Change in Rules for Contract Exchanges

“I have an active employee who does not qualify for a distributable event from the plan. He wishes to transfer his account balance out of our plan to another 403(b) contract that does not appear to be connected to any 403(b) plan of another plan sponsor; and, at any rate, even if it were, our plan does not permit plan-to-plan transfers.

“However, he was quite insistent that he was permitted to complete such a transfer under the law, and that he in fact, had completed an identical transfer a number of years ago. I am new to the church, so I cannot explain to him why he was able to complete such a transfer back then, but cannot do so now. Can the Experts assist? Thanks in advance!”

Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

The Experts can indeed assist, and, as is typically the case, we can turn to the regulatory guidance to address such an issue; in this case, the final 403(b) regulations issued by the IRS back in 2007. There is a section that specifically addresses this issue you are having, under the heading of Contract Exchanges:

“Rev. Rul. 73-124, 1973-1 C.B. 200, and Rev. Rul. 90-24, 1990-1 C.B. 97, dealt with contract exchanges. Rev. Rul. 73-124 had allowed section 403(b) contracts to be exchanged, without income inclusion, if, pursuant to an agreement with the employer, the employee cashed in the first contract and immediately transmitted the cash proceeds for contribution to the successor contract to which all subsequent employer contributions would be made. This ruling was replaced by Rev. Rul. 90-24 which does not provide for the first contract to be cashed in but allows section 403(b) contracts to be exchanged, without income inclusion, so long as the successor contract includes distribution restrictions that are the same or more stringent than the distribution restrictions in the contract that is being exchanged.”

Thus, for many years, there were relatively few restrictions on transfers between contracts, especially in plans that were not subject to the Employee Retirement Income Security Act (ERISA) such as your church plan (ERISA contains additional restrictions as to the movement of plan assets outside of a plan). At one time, a non-ERISA 403(b) plan participant could essentially choose his/her  own investment provider by simply transferring his/her 403(b) contract to a contract with that provider, though this was later modified by Rev. Rul. 90-24, which did restrict transfers to contracts where the distribution restrictions were the same or more stringent than the prior contract. Other than that, however, there were little In the way of restrictions, which likely explains how your plan participant was able to complete his transfer a “number of years ago” without incident.

However, the IRS began to realize that such transfers were problematic, as they further explain in the Contract Exchanges section of the final regulations:

“……..where assets have been transferred to an insurance carrier or mutual fund that has no subsequent connection to the plan or the employer, IRS audits and related investigations have revealed that employers encounter substantial difficulty in demonstrating compliance with hardship withdrawal and loan rules. These problems are particularly acute when an individual’s benefits are held by numerous carriers. Such multiple contract issuers are commonly associated with plans in which Rev. Rul. 90-24 exchanges have occurred.”

To solve the problem, the final regulations restricted contract exchanges to contracts within the plan, as follows:

“(b) Contract exchanges and plan-to-plan transfers—(1) Contract exchanges and transfers—(i) General rule. If the conditions in paragraph (b)(2) of this section are met (Experts Note: “(b)(2) of this section” defines Contract Exchanges), a section 403(b) contract held under a section 403(b) plan is permitted to be exchanged for another section 403(b) contract held under that section 403(b) plan.”

Thus, contract exchanges may only be made within a 403(b) plan. The regulations also permit plan-to-plan transfers, but, as you explained in your question, your plan does not allow for such transfers and, even if it did, the employee must be a current or former employee of the recipient plan sponsor in order for such a transfer to take place, which he was clearly not in the example you provided. (In fact, the experts would be surprised if the 403(b) vendor who is not part of the plan would actually take the transfer if requested.)

Thus, you can simply inform the participant that the law changed since he was permitted to complete his transfer so long ago, and now such transfers are not permitted. Or you can provide him a copy of this column if you wish!

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.