. the employer fails to meet the universal availability/nondiscrimination requirements described in items 9 and 10 above, or
4. the problem is not an "operational" problem. An operational problem is one that arises because the plan did not follow the terms of the plan document.
2. Operational defects that occur within one product provider’s contract will disqualify ALL contracts held for that employee under the plan. There are two minor exceptions to this consequence for vesting failures and excess contribution failures.
   1. Non-vested contributions and
   2. Contributions that exceed the Section 415(c) contribution limits (the lesser of $45,000 or 100% of compensation, for 2007)
   will not disqualify the entire contract or account so long as the product provider maintains separate accounts for such amounts.

Provisions Affecting ERISA 403(b) Plans

15. The "safe harbor" nondiscrimination test permitted under IRS Notice 89-23 was eliminated. Thus, employer contributions to 403(b) plans by any type of employer other than a governmental entity or church plan, as defined in Section 3121(w) of the Code, must satisfy the same nondiscrimination requirements applicable to other qualified plans.
16. The "good faith reasonable standard" for compliance with nondiscrimination requirements permitted under IRS Notice 89-23 was also eliminated. That means that the nondiscrimination testing must adhere precisely to the requirements under the applicable Code sections and the IRS will not accept a "best efforts" test.
17. The special exceptions to the universal availability requirement of collectively bargained employees, visiting professors, government employees who make a one time election not to participate in the plan and employees working under a vow of poverty are also repealed, meaning these employees must now be permitted to participate in the 403(b) plan. There is some transition relief for individuals working under a vow of poverty and for certain visiting professors who are permitted to make elective deferrals to their "home" college or university.
18. The IRS basically incorporated the rules from the proposed regulations for determining "controlled groups" of employers for tax-exempt entities by requiring an 80% director or trustee common control standard. This is important for organizations that have multiple entities, since many Code requirements must be satisfied by the entire "controlled group," not by one entity that is within the controlled group. There are also provisions that permit the disaggregation of entities in the controlled group if there are legitimate business reasons for maintaining each entity separately and the result would not "abuse" the regulations.
19. 403(b) plans may be terminated provided that the employer distributes all plan assets and no new 403(b) contributions are made in the 12 month period before the termination and the 12 month period following the termination. I am still unsure how an employer distributes assets in a 403(b) plan where such assets are legally owned and controlled by individual plan participants. I am seeking additional guidance on this issue from the IRS.

For Tax Exempt Entities Not Subject to ERISA

20. The Department of Labor issued Field Assistance Bulletin 2007-2 which purportedly provides some guidance for Section 501(c)(3) organizations that wish to avoid converting the voluntary 403(b) programs into ERISA plans. This guidance states that the exception from ERISA will still apply and that it is possible for employers to maintain a 403(b) plan that complies with the IRS regulations and maintain the exemption from ERISA. The guidance states that the employer can provide tax compliance activities, such as payroll activities, development of compliance procedures, universal availability compliance, enforcement of contribution limitations and similar types of compliance actions. The guidance also states that employers can provide known information about participants for compliance purposes to a third party, such as certifying that an employee has terminated employment or the employee’s compensation. The guidance also permits maintenance of a "written plan" and may include or exclude certain provisions. However, the guidance would not permit an employer to have responsibility for or to exercise discretion in administering the 403(b) program. For example, the employer could not determine whether or not a participant meets the requirements for a financial hardship or whether or not the participant has met the distribution requirements of the plan. Such discretionary responsibilities should be allocated to the vendors, a third party administrator or other entity who agrees to be responsible for such determinations. However, as stated above, the responsibility may NOT be allocated to the participant under the regulations.