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A M E R I C A N S O C I E T Y O F P E N S I O N P R O F E S S I O N A L S & A C T U A R I E S

403(b) and 457(b) Plans, 6th Edition

THESOURCE

Ellie Lowder, TGPC & Susan D. Diehl, CPC, QPA, ERPA

The Source 403(b) & 457(b) Plans Sixth Edition

Multi-User Distributable Version

ii TableofContents

4245NorthFairfaxDrive,Suite750Arlington,VA22203703.516.9300www.asppa-net.orgE-mail:rpa@usaretirement.org6thEdition

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Copyright ©2017. All Rights Reserved. ASPPA is a not-for-profit professional society. The materials contained herein are intended for instruction only and are not a substitute for professional advice. No part of this book may be reproduced in any form by any means without permission in writing from ASPPA. Thispublicationisnotintendedtoprovidelegalortaxadvice,andcannotbeusedforthepurposeofavoidingincometaxesorpenaltiesthatmaybeimposedbyanytaxingauthority.Legalandtaxadviceshouldbeobtainedfromlegalortaxprofessionals.

Whileeveryefforthasbeenmadetoensuretheaccuracyofthecontentcontainedinthispublication,itshouldbenotedthattherearevaryinginterpretationsofregulation(s)and/orguidancecovered.

iii The Source

About the Authors

Ellie Lowder, TGPC has been involved in the 403(b) tax-sheltered annuity markets since

1961, and is regarded in the industry as an expert in this specialty field. She is an advisor to

the National Tax-deferred Savings Accounts Association (NTSA), provides articles for the

NTSA Market Beat; assigns and edits articles by other authors, and otherwise manages each

issue and provides technical and sales support to members. Lowder carries the Tax-Exempt &

Governmental Plan Consultant (TGPC) credential, resulting from completion of advanced

courses of study specific to retirement plans for non-profits and public education employers.

She has authored a number of widely used tax-sheltered annuity training manuals, taught

hundreds of continuing education credit classes nationally, and has written a number of

articles that have been published in trade magazines. She is the author of Section 403(b)

Compliance Guide for Public Education Employers, written for the Association of School Business Officials, Intl. (ASBO) and published by Rowman and Littlefield as well as co-

author of The Source 403(b) and 457(b) Plans, which serves as the core curriculum for

ASPPA’s TGPC credential. She is a volunteer member of the ASBO Retirement Plan

Council, and, as such, helped develop the 403(b) Resources portion of the ASBO website.

She further responds to queries from school business officials who are members of that

organization.

She is currently a consultant offering 403(b) consulting and training services for industry

vendors and producers and assists nonprofit employers with retirement plan design and

compliance. She is a frequent speaker at the national meetings held by insurance companies,

mutual fund companies, ASBO, the NTSA and other groups. Her broad experience includes

sales, marketing, the technical aspects of the 403(b) market, and other retirement savings

plans that are utilized by the employees of non-profit and public education employers. She

also has routinely conducted audio casts for the Association of School Business Officials

International and responds to queries from school business officials who are members of that

organization.

Susan D. Diehl, CPC, QPA, ERPA is the President of PenServ Plan Services, Inc. During her career, Susan has served on renowned committees at the IRS including the Advisory Committee on Tax Exempt and Government Entities (“ACT”), where she contributed to the formation of the IRS’ 403(b) Liaison Group that provides support to employers and financial institutions dealing with 403(b) plans and brings issues involving these plans to the IRS, and the Information Reporting Program Advisory Council (“IRPAC”). In addition, Susan has participated in various committees at the DOL including the ERISA Advisory Council. As an authority on retirement plans, Susan continues to testify before the IRS and DOL on retirement plan regulatory issues. Currently, Susan is serving as a Board of Director with the American Retirement Association (ARA). She is Past-President of the National Tax-deferred Savings Association (NTSA) and serves on the Leadership Council of this same organization. She is also a member of The American Society of Pension Professionals and Actuaries (“ASPPA”). In addition, she divides her time as Chair of the Tax-Exempt/Government Plans (“TEGP”) at NTSA as well as serving on the Government Affairs Committee (“GAC”) and the Legislative Relations Committee at ASPPA. Susan also served on the editorial team of the 403(b) Advisor Magazine. In 2012, Susan was honored with the Bob Schiller Meritorious Service Award for her years of service to and support of NTSA. As a leader among women, she was awarded the Athena Award for promoting women in business and was inducted to the Athena Hall of Fame in Michigan. In 2016, Susan received the NTSA Kelli Award and was recognized for serving on the NTSA Leadership Council.

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Table of Contents

Chapter 1: Historical Perspective and an Overview of 403(b) Plans 1.1 Something for Everyone ........................................................................................................ 1 1.2 Legislative and Regulatory History of 403(b) Programs ................................................ 2

The History of 403(b) - How We Arrived Where We Are Today ............................... 2

The Department of Labor Fiduciary Guidance ............................................................... 5 Internal Revenue Service Audits, Correction and Compliance Programs ............... 5

1.3 403(b) Product History ........................................................................................................... 7 Product Evolution .................................................................................................................. 7 Investment Trends ................................................................................................................. 9

1.4 Market Size and Participation ............................................................................................. 10 Market Size, Participation and the Impact of 457(b) Plans ...................................... 10 Some of the Historical Major Carriers ............................................................................ 10 Education and Professionalism:

The National Tax-deferred Savings Association .......................................................... 11 1.5 Distribution Trends ................................................................................................................ 12 1.6 Compliance Trends ................................................................................................................. 13

IRS Audit Activity and the General Impact of the Final 403(b) Regulations ........ 13 Which Employers Were Most Affected by the Final 403(b) Regulations? ........... 13

Reducing the Number of Approved Providers ............................................................ 14

1.7 The 403(b) Market in General ............................................................................................. 15 Eligible Employers ............................................................................................................... 15 General Data on the Marketplace ................................................................................... 16 Elective Deferral Only Plans .............................................................................................. 18 Is an Elective Deferral Only 403(b) Plan Ever an ERISA Plan? .................................. 19 Maximum Allowable Contributions ................................................................................ 20 Employer Funded non-ERISA 403(b) Plans ................................................................... 20 ERISA 403(b) Plans .............................................................................................................. 21 457(b) Eligible Deferred Compensation Plans ............................................................. 21 Tax-Free Transfers, Exchanges & Rollovers .................................................................. 22 Tax-Free Transfers to Purchase Years of Service Credits .......................................... 23 Rollovers ................................................................................................................................ 23

Chapter 2: The General Rules for 403(b) Plans 2.1 Introduction ........................................................................................................................... 25 2.2 Eligible Employers................................................................................................................. 25

What Types of Employers May Establish 403(b) Programs? .................................... 25 2.3 Fee Disclosures for Non-ERISA Plans............................................................................... 27 2.4 Determining Eligible 403(b) Investment Options ......................................................... 27 2.5 Fiduciary Issues ...................................................................................................................... 28 2.6 Eligibility of Employees and Nondiscrimination Rules in 403(b) Plans .................. 28

Who is an Employee?.......................................................................................................... 29 Nondiscrimination Rules for Employee Contributions .............................................. 30 What is the $200 Minimum Contribution Requirement? .......................................... 32 Are Elective Deferrals to 403(b) Programs Subject to Nondiscrimination

Testing? .................................................................................................................................. 32

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2.7 The Written Plan Requirement .......................................................................................... 33 Pre-Approved 403(b) Plan Documents .......................................................................... 34 Other Written Plan Sources .............................................................................................. 35

2.8 Which 403(b) Accounts Are Not Required to Be Included in the Employer's Plan?

......................................................................................................................................... 36 2.9 Which 403(b) Accounts Are Required to Be Included in the Plan? .......................... 37 2.10 Taxation and Reporting of 403(b) Contributions ......................................................... 38

Employee contributions are taxed and reported as follows: ................................... 38 Employer contributions are taxed and reported as follows: .................................... 38

2.11 Bankruptcy Protection for Retirement Plan Assets ...................................................... 39 2.12 Contributions into Elective Deferral 403(b) Plans ........................................................ 39

Post-Employment Salary Reduction Contributions .................................................... 40 Should Employee Contributions Be Made Pre-Tax or After-Tax? ........................... 41

Reasons Employers Are Considering the Roth 403(b) Option ................................. 43 Determining Maximum Allowable Contributions for 403(b) Plans ........................ 43

2.13 Employer Contributions in Non-ERISA 403(b) Plans—Pairing Complementary

Plans ........................................................................................................................................ 50 2.14 Distributions and Loans from 403(b) & 457(b) Plans ................................................... 56

Distributions in General ..................................................................................................... 56 Loans from 403(b) and 457(b) Governmental Plans .................................................. 57

2.15 Required Minimum Distributions (RMDs) ...................................................................... 64 2.16 Establishing Relationships with Plan Sponsors for Elective Deferral 403(b)

Programs ................................................................................................................................ 65 Public School Systems ........................................................................................................ 65 Colleges and Universities................................................................................................... 66 501(c)(3) Hospitals .............................................................................................................. 66 Charitable and Community Services Organizations ................................................... 67 Religious Organizations ..................................................................................................... 68 More on Nondiscrimination Rules for Religious Organization ............................... 68 Special Rule for Minister’s Self-Employment Income ................................................ 68 Other 501(c)(3) Organizations.......................................................................................... 68

Chapter 3: Distribution, Rollovers, Plan-to-Plan Transfers, Exchanges, &

Roth Conversions 3.1 Introduction .......................................................................................................................... 71 3.2 Historical Perspective: Forecasting the Impact of the Final Regulations ............... 72

How Will the Final Regulations Affect Control of 403(b) Plan Accounts? ............ 73 3.3 Suitability and Disclosure ................................................................................................... 74 3.4 Why Participants May Want to Move Account Values ............................................... 74

Diversification of Investment Options ........................................................................... 74

Reduced Control of Accounts under the Employer's Plan ........................................ 75 3.5 Tax-free Plan-to-Plan Transfer and Exchanges for 403(b) Plans Only .................... 77

Definitions ............................................................................................................................. 77 Transition Timeline from Transfers to Exchange ......................................................... 78 The General Requirements for Plan-to-Plan Transfers and Exchanges ................. 79 A Transfer or Exchange is Not a Distribution ............................................................... 80

3.6 Tax-free Transfers to Purchase Additional Years of Service Credits ........................ 82 Most Systems Permit Service to be Purchased ............................................................ 82

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Types of Credit That Can Be Purchased ......................................................................... 83 3.7 Rollovers: All Plan Types Including IRAs and SEPs ....................................................... 83

Who Is Eligible to Rollover Distributions? ..................................................................... 83 Interchangeable Rollovers ................................................................................................. 83 Pension Portability for Roth 403(b), Roth 401(k), Roth 457(b) and Roth IRAs ... 84 Rollovers from Qualified Plans, 403(b) Plans and 457(b) Governmental Plans to

a Roth IRA .............................................................................................................................. 85 What are the General Rollover Rules for a Qualified Plan, a Governmental

457(b) Plan and a 403(b) Plan? ........................................................................................ 85 What Are the General Rollover Rules for IRAs and SEPs? ......................................... 86 How to Handle IRAs That Consist of Both Pre-Tax and After-Tax Amounts ....... 87 Any Distribution from a Qualified 401(a), 457(b) Governmental Plan and a

403(b) Plan Is Eligible for Rollover Except: ................................................................... 87 When Are Participants Eligible for a Distribution? ..................................................... 88

3.8 Rollovers from Various Types of Plans to Other Types of Plans .............................. 90 Do Rollovers Assume the Characteristics of the Receiving “Plan”? ........................ 90 Issues to Consider about Rollovers from a Deductible IRA to a 403(b) Plan ....... 90 Issues to Consider about Rollovers from a 457(b) Governmental Plan to a 403(b)

Plan or IRA ............................................................................................................................. 91 Issues to Consider about Rollovers from Qualified Plans, 403(b) Plans and IRAs

to 457(b) Governmental Plans ......................................................................................... 91 Issues to Consider about Rollovers in General ............................................................ 91

3.9 403(b) Restrictions on Distributions and the 10 Percent Penalty Tax..................... 93 Distribution Restrictions for 403(b) Plans in General ................................................. 93 When Are Distributions Permitted from Salary Reduction Contributions to

403(b) Accounts? ................................................................................................................. 94 When Are Distributions Permitted from Employer Contributions to 403(b)

Accounts?............................................................................................................................... 94 3.10 Required Minimum Distribution Rules: Qualified Plans, 403(b) Plans, 457(b) Plans

and IRAs .................................................................................................................................. 97 Required Beginning Date .................................................................................................. 97 General RMD Rules for Multiple Accounts ................................................................... 98 RMD Calculations ................................................................................................................ 98 Plan Amendments and New IRA Reporting Requirements ...................................... 98 RMDs during the Participant’s Lifetime ......................................................................... 98 Determination of the Beneficiary for Distribution Purposes ................................... 99 RMDs if Participant Dies after the Required Beginning Date .................................. 99 Distributions if the Participant Dies before the Required Beginning Date ........ 101

3.11 Addendum: Treas. Reg. 1.403(b)-10(b) of Final 403(b) Regulations Explaining

Plan-to-Plan Transfer and Exchanges ........................................................................... 101

Chapter 4: ERISA 403(b) and 457(b) Plans 4.1 Introduction ......................................................................................................................... 105 4.2 When Are 403(b) and 457 Plans Subject to ERISA? ................................................... 106

Statutory Exemptions ....................................................................................................... 106 Regulatory Exemptions for 403(b) Plans ..................................................................... 107 ERISA Exemptions for 457 Plans .................................................................................... 110 What is a “top hat” plan? ................................................................................................. 111

4.2.1 Do Negative Elections (Or Auto-Enrollment) Cause a 403(b) Plan to Become

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Subject to ERISA? ............................................................................................................... 111 4.3 What Additional Compliance Requirements Apply to ERISA 403(b) Plans?........ 112

Graded Vesting................................................................................................................... 113 Cliff Vesting Schedule ...................................................................................................... 114 Benefit Accruals ................................................................................................................. 116 Joint and Survivor Requirements .................................................................................. 116 Funding Requirements ..................................................................................................... 117 Miscellaneous Technical Requirements ....................................................................... 119 Reporting and Disclosure Requirements ..................................................................... 119 Fiduciary Requirements ................................................................................................... 119

4.4 What Additional Compliance Requirements Does ERISA Impose on 457(b)

Plans?..................................................................................................................................... 119 4.5 Nondiscrimination Requirements That Apply to Employer Contributions to 403(b)

Plans ...................................................................................................................................... 119 Specific Requirements for Matching and After-tax Employee Contributions ... 120 Safe Harbor Contributions .............................................................................................. 123 Other Nondiscrimination Requirements ..................................................................... 123 What if there are no HCEs for the tested year? ......................................................... 124 General Comments on Nondiscrimination Tests ....................................................... 124

Saver's Tax Credit .............................................................................................................. 124 4.6 Are ERISA Plan Assets Available to Creditors of the Participants? ........................ 125

Bankruptcy Protection...................................................................................................... 126 4.7 Does ERISA Require a Servicing Representative to Be Bonded? ............................ 128 4.8 What Other Compliance Requirements Does ERISA Impose on 403(b) Plans? .. 129 4.9 What Are the “Reporting and Disclosure” Requirements for ERISA 403(b)

Plans?..................................................................................................................................... 130 4.10 Under ERISA, What Informational Materials Must be Provided to Plan

Participants? ........................................................................................................................ 130 4.11 What Are the Reporting Requirements for ERISA 403(b) Plans? ........................... 133

Plan Reporting .................................................................................................................... 133 Participant Reporting ....................................................................................................... 134 Fee Disclosures ................................................................................................................... 134 What Should Fiduciaries Do to Satisfy These Disclosure Responsibilities? ........ 137

4.12 Are 403(b) Plans Subject to the New Fiduciary Rules under ERISA? ..................... 138 What Are the Key Elements of the New Rule? ........................................................... 138

What Plans Are Covered Under the New Rule? ......................................................... 138 Who Is a Fiduciary? ........................................................................................................... 138 What Is a Recommendation? .......................................................................................... 138 What Is Compensation? ................................................................................................... 138 How Does This Affect My Organization?..................................................................... 139 What Are "Level Fee Fiduciaries"? ................................................................................. 139 What Is Required and When? The Key BICE Requirements .................................... 140 Full BICE Requirements - 6 Items .................................................................................. 140 Streamlined BICE for "Level Fee" Advisors - Referred to as BICE Lite - Only 3

Items ..................................................................................................................................... 140 When Is the Best Interest Contract (BICE) Required ................................................ 140 Miscellaneous Fiduciary Rules ........................................................................................ 141

4.13 Am I a Fiduciary under ERISA? ........................................................................................ 141

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What Was the Major Change in the Definition of Fiduciary? ................................ 143 Missing Person Fiduciary Issues for ERISA 403(b) Plans ......................................... 144

4.14 If I Sell Investment Products to Plan Participants, Am I a Fiduciary? .................... 144 Focus ..................................................................................................................................... 145

4.15 If I Am a Fiduciary, Am I Responsible for All Plan Activities? .................................. 145 4.16 If Participants Determine How to Invest Their Accounts, Can Fiduciary Liability for

Investment Performance Be Reduced? ......................................................................... 146 Default Investment Safe Harbor .................................................................................... 148

4.17 If I Am a Fiduciary, Are My Activities Restricted in Any Way? ................................ 148 How Does a Plan Fiduciary Evaluate the Fee Disclosures Provided by the

Covered Service Providers? ............................................................................................. 151 4.18 Do These PT Rules Interfere with Normal Business Relationships? ....................... 152 4.19 If I Am Not a Fiduciary, Can I Be Responsible for a PT Violation? ......................... 154 4.20 What Are the Penalties for Fiduciary and PT Breaches? ........................................... 154 4.21 How Do I Protect Myself if I Am a Fiduciary? .............................................................. 154 4.22 Are Investment Products Available in the 403(b) Market that Satisfy ERISA

Requirements? .................................................................................................................... 156 4.23 How is a 403(b) Plan Terminated? Does ERISA Liability End if the Plan is

Terminated? ......................................................................................................................... 158 4.24 Financial Professionals: Considerations for Entering the ERISA Market ............... 160

Financial Rewards .............................................................................................................. 160 Preferred Access to Employees ...................................................................................... 161 Increased Time and Cost to Service .............................................................................. 161 Less Competition in Marketplace .................................................................................. 162

4.25 Should I Get into the ERISA Market? ............................................................................. 162 4.26 What Should Employers Do to Implement ERISA 403(b) Plans? ............................ 163 4.27 Guidance on Controlled Groups ..................................................................................... 163

"Deemed" Control for §415 Purposes - Final Regs Clarify and Make Effective in

2008! ..................................................................................................................................... 164

Chapter 5: Alternative Plan Designs for 501(c)(3) Employers 5.1 Traditional Model 403(b) Plans ........................................................................................ 167 5.2 ERISA 403(b) Model ............................................................................................................ 168

Advantages of an ERISA 403(b) Model Plan ............................................................... 170 Disadvantages of an ERISA 403(b) Model Plan ......................................................... 172

5.3 401(k) Plans ........................................................................................................................... 175 Advantages of a 401(k) Plan ........................................................................................... 178 Disadvantages of a 401(k) Plan...................................................................................... 179

5.4 Defined Contribution Plans Incl. Money Purchase and Profit Sharing Plans ....... 181 Advantages of Defined Contribution Plans ................................................................ 184 Disadvantages of Defined Contribution Plans ........................................................... 185

5.5 Defined Benefit Pension Plans .......................................................................................... 185 Advantages of Defined Benefit Pension Plans ........................................................... 187 Disadvantages of Defined Benefit Pension Plans ..................................................... 187

5.6 Simplified Employee Plans ("SEPs") ................................................................................ 188 Advantages of SEP Plans ................................................................................................. 190 Disadvantages of SEP Plans ............................................................................................ 190

5.7 SIMPLE Plans ......................................................................................................................... 190 Advantages of SIMPLE Plans .......................................................................................... 192

ix The Source

Disadvantages of SIMPLE Plans ..................................................................................... 192 5.8 457 Plans ................................................................................................................................ 193 5.9 Individual Retirement Accounts (Regular IRAs) ........................................................... 195

Traditional Deductible IRA (Regular IRA) .................................................................... 195 Nondeductible IRA ............................................................................................................ 196 Roth IRAs ............................................................................................................................. 196

5.10 MyRAs ..................................................................................................................................... 198 5.11 Helping the Employer Select the Best Plan and Products ......................................... 198

Financial Motivations........................................................................................................ 198 Personal and Emotional Needs ...................................................................................... 200 Employee Relations ........................................................................................................... 200 Competition for Qualified Employees .......................................................................... 200 Other Compensation Received by the Employees .................................................... 201 Corporate Perceptions ..................................................................................................... 201 Helping Employers on a Case by Case Basis ............................................................... 202

Chapter 6: Relevant Code Sections with Clarifying Comments 6.1 Code Sections and Regulations for 403(b), 457 Plan and Roth 403(b) ................ 205

Code Sections Included in This Chapter: ..................................................................... 205 6.2 The Section 403(b) Code Explained ............................................................................... 206

Internal Revenue Code ..................................................................................................... 206 6.3 Section 402A: Optional Treatment of Elective Deferrals as Roth Contribution

(Effective January 1, 2006) ............................................................................................... 214 6.4 The Section 402(g) Code Explained ............................................................................... 218 6.5 Code Section 414(v) ........................................................................................................... 222 6.6 Code Section 415(c) ........................................................................................................... 225

IRC 415(c): Limitation for Deferred Contribution Plans........................................... 225 6.7 Code Section 457(b) and Excerpts from Sections 457(d) and 457(g) Explained 228 6.8 Code Section 501(c)(3) Explained ................................................................................... 232 6.9 Code Section 72(p) Explained .......................................................................................... 233 6.10 Sections Relating to Distributions ................................................................................... 236

IRC 72(t) Code Explained ................................................................................................. 236 Code Section 401(a)(9)(c) Explained ............................................................................. 240

6.11 Churches and Religious Organizations; Relevant Definitions from the Code ...... 240 IRC Section 3121(w)(3) Explained ................................................................................. 240 Relevant Sections from IRC 414(e) Defining Organizations Eligible to Sponsor

Church Plans ....................................................................................................................... 241 Relevant Sections of the Code Treating Self-Employed Ministers as the

Employer .............................................................................................................................. 241 6.12 Segregation of Excess Annual Additions under Final 403(b) Regulations .......... 242 6.13 The Application of Nondiscrimination Rules to Non-Matching Employer

Contribution Plans Sponsored by 501(c)(3) Non-Governmental Employers ...... 243 6.14 Section 414(h) Picked Up Contributions ...................................................................... 247 6.15 Revenue Procedure 2007-71 ............................................................................................. 247

Section 1. Purpose ............................................................................................................. 247 Section 2. Background and General Information ...................................................... 248 Section 3. Use of Model Plan Language by Public Schools .................................... 249 Section 4. Reliance by Public School Employers on Model Plan Language ....... 249 Section 5. Use of the Model Plan Language by Employers That Are Not Public

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Schools ................................................................................................................................. 250 Section 6. Date Amendments Are Adopted ............................................................... 250 Section 7. Areas Not Covered by Sections 3 and 4 of This Revenue Procedure250 Section 8. Guidance Regarding Certain Contracts Issued before 2009 ............... 251 Section 9. Comments Requested ................................................................................... 252 Section 10. Effective Date ................................................................................................ 252 Appendix for Revenue Procedure 2007-71 Model Plan Language ...................... 252 Section 403(b) Model Plan Language for a Public School ...................................... 253

Chapter 7: Compliance: Details, Checklists and Comprehensive Tools for

403(b) and 457(b) Plans 7.0 Introduction ......................................................................................................................... 269 7.1 For All Types of Employers ............................................................................................... 271 7.1.1 IRS Audits ............................................................................................................................. 271

Where Are Audits Being Conducted and Which Employers Are Being Audited?

....................................................................................................................................... 272 What Have Been Some of the Audit “Experiences"? ................................................ 272 Most Common Violations ................................................................................................ 273

7.1.2 Hold Harmless/Vendor Agreements ............................................................................... 275 The Vendor’s or Third Party Administrator’s Responsibilities ............................... 276

7.1.3 Salary Reduction Agreement (SRA) ................................................................................. 281 Employer Rules ................................................................................................................... 282

7.2 Public Education Institutions ........................................................................................... 282 Current Statutes ................................................................................................................. 283

7.2.1 Nondiscrimination Requirements for 403(b) Elective Deferral Plans ..................... 284 Issues .................................................................................................................................... 284 Issues .................................................................................................................................... 285 Problem Solving ................................................................................................................. 285 What Does the Requirement to “Make the Program Available” Mean? ............. 285

7.2.2 Compliance Tools ................................................................................................................. 286 Compliance Checklist: Public Education Employer Contributions ........................ 287

7.3 501(c)(3) Organizations ..................................................................................................... 289 7.3.1 403(b) Elective Deferral Only Plans ................................................................................. 290 7.3.2 DOL Reg 2510.3-1(F) (Limited Involvement Exception) and Field Assistance

Bulletins 2007-02 and 2010-01....................................................................................... 290 7.3.3 The Nondiscrimination Rules for Elective Deferral Contributions .......................... 293 7.3.4 403(b) Plans with Employer Contributions................................................................... 295 7.3.5 MAC Calculations for Employer Contributions and Salary Deferral

Contributions ...................................................................................................................... 296 7.3.6 Compliance Issues Specific to 403(b) ERISA Plans ..................................................... 296 7.3.7 Checklist for Non-Church 501(c)(3) Organizations: Avoiding ERISA Coverage .. 298 7.4 Tools for Employers, Providers and Practitioners ...................................................... 299 7.4.1 Introduction to Checklists ................................................................................................. 300

403(b) Checklists ................................................................................................................ 300 Checklist 1 ........................................................................................................................... 302 Optional: .............................................................................................................................. 303 Checklist 1A ......................................................................................................................... 304

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Checklist 1B: IRS Plan Compliance Checklist for Religious Organizations

Sponsoring 403(b) Plans .................................................................................................. 306 Checklist 2: Compliance Strategies ............................................................................... 308 Checklist 3: Vendor Selection ......................................................................................... 309 Checklist 4: Vendor Notification .................................................................................... 312 Checklist 5: TPA Selection ............................................................................................... 315 Checklist 6: Consultant Selection .................................................................................. 318 Checklist 7: Implementing a Do-It-Yourself Compliance Program ...................... 320 Checklist 8: Common Problems ..................................................................................... 322 Checklist 8A: Common Problems .................................................................................. 325 Checklist 9: Establishing or Amending a 403(b) Plan ............................................... 328 Checklist 10: Is Your 403(b) Plan Subject to ERISA? ................................................. 329 Checklist 11: ERISA Compliance Issues ........................................................................ 331 Checklist 12: Covered Service Provider Disclosure Requirements ERISA

§408(b)(2) Regulations .................................................................................................... 334 Checklist 13: Participant Fee Disclosure Requirements ERISA §404(a)

Regulations ......................................................................................................................... 336 7.4.2 Introduction to Forms and Agreements ....................................................................... 341

Form 1: Public School Board Resolution Adopting an Elective Deferral Only

403(b) Plan .......................................................................................................................... 343 Form 2: Public University Board Resolution Adopting an Elective Deferral Only

403(b) Plan .......................................................................................................................... 344 Form 3: 501(c)(3) Organization Board Resolution Adopting an Elective Deferral

Only 403(b) Plan ................................................................................................................ 345 Form 4: Religious Organization Adopting an Elective Deferral Only 403(b)

Plan ....................................................................................................................................... 346 Form 5: ERISA Exempt Employer Board Resolution Adopting a 403(b) Plan with

Employer Contributions ................................................................................................... 347 Form 6: 501(c)(3) Organization Board Resolution Adopting a 403(b) Plan with

Employer Contributions ................................................................................................... 348 Form 7: Board Resolution Adopting 457(b) Governmental Plan with Optional

Roth 457(b) Option (After 1/1/2011) ........................................................................... 349 Form 8: Sample Board Resolution Adopting 457(b) Nongovernmental Plan ... 350 Form 9: Sample Salary Reduction Agreement (SRA) for 403(b) Plans ................. 351 12-Month Compensation Election Form ..................................................................... 354 Form 10: Sample Salary Reduction Agreement (SRA) for 403(b) Plans .............. 355 12-Month Compensation Election Form ..................................................................... 359 Form 11: Salary Reduction Agreement for the Governmental 457(b) Plan ...... 360 Form 12: 457(b) Non-Governmental Plan .................................................................. 362 Form 13: Sample Hold Harmless/Vendor Agreements for 403(b) Plan .............. 364 Form 14: Sample Hold Harmless/Vendor Agreements for Governmental 457(b)

Plan ....................................................................................................................................... 368 Form 15: Sample Hold Harmless/Vendor Agreements for Non-Governmental

457(b) Plan .......................................................................................................................... 371

Form 16: K-12 Administrative Appendix ..................................................................... 374 Form 17: ERISA 403(b) Administrative Appendix ...................................................... 380

7.4.3 Communications .................................................................................................................. 389 Tying It Together ............................................................................................................... 389

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Form II-A .............................................................................................................................. 391 Form II-B .............................................................................................................................. 393 Form II-C .............................................................................................................................. 394 Form II-D .............................................................................................................................. 395 Form II-E............................................................................................................................... 397 Form II-F ............................................................................................................................... 398 Form II-G .............................................................................................................................. 401

7.4.4 Miscellaneous Materials ..................................................................................................... 402 403(b) Plan Design Chart ................................................................................................. 402 Records Retention and Maintenance Checklist ......................................................... 404

Cost of Living Chart .......................................................................................................... 405 The NTSA Best Practices Manual, Third Edition ........................................................ 407

Chapter 8: Third Party Support Providers 8.1 Introduction ......................................................................................................................... 409 8.2 What Does a Third Party Support Provider Do? ......................................................... 410 8.3 Are There Different Types of Administrators?............................................................. 414 8.4 Which Type of Administrator Is Best? ........................................................................... 418 8.5 Must Employers Use Administrators for Their 403(b) Programs? .......................... 419 8.6 How Much Do Administrators Cost? ............................................................................. 420 8.7 What If Employers Can’t or Won’t Pay for Administrative Services? .................... 423 8.8 Are there Special Legal Requirements That Must Be Satisfied by Plan

Administrators?................................................................................................................... 424 8.9 Is It Worth It for an Employer to Use an Administrator? .......................................... 426 8.10 Must Administrative Services Be Offered in the 403(b) Marketplace to Remain

Competitive? ....................................................................................................................... 427 8.11 I Am Seeing More “Consultants” Working with Employers on 403(b) Plans. Is This

a New Development and How Will It Affect 403(b) Plans? ..................................... 427 8.12 Why Should an Employer Hire a Consultant to Review Its 403(b) Program?....... 429 8.13 How Can Administrators Be Located? ............................................................................ 430 8.14 Conclusion ............................................................................................................................. 430

Chapter 9: 457 Eligible and Ineligible Plans 9.1 Introduction ......................................................................................................................... 433 9.2 What Is a Section 457 Plan? ............................................................................................. 434 9.3 What Types of Plans Are Excluded from Section 457 Coverage?........................... 434

What If the Employer Does Not Want Its Plan to Be Subject to Section 457? .. 435 9.4 Which Type of Employers May Be Subject to the Requirements of IRC §457? .. 436

What Kind of Churches and Other Religious Organizations Can Offer Eligible

457 Plans? ............................................................................................................................ 436 9.5 What Is an Eligible 457 Plan? ........................................................................................... 437 9.6 Who Can Participate in an Eligible 457 Plan? .............................................................. 440 9.7 What Are the Contribution Limits for Eligible 457 Plans? ........................................ 440

What Is the Final 3 Year Catch Up Limit? .................................................................... 441 What Is the Age 50+ “Catch up” Limit? ....................................................................... 443 Can Both “Catch Ups” Be Used in the Same Year? ................................................... 443 Are the Contribution Limits Affected by Other Plans? ............................................ 443

9.8 What Is “Includible” Compensation under 457? ......................................................... 444 How Is Includible Compensation Determined for an Independent Contractor?

xiii The Source

....................................................................................................................................... 445 9.9 Are There Any Special Rules for the Agreement to Defer Compensation? ......... 445 9.10 When May Distributions Be Made from an Eligible 457 Plan? ............................... 446

May “In Service” Distributions Be Made? .................................................................... 447 9.11 When Must Distributions Begin? .................................................................................... 447

If a Participant Elects When or How to Receive Distributions on the

Participation Agreement, Can the Participant Change That Election? ................ 447 When Can a Distribution Be Made to an Independent Contractor? .................... 447 Do the QDRO Distribution Rules Apply to 457 Plans? ............................................. 448 Can Amounts Be Transferred between Eligible 457 Plans? .................................... 448 Can Distributions from Eligible 457 Plans Be Rolled Over into IRAs or Other

Plans? .................................................................................................................................... 448 9.12 Are There Any Other Special Provisions Related to Eligible 457 Plans? ............... 449 9.13 Are Eligible 457 Plans Subject to ERISA? ...................................................................... 452

How Does ERISA Affect Eligible 457 Plans? ................................................................ 452 What Is a “Top Hat” Plan? ............................................................................................... 452 Which ERISA Requirements Must “Top Hat” Plans Satisfy? ................................... 453 Is There a New Interest in Top Hat Plans? .................................................................. 453

9.14 Is the Employer Responsible for Investment Performance? .................................... 454 9.15 What Is an Ineligible 457 Plan? ....................................................................................... 454 9.16 What Are the Contribution Limits for Ineligible 457 Plans? ................................... 456 9.17 What Are the Distribution Requirements for Ineligible 457 Plans? ....................... 456 9.18 When Are the Proceeds of an Ineligible 457 Plan Included as Income for Federal

Tax Purposes? ...................................................................................................................... 457 How Does Section 409A Affect the Taxation of 457(f) Plans? ............................... 458

9.19 Are Ineligible 457 Plans Subject to ERISA? .................................................................. 458 9.20 Rabbi Trusts – Available for Ineligible 457(f) and Top Hat 457(b) Plans ................. 459 9.21 Are There Any Special Rules That Apply to Ineligible 457 Plans? .......................... 459 9.22 Conclusion ............................................................................................................................ 459 9.23 Endnotes ............................................................................................................................... 461

Chapter 10: Working with Religious Organizations 10.1 Introduction ....................................................................................................................... 463 10.2 Defining the Impact of Final Regulations .................................................................. 464

Churches, Qualified Church Controlled Organizations, 414(e) Religious

Organizations Impact of Final 403(b) Regulations ................................................... 464 10.3 Defining the Marketplace ............................................................................................... 465 10.4 The IRS Audit Program and Churches ......................................................................... 466 10.5 The 403(b) Nondiscrimination Rules for Religious Organizations ...................... 466

Is a Church School a “Church” under IRC §3121(w)? ................................................ 467 What Is a “Qualified Church Controlled Organization” (QCCO) under Section

3121(w)? ............................................................................................................................... 467 10.6 Churches, QCCOs and 457 Deferred Compensation Plans .................................... 468 10.7 Churches, QCCOs, 414(e) Religious Organizations and 401(k) Plans .................. 468 10.8 Section 414(e) Religious Organizations Who Are Subject to the

Nondiscrimination Rules .................................................................................................. 468 10.9 Written Plan Requirement.............................................................................................. 469 10.10 ERISA Coverage .................................................................................................................. 470 10.11 Recap of Sections 10.1-10.10 ......................................................................................... 471

xiv Table of Contents

10.12 The “Special Rules” under IRC §403(b) ........................................................................ 472

10.13 Tax-Free Transfers for Different Plan Types .............................................................. 473 10.14 Clergy Who Provide Ministerial Services .................................................................... 473 10.15 Types of Accounts ............................................................................................................. 474 10.16 Retirement Income Account ........................................................................................... 474 10.17 Automatic Enrollment in Church Plans ....................................................................... 475 10.18 Is This an Expanding Market? ........................................................................................ 475

xv The Source

Preface Susan D. Diehl, CPC, QPA, ERPA and Ellie Lowder, TGPC have over eighty years of

combined experience in 403(b), 457(b) plans and the governmental/non-profit marketplace.

The scope of their experience is diverse, encompassing both the technical and practical

aspects of this rapidly changing market. They are uniquely qualified to present this resource

manual.

Why write The Source? There was need for a book that covers technical, compliance,

administrative and marketing aspects of the 403(b) and 457(b) markets. In the post-403(b)

regulations environment, the marketplace has begun to focus on plan administration and

compliance for both ERISA and non-ERISA 403(b) plans. While there are some resources

that address technical issues, there is virtually nothing else available that covers 403(b) plans

globally – offering information on a historical perspective, compliance, administration,

marketing and plan coordination issues, as well as a comprehensive range of forms, tools,

checklists, communications pieces and other items needed to effectively operate a 403(b)

program (substantially expanded in this edition with fee disclosure information to assist all

types of 403(b) eligible employers whether exempt from ERISA coverage or subject to

ERISA). The Source, therefore, is a valuable tool designed to provide attorneys, consultants,

employers, insurance companies, mutual fund companies, broker/dealers, marketing firms,

third party plan administrators, and practitioners with a clear understanding of 403(b) and

457(b) plans in a rapidly changing environment.

The Sixth Edition of The Source: 403(b) & 457(b) Plans includes legislation and final

regulations (as well as other guidance) available as of September, 2016. Of particular note

are the mandatory fee disclosure requirements for ERISA Plans (including new checklists and

changes to the Service Provider Agreements) which are effective in 2012, as well as the

optional fee disclosures for non-ERISA plans. Also, included in the 6th Edition are sections

on the Department of Labor Fiduciary Regulations.

Your comments are welcome: New editions of The Source will be made available as soon as practical after major change takes place. In the absence of major change, The Source will be

updated once every two years. Both authors welcome suggestions, and readers are invited to

send comments to the NTSA at webupdates@asppa.org. Those comments will be shared with

the authors.

Finally, the authors warmly welcome ASPPA, NAPA, and NTSA members who are utilizing

the book to obtain the Tax-Exempt and Governmental Plan Consultant designation (TGPC);

the joint NTSA/ASPPA designation program first made available in the fall of 2009.

 

The Source 1

Chapter 1

Historical Perspective and an Overview of

403(b) Plans

1.1 Something for Everyone

here is something for everyone in this book, beginning with this chapter which provides

important background on the 403(b) and 457(b) markets, a historical perspective of

those markets and an overview that helps lay the foundation for the remaining nine

chapters. Included are the impacts of the final Internal Revenue Service (“IRS”) regulations

for 403(b) plans (posted on July 27, 2007 with a general effective date of January 1, 2009 for

most employers). This chapter provides an overview of the marketplace segmented into elec-

tive deferral only 403(b) programs and potential issues under the Employee Retirement In-

come Security Act of 1974, as amended (“ERISA”), 457(b) plans, tax-free exchanges and

rollovers, and finally, employer funded 403(b) and 457(b) plans. Subsequent chapters provide

more detailed information on public education employers and 501(c)(3) employers as plan

sponsors, focusing on both ERISA plans and non-ERISA plans. Throughout the book, refer-

ence will be made to Internal Revenue Service audit programs, correction programs, and the

403(b) final regulations, which signal great change particularly in the non-ERISA market

segments. Because nonprofit organizations are eligible for 401(k) plans and often utilize other

types of plans (such as SIMPLE IRAs and SEPs), an entire chapter focuses on plan designs

for nonprofits, including the potential use of 401(k) plans in conjunction with 403(b) ar-

rangements for certain 501(c)(3) organizations.

Another entire chapter is devoted exclusively to 457(b) plans (including 457(b) eligible de-

ferred compensation plans and 457(f) ineligible deferred compensation plans). The Economic

Growth & Tax Relief Reconciliation Act of 2001 (“EGTRRA”) created opportunities and

interest on the part of employers by offering both 457(b) and 403(b) plans in the public edu-

cation segment as well as in the tax-exempt segment (with 457(b) top hat plans). Chapter 10,

“Working with Religious Organizations” focuses on the church market segment and includes

the impact of final regulations on both churches and related religious organizations.

Employers will be particularly interested in the chapter devoted to compliance because it

provides step by step guidance (check lists and explanations) as well as sample forms and

communication materials that will help employers as they assume new responsibilities result-

ing from changes in the marketplace.

T

2 Chapter 1

1.2 Legislative and Regulatory History of 403(b) Programs

Because the legislative history of the 403(b) marketplace has dictated many of the trends, it is important to spend some time looking at the most significant pieces of legislation or regula-

tion beginning with the addition of section 403(b) to the Internal Revenue Code in 1958 through September 2014. This book will not explain every piece of legislation that impacted the 403(b) and 457(b) marketplace, but will focus on the legislation and published guidance

that have changed the face of the 403(b), 457(b) and related markets, as well as audit and ex-am activity by the Internal Revenue Service that affected this marketplace.

403(b) plans (tax-sheltered accounts, including both annuities and mutual funds with cus-todial arrangements) represent a sizeable market. The Spectrum Group estimated that over

$1,081 billion was invested in 403(b) accounts of the end of 2014, and other surveys predict substantial growth as the 403(b) eligible population grows. 403(b) markets have moved from obscurity, when only 501(c)(3) tax-exempt organizations were eligible to establish such pro-

grams, to a significant share of today’s financial marketplace.

The History of 403(b) - How We Arrived Where We Are Today

Legislation and related IRS guidance (or lack thereof) form the backbone of any historical perspective of the 403(b) plan marketplace. However, ongoing IRS audit activity has also had

a significant impact on the changing face of the 403(b) markets. Finally, the issuance of the 403(b) regulations by the IRS has had the most significant impact affecting every segment of the marketplace.

The following timeline illustrates the most important guidance or legislation affecting

403(b) plans and the marketplace.

▄ 1958 - Addition of Section 403(b) to the Internal Revenue Service Code Public Law 85-866 made elective deferral 403(b) programs available to section 501(c)(3) organizations. However, there was confusion about whether or not public education organ-izations were included as employers eligible to offer 403(b) programs to their employees. Despite this uncertainty, a number of public schools did set up 403(b) programs prior to 1961. As a result, there was concern about whether these programs would be considered to be qualified 403(b) programs for tax purposes.

▄ 1961- Addition of 403(b) for Public Education Institutions Public Law 87-370 specifically added public education institutions by direct reference, clearing up any uncertainty. The passage of this bill was the real “starting point” for the 403(b) market, as the public education segment has since become a very large segment of the 403(b) market.

▄ 1974 - Passage of Employee Retirement Income Security Act (ERISA) ERISA was aimed at providing federal standards and protections applicable to employee benefit plans, in general. Included in ERISA was the addition of paragraph 7 to section 403(b) of the Internal Revenue Code (the “Code”). Section 403(b)(7) specifically expand-ed available investment options from only annuities to include mutual funds held in a qual-ifying custodial arrangement with a bank or other approved financial institution.

▄ 1982 - Tax Equity & Fiscal Responsibility Act (TEFRA) TEFRA added paragraph 9 to section 403(b) of the Code permitting churches to establish Retirement Income Accounts. Such accounts can include investment options other than annuities and mutual funds, including stocks and bonds. The bill also permits loans from qualified plans (including 403(b) plans), citing the rules under which a loan can be made without the loan becoming a taxable distribution.

▄ 1986 - Tax Reform Act (TRA) The TRA included sweeping changes which brought 403(b) more in line with qualified

plans. These changes included a 10% penalty tax for pre-59½ withdrawals; restrictions on

The Source 3

withdrawals from 403(b) accounts, required minimum distributions, premature distribution

penalties and a new annual contribution limit of $9,500 for elective deferrals. Nondiscrim-

ination rules with delayed effective dates were also added. TRA included some grandfa-

thering protection against application of the withdrawal restrictions (December 31, 1988

annuity values remain unrestricted) and required minimum distribution requirements (De-

cember 31, 1986 contract values are covered under old rules). But the TRA marks the be-

ginning of the application of “retirement plan” requirements to 403(b) programs and the

403(b) marketplace was radically changed.

▄ 1990 – Issuance of Revenue Ruling 90-24 Prior to Rev. Rul. 90-24, changes to existing investments held in 403(b) annuities could

only be accomplished under section 1035 of the Code which required a literal exchange of

substantially similar 403(b) contracts. In response to concerns raised by the Securities and

Exchange Commission requirements on “transferability” of registered securities, Rev. Rul.

90-24 was issued to liberalize restrictions on tax-free investment changes under 403(b)

contracts. For the first time, partial transfers were allowed and 403(b)(7) mutual funds

could be “transferred” to 403(b) annuities (provided applicable withdrawal restrictions

were applicable to the entire transferred value). The impact of Rev. Rule 90-24 was modi-

fied by interim requirements in the final 403(b) regulations. Under this subsequent guid-

ance, transfers under Rev. Rul. 90-24 taking place on and after September 24, 2007 are re-

stricted only to product providers which are a part of an employer’s plan, and on January 1,

2009, the ruling is altogether replaced with transfer and exchange rules contained in those

regulations.

▄ 1996 - The Small Business Job Protection Act of 1996 (SBJPA) The SBJPA included significant changes that included permitting multiple salary reduction

agreements in a single tax year and a new definition of includible compensation under sec-

tion 415 that includes the value of elective deferrals and pre-tax contributions to section

125 and 457(b) plans as includible compensation when calculating limitations. The SBJPA

also made all 501(c) organizations (including 501(c)(3) charitable organizations) again eli-

gible to sponsor 401(k) plans and introduced SIMPLE 401(k) and SIMPLE IRA plans for

small employers. With the return of 401(k) plans to the nonprofit sector, section 501(c)(3)

employers had a choice of elective deferral programs and a need to understand the ad-

vantages and disadvantages of each available plan. Chapters 4 and 5 explore that issue.

▄ 1997 - The Tax Payer Relief Act of 1997 (TPA 97) The most significant element of this bill was the repeal of the section 403(b)(12)(A)(i)

nondiscrimination rules for 403(b) programs sponsored by public education employers (re-

lating to non-salary reduction 403(b) plans). Roth IRA was also included under TPA 97.

▄ 2001 - The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) This massive law included significant increases in contribution limits for all types of re-

tirement accounts, including 403(b) and 457(b) plans, the repeal of the maximum exclu-

sion allowance for 403(b) plans and the coordination of contributions to elective deferral

plans and 457(b) eligible deferred compensation plans. EGTRRA also included pension

portability, direct rollovers of eligible distributions between 401(a), 401(k), 403(b), tradi-

tional IRAs, and, for the first time ever, the rollover of governmental 457(b) plan distribu-

tions to any of the previously mentioned types of plans. The codification of post retirement

nonelective employer contributions to 403(b) plans was also included. Originally sched-

uled to sunset at the end of 2010, the changes were made permanent by the PPA.

▄ 2006 - The Pension Protections Act of 2006 (PPA) Key in the changes signed into law on August 17, 2006 is the repeal of the sunset date for

the retirement plan changes made in EGTRRA and in the permanency of the Saver’s Credit

for low-income taxpayers. Also significant in this legislation is the new right for non-

spouse beneficiaries to roll over the death benefit proceeds from 401(a), 401(k), 403(b) and

4 Chapter 1

governmental 457(b) plans into IRAs and to have such rollovers treated as inherited IRAs,

permitting beneficiaries to “stretch” their inherited account over their own life expectances.

▄ 2009 – The Final 403(b) Regulations (posted on July 27, 2007) These regulations have a general effective date of January 1, 2009, although there are dif-

ferent dates for certain provisions and later dates for certain church, governmental and col-

lectively bargained plans that meet the criteria for the delayed effective dates. The greatest

impact of these regulations is the shift toward employer responsibility for plan compliance,

specifically how employers will manage the new responsibilities created by the imposition

of a written plan requirement. It is anticipated that the application of the final regulations

will be the impetus for the most significant changes applicable to 403(b) plans because

they create a new culture where employers are responsible for the adoption and adherence

to the terms of a written plan, and bear the responsibility for all plan compliance transac-

tions. The real challenge for everyone involved in the 403(b) market will be to “fit” indi-

vidually owned annuity contracts and custodial accounts which have traditionally been

used to fund 403(b) accounts into a new “plan” environment. (See Section 1.6 Compliance

Trends for more information.)

▄ 2009 – Guidance Relevant to the Final Regulations Revenue Procedure 2007-71 Posted in November, 2007, Revenue Procedure 2007-71 included limited model plan lan-

guage for public education employers only, and, more importantly included guidance on

the status of 403(b) accounts in existence prior to the general effective date of January 1,

2009. That procedure is covered in Chapter 2. However, it is important to note that the

guidance identifying grandfathered vs. non-grandfathered accounts and transition relief for

non-grandfathered accounts created a number of questions for employers and providers.

While those questions were not addressed in additional written guidance, they have been

addressed in public statements made by IRS and Treasury officials. Chapter 2 focuses on

those issues.

Internal Revenue Service Notice 2009-3 Posted on December 11, 2008, the Notice responded to a number of comment letters filed

by various trade and industry organizations (including the National Tax Sheltered Accounts

Association) requesting an extension of the general effective date of the final regulations.

The gist of the comment letters was focused on the need for a delay in the general effective

date in light of the lack of a plan document approval program and the lack of current Inter-

nal Revenue Service correction procedures based on the content of the final regulations.

Unfortunately, the Notice simply provided limited relief noted below.

1) Employers are given an extension of the time to adopt written plans. Written plans

can be adopted as late as December 31, 2009. However, when adopted, the plan must

be made retroactively effective on January 1, 2009.

2) Throughout 2009, employers must operate their plans in conformance with a “rea-

sonable interpretation” of the requirements of the final regulations.

Any operational failures occurring in 2009 can be corrected using the general principles of

the correction procedures as set forth in Section 6 of Revenue Procedure 2013-12 covering

the Employee Plans Compliance Resolution System (EPCRS). The EPCRS updated cor-

rection procedures with the publication of Revenue Procedure 2013-12 to reflect elements

of the final 403(b) regulations.

Additionally, the Internal Revenue Service finalized its plan for approval of mass submit-

ter; prototype 403(b); and volume submitter 403(b) plan documents with the expectation that approved documents might become available in 2016. (The deadline for filing by

mass submitters was extended in Rev. Proc. 2014-28 to April, 2015.) As of this update,

The Source 5

we now are being told that the IRS approval of these plans will probably be in the first

quarter of 2017, at which time employers will receive their first RAP (remedial amend-

ment period) to restate their 403(b) plans. That period will probably be a 2 year period

with a stated deadline provided by the IRS.

The Department of Labor Fiduciary Guidance

In November, 2015, the Department of Labor finalized fiduciary regulations, which will ap-

ply fiduciary status to financial advisors who provide investment advice for a fee. The regu-

lations are effective in April, 2017, and will apply to 403(b) ERISA plans, and rollovers from

both ERISA and non-ERISA 403(b) plans to IRAs. As we go to press with the 6th edition, the

industry, after studying the regulations, is developing strategies to help their contracted agents

manage the new disclosure requirements. In addition, the NTSA, in cooperation with Morn-

ingstar, is developing a new fiduciary training study course which will result in the awarding

of a designation. The course will be made available to assist financial institutions with train-

ing their representatives to meet the requirements of the fiduciary regulations. Additional

information appears in the IRA rollover section and, again, in the ERISA chapter in The

Source.

Internal Revenue Service Audits, Correction and Compliance Programs

IRS Audits of 403(b) Plans The IRS began the audit process for 403(b) plans by issuing proposed examination guidelines

in April, 1995, followed by the training of an initial group of IRS field examiners in very ear-

ly 1996. Since that time, audits of 403(b) plans have been conducted on an ongoing basis with

the results of those audits widely shared by both 501(c)(3) and public education employers.

The audit program (specifically in the public education sector) also has been expanded to in-

clude the audit of 457(b) deferred compensation plans. The IRS plans to continue the 403(b)

and 457(b) audit program with new focus on whether employers have met the requirements of

the final regulations by adopting a written plan and operating in accordance with the terms of

the written plan. Chapter 8, which deals extensively with compliance requirements of both

public education and 501(c)(3) employers will offer important compliance tools, including

check lists and sample forms. The emphasis of the 403(b) audit program has changed through the years with focus cur-

rently on such issues as loans, hardship withdrawals, and the universal eligibility requirement

for 403(b) elective deferral plans. The universal availability requirement has been expanded

to measure whether the employer is providing meaningful opportunity for employees to par-

ticipate and make changes by requesting information on the employer’s educational pro-

grams. In public webcasts, the Service has said that the methods of providing meaningful

opportunity must be diverse, and require year-round activity. The expectation is that the fo-

cus will evolve to include the new responsibilities (e.g., has the employer adopted a written

plan and is the employer operating the plan in accordance with the terms). Hold Harmless and

Service Provider Agreements are being revised to require compliance coordination between

product vendors and, when applicable, third party plan administrators, for processing loans

and distributions, and satisfying the notice requirements for hardship withdrawals so that the

employer following safe harbor rules can suspend elective deferrals to all plans for a period of

6 months. Additionally, vendors are being asked to provide contribution calculations for em-

ployees using available catch-up options (for both 403(b) and 457(b) plans), notice of re-

quired minimum distributions, correction of excess deferrals, premature distribution monitor-

ing (as well as income tax reporting) and cooperation with employers’ efforts under any vol-

untary correction program.

6 Chapter 1

The IRS Correction Programs

Correction programs permit employers to avoid possible disqualification of their plans if the

IRS discovers violations that would cause disqualification. The correction procedures, origi-

nally available only for qualified plans, were first expanded to include 403(b) plans in 1999.

The most popular correction procedure for 403(b) plan operational violations is the Self-

Correction Program (SCP) under which no formal submission to the IRS is required, and no

fees are paid. The SCP does require that the employer have written compliance practices and

procedures in place: something that is required in any event under the final 403(b) regula-

tions. Additionally, Voluntary Correction Program (VCP) is available for more serious viola-

tions, such as eligibility failures or certain violations of the nondiscrimination rules, with

formal submission and the payment of fees. Audit Closing Agreement Program (CAP) per-

mits correction of certain plan defects under the principles of self-correction following a ne-

gotiated agreement at the close of an IRS audit.

Revenue procedures describing the correction processes for SCP and the submission pro-

cesses for VCP are issued periodically (the latest version posted in 2016 is Rev. Proc. 2016-

51), describing all of the requirements and definitions. The procedures describe correction pro-

grams for qualified plans, 403(b) plans, SIMPLE plans and SEPs. However, 457(b) plans are not

formally included although under the most recent guidance, governmental 457(b) plan sponsors

may apply correction procedure principals applicable to other plans to the extent those procedures

would be applicable.

Employers considering utilization of the Self Correction Program, or a formal submission under

the Voluntary Correction Program should obtain a copy of Revenue Procedure 2016-51 or applica-

ble successor revenue procedures when available.

Internal Revenue Service Compliance Projects

The Employee Plans Compliance Unit (EPCU) has and will likely continue to engage in spe-

cific compliance projects relating to 403(b) plans. Selected for a compliance “test” beginning

in 2006 and ending in 2008 were letters and questionnaires sent to a variety of public school

districts in all fifty states requesting that employers complete a questionnaire designed to de-

termine if the requirements of the universal availability requirement (covered in chapter 2)

have been met. Failure to respond (for example, by not completing and returning the ques-

tionnaire) would likely result in an IRS audit and those that received the questionnaire were

anxious to respond correctly and comply with the deadlines. Unfortunately, there was some

confusion in the marketplace which the IRS has addressed by revising the questionnaire to

more specifically focus on the universal eligibility requirements. But for the original recipi-

ents of the questionnaire that provided answers suggesting that the universal eligibility re-

quirement was not met, (for example, the plan excluded entire classes of employees such as

“substitute teachers” or “per diem employees”), the IRS sent a follow up letter suggesting a

correction mechanism to “fix” the violation. The correction mechanism required the employer

to make contributions to the 403(b) program under one of two calculations. The EPCU is fol-

lowing up with additional letters to employers that had identified a violation to determine

whether the suggested correction (the making of employer contributions for improperly ex-

cluded employees) has, in fact, been done.

The IRS also began sending letters and questionnaires to higher education institutions in

2010 to check for violations of both the universal availability requirement and the use of the

IRC §402(g)(7) increased limit for certain employees with 15 or more years of service with

the employer. There is also a likelihood that other projects will be undertaken to ask whether

employers have adopted a written plan and are conforming to the requirements of the final

403(b) regulations. Thus, employers are advised NOT to overlook the importance of compli-ance with final regulations and are reminded that failure to adopt and follow the terms of a

written plan is listed as a plan disqualification failure. Also a great resource is the EPCU in-

The Source 7

formation on the IRS website (https://www.irs.gov/retirement-plans/employee-plans-

compliance-unit-epcu?_ga=1.97874783.177483504.1388521496). The EPCU has listed cur-

rent projects; completed projects with summary reports; completed projects with summary

reports pending; and approved projects for the future. This is a great way to know what the

IRS is considering.

1.3 403(b) Product History

Product Evolution

Fixed Annuities

In the earliest days of 403(b), the only available product was the fixed annuity, which resem-

bled life insurance contracts, specifically retirement endowment type annuities. Despite the

fact that cash values under these types of annuities often did not exceed contributions for sev-

eral years, the ability to save