(b)lines Ask the Expert – Plan Termination or Moving to ERISA

Plan Termination

A plan adviser asks: “If a 403(b) Plan is terminated what happens to the individual participant’s contracts?  Does the value of those contracts become taxable to the participant at that time?”

The regulations simply provide that: “In order for a section 403(b) plan to be considered terminated, all accumulated benefits under the plan must be distributed to all participants and beneficiaries as soon as administratively practicable after termination of the plan. For this purpose, delivery of a fully paid individual insurance annuity contract is treated as a distribution.”  (See Treas. Reg. section 1.403(b)-10(a)(1).)  IRS national office representatives have informally seemed to interpret this as being akin to the distribution of annuity contracts in a defined benefit plan termination, where the distribution of a nontransferable annuity containing the relevant distribution restrictions is not the taxable event, but, rather, amounts are taxed upon subsequent distribution from the annuity. 

Note, too, that there are a couple of other issues involving distributions upon termination that the regulations do not address, such as whether a certificate under a group contract is treated the same as an individual contract for such distribution purposes (though IRS personnel have informally indicated so), and whether custodial accounts should be treated like annuities for this purpose (where the answer is less clear).  More IRS guidance is needed in this area.

A 403(b) plan sponsor asks: "Is there any advantage to just moving to an ERISA 403(b) plan versus maintaining non-ERISA status?"

In the past, a 403(b) plan being subject to ERISA was not that much of a downside; it would have to abide by the reporting and disclosure rules (such as providing a summary plan description (SPD)), but having to file a 5500 was not burdensome.  It also had to have a written plan document. 

The fiduciary, claims procedure and prohibited transaction rules are, generally, not that hard to follow when all investments have to be in 403(b) contracts or annuities.  Spousal consent and QJSA and QPSA rules would also apply, depending on the plan design, but many annuity contracts comply with those anyway. 

On the plus side, preemption of state laws under ERISA means that any claims against the plan had to be based on ERISA and be in federal court, which is often more favorable to the plan sponsor than state law causes of action, courts, and remedies would be.  The calculus has changed somewhat, however, in that ERISA 403(b) plans now have to file a more complete 5500 in the same manner as for 401(k) plans beginning with the 2009 plan year.  For large (generally, 100 or more participant) ERISA 403(b) plans, those plans will also have to be audited by an outside CPA firm.  Thus, an employer whose plan design has the option should weigh carefully the pros and cons of being subject to ERISA.

Keep in mind, too, that, while a governmental 403(b) plan will never be subject to ERISA, and a church plan must make an affirmative election to be subject to ERISA, the DoL safe harbor for salary reduction 403(b) plans with little employer involvement does not have bright line tests, and an employer can easily and inadvertently slip out of it, particularly as that employer tries to come into compliance with the IRS regulations by 2009.  Worst case would be to think you are not subject to ERISA and then find out that you have been.

-David Powell, Groom Law Group, Chartered

This feature is to provide general information only, does not constitute legal advice as part of an attorney-client relationship, and cannot be used or substituted for legal or tax advice.